Bankruptcy 101 – A Complete Guide and What to Expect
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When debts become unmanageable, and you feel like there is no way out, you could think of bankruptcy as the next logical step. Nobody is happy to leave their financial fate to the courts, but bankruptcy is the only solution when the situation becomes too hard to handle. This guide takes you through the process and the pros and cons of bankruptcy.
In this article
What is bankruptcy?
If you want to file for bankruptcy, you need to understand what it is and how it works. Bankruptcy is the formal legal process that helps absolve you of some of the debts or helps reorganize the debts so that they can be paid off. It is governed by a law known as the Bankruptcy Code. There are several types of bankruptcy that lead to different outcomes, while many are geared toward different types of customers.
Some consumers prefer working with an attorney when they file bankruptcy, but it is possible to file on your own. It is a process that begins with the debtor filing a bankruptcy petition for bankruptcy with the court. Businesses have a different process for filing for bankruptcy.
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Types of Bankruptcy
There are different bankruptcy types for consumers and businesses, each of which will make sense based on the consumer's financial situation.
- Chapter 7 bankruptcy. In Chapter 7 bankruptcy, your property is sold, and all the proceeds are used to pay off the debt. It is pursued by consumers who do not have the money to repay their debts.
- Chapter 9 bankruptcy. Chapter 9 bankruptcy provides financially distressed municipality protection from creditors as it develops and negotiates a plan to adjust the debts.
- Chapter 11 bankruptcy. Most corporations file for Chapter 11 bankruptcy, also known as reorganization bankruptcy, since it involves reorganizing the business affairs, assets, and debts.
- Chapter 13 bankruptcy. Chapter 13 bankruptcy is slightly different from Chapter 7. It is a process where some of the unsecured debts are forgiven while the remaining debt is reorganized so that it can be repaid over a certain period of time. It is often pursued by consumers who earn enough to repay their debts but need help to make a fresh start.
How does bankruptcy work?
A bankruptcy process will depend on the type of bankruptcy you choose to file. For individuals, it is either Chapter 7 or Chapter 13. If you opt for Chapter 7 bankruptcy, a trustee will be appointed to handle the property and assess it for resale. Your property will be valued and sold to raise the creditors' money. You will also be able to keep the important personal items and sometimes even real estate since the rules of Chapter 7 bankruptcy will change depending on where you live.
On the other hand, you keep the property whenever you file for Chapter 13 bankruptcy, but you need to have regular income and agree to repay the debts based on the installments approved by the courts. You will have a trustee working with you to collect the payments, and they will use this amount to repay the creditors as per the payment plan.
However, it is important to keep in mind that bankruptcy will not discharge all the debts. If there are tax debts, they cannot be discharged. You also cannot discharge a few types of student loans, alimony, child support payments, criminal restitution, court fines, or the amount you owe due to personal injury caused when driving under the influence.
Why should you file for bankruptcy?
Bankruptcy is undoubtedly the last resort, mainly due to the lasting impact on your finances. Whenever you file for bankruptcy, it will cause your credit score to drop and immediately make it hard for you to purchase a car, or home or even qualify for other loans. It could also have an impact on insurance rates. But when there is no other choice, you must file for bankruptcy to escape the financial crisis. It is a drastic move and a permanent decision that comes with many downsides but it helps discharge debts throughout the process. This is why it is also seen as a godsend for the ones struggling financially.
When to consider bankruptcy:
- When the debt is so much that you cannot pay it off in your lifetime.
- You have been sued for a large amount of money you cannot repay.
- A recent business loss has made it hard to repay debts.
- The financial situation is grim, and you need external help.
- Creditors or collection agencies are calling you constantly.
Related: Pros and Cons of Filing for Bankruptcy
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How to file Chapter 7
Your bankruptcy proceedings will begin when you file the petition for bankruptcy with a court. Once you have filed for liquidation, this petition will start to operate as an immediate automatic stay and will prevent the creditors from taking any debt collection actions unless it is approved by the bankruptcy judge first. The stay will be in effect as soon as you file the petition, and no approval is required.
Once you file for bankruptcy, all the debts should be listed first. They are known as prepetition liabilities. After this filing, a U.S. trustee from the judicial district will appoint another trustee to go through the financial affairs and manage the case. There will be a meeting of creditors where the trustee and creditors will ask questions about your financial situation, which will be presided over by the trustee.
This trustee will have the power of asset liquidation. They can liquidate the assets you own, which are not exempted by bankruptcy law from collection or are not subject to a lien. As per Bankruptcy Code, your debts will be divided into secured or unsecured. All the unsecured debts will be those not secured by a lien, most commonly credit card debt.
When the court finally issues the bankruptcy discharge, you will be relieved from the liability for the unsecured debts. Now, the secured debts remain and they are those that are secured by lien like a mortgage, and a discharge will not provide relief to you from the liability to pay the secured debts. If you do not make the payments on time, creditors can take the property.
Related: What Types of Debt are Discharged in Bankruptcy
Eligibility to file for Chapter 7 bankruptcy
If you want to file a Chapter 7 bankruptcy case, you must receive credit counseling from an approved agency within 180 days before filing. Once you file, you will have to provide a certificate from the agency stating the services you received with a copy of the debt repayment plan to the court.
Once done, you will also have to complete an instructional course on personal financial management to receive a discharge. Before filing for bankruptcy, it is essential to pass a means test to determine eligibility by comparing disposable income with living expenses.
Which debts will not be discharged in Chapter 7?
In a discharge, you will be relieved of most of the debt, but not all debts will be fully discharged under Chapter 7. There are several nondischargeable debts, including child support obligations, alimony, fines, and certain taxes, debts for personal injury or death caused due to the debtor’s use of a vehicle under an intoxicated state, certain education loans, or those debts that you did not disclose to the court at the time of filing the petition. The debts can also be exempted from discharge if the creditor requests the court to declare them non-dischargeable.
How to file a Chapter 13 case
Whenever you decide to file Chapter 13 bankruptcy, there will be no asset liquidation to pay the creditors, but you will have a repayment plan to pay all or a part of the debt over time. This means you will be able to keep the majority of the property you own. Once a petition is filed with a bankruptcy court, it will automatically put a stay on the debt collection activities against you. A repayment plan should be filed with the petition or within 14 days of filing the case.
While the plan is ready, you need to make consistent payments to the trustee assigned to your case. He will then distribute the amount to the creditors. The commitment tenure for payment under this Chapter is usually three years.
The repayment plan should pay the unsecured creditors at least the amount they would receive if the nonexempt assets were liquidated as per Chapter 7. The payment plans for all the unsecured debts should be the same as the disposable income so there is no chance of retaining cash reserves every month.
Eligibility for Chapter 13
To file for Chapter 13 bankruptcy, you must have a source of income and meet the debt limitations on the secured and unsecured debts. Individuals, spouses, and sole proprietors can file for Chapter 13. A self-employed individual or one operating an unincorporated business is eligible for chapter 13.
Individuals with secured and unsecured debts up to $2.75 million can only file for relief under Chapter 13 of the Bankruptcy Code. You will also have to receive credit counseling from an approved agency within 180 days of filing. That said, some state median income requirements will decide the plan's duration.
Which debts are not discharged in Chapter 13?
Certain debts are not discharged in Chapter 13 and these include the debts for child support or alimony, home mortgage, taxes, debts caused by a personal injury or death caused by driving under the influence of drugs, debts for a criminal fine or restitution and debts for guaranteed educational loans or government-funded loans.
Related: What Happens to a Car in Bankruptcy?
Impact of bankruptcy on your credit score
A bankruptcy on the credit report will hurt the credit score. It will become difficult to get credit or loans in the future; even if you do, the rates will be higher. The duration for which bankruptcy stays on the credit report depends on the type of bankruptcy. A Chapter 7 bankruptcy will remain for 10 years, and a Chapter 13 will last for seven years. It is important to remember that its impact on the credit score will reduce with time.
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How much does it cost to file bankruptcy?
The cost of filing for bankruptcy can vary depending on several factors, including the type of bankruptcy you're filing, the complexity of your case, and the location where you file. Here are some general guidelines regarding the costs involved:
- Court filing fees. When you file for bankruptcy, you must pay filing fees to the bankruptcy court. These fees are approximately $335 for Chapter 7 bankruptcy and $310 for Chapter 13 bankruptcy.
- Attorney fees. Hiring a bankruptcy attorney is highly recommended to guide you through the bankruptcy process and ensure your rights and interests are protected. Attorney fees can vary significantly depending on your location, the complexity of your case, and the attorney's experience and reputation. Generally, attorneys charge a flat fee for Chapter 7 bankruptcy, while Chapter 13 cases often involve a combination of upfront and ongoing fees, as they require more ongoing representation. Hiring an attorney can range from a few hundred to several thousand dollars.
- Credit counseling and debtor education courses. Before and after filing for bankruptcy, you are required to complete credit counseling and debtor education courses from an approved agency. The fees for these courses can vary but are typically around $50 to $100 for each course.
It's important to note that the information provided above is a general overview, and the actual costs can vary based on individual circumstances. Additionally, bankruptcy laws and fees can change over time, so it's always advisable to consult with a bankruptcy attorney or research the current fees in your jurisdiction for accurate and up-to-date information.
Pros and cons of bankruptcy
Pros
- Puts an end to the foreclosure: Whenever you file for Chapter 13 bankruptcy, it will keep your home safe. You can stop the foreclosure proceeding and cure the delinquent mortgage payments, but you will have to pay an amount equal to the value of the nonexempt assets to the unsecured creditors.
- Debts are discharged: A major reason why people file for Chapter 7 bankruptcy is that it helps discharge the unsecured debts.
- Stops the collection efforts: When you file for bankruptcy, it will trigger an automatic stay and stop all the collection efforts. The creditors will no longer keep calling or threatening you with wage garnishment. It will also protect the third parties liable with the filer on consumer debts.
- Fresh start: Bankruptcy can give you a fresh start with your finances. Once the unsecured debts have been discharged, you can start to make better financial decisions.
Cons
- Impact on credit score: Chapter 13 bankruptcy stays on your credit report for 7 years and Chapter 7 filing can remain on the credit report for 10 years.
- Cost: It is not cheap to file a bankruptcy. The filing fee costs upward of $300, excluding the fees a lawyer will charge.
- Tenure: It can also take three to five years for the bankruptcy to complete.
- All debts are not discharged: In Chapter 7 filing, all your debts will not be discharged. You will have to continue to pay certain taxes, child support, or alimony.
Bankruptcy alternatives
Bankruptcy is only viable when it is the last resort, and you cannot pay off the debt through any other means. This is also why the credit penalty is so severe that you try your best to avoid bankruptcy. Here are a few alternatives to bankruptcy.
- Balance transfer card: You can find many lenders offering a balance transfer card that has a 0% APR for a certain time. It is a good option if you are looking to handle credit card debt.
- Debt consolidation loan: A debt consolidation loan is a good option if you want to clear all your debts. It will be one loan and one payment instead of multiple debts.
- Debt settlement: If you can engage with a debt settlement company, they will help negotiate with the creditors on behalf of you to repay a part of what you owe instead of the complete amount. However, you will have to pay a charge for their services.
- Debt management plans: Work with a nonprofit credit counseling agency to develop a debt management plan once you consider your income, debts, and expenses.
FAQs
What property can I keep if I file for bankruptcy?
Everyone who files for bankruptcy can keep a property that qualifies for exemption per law. There is no limit to the value of the personal property you can keep regarding family pictures, IRAs, life insurance, qualified retirement plans, worker compensation benefits, and family photos. This is known as exempt property. In all the other cases, the equity you can claim as exempt will be limited by a fixed dollar amount.
What if the property I own is subject to a lien?
If a lien secures a property, you can enter into reaffirmation agreements with the secured creditors. As per the agreement, you promise in writing to continue to pay the amount owed to the creditor despite the bankruptcy, and the creditor agrees not to seize the secured property as long as you continue to make the payments. The reaffirmation agreement should be filed with the bankruptcy court, and if you default on the payments under the agreement, the creditor will hold you liable for the deficiency.
When should you file a Chapter 13 bankruptcy instead of Chapter 7?
There are some advantages to filing a Chapter 13 case over a Chapter 7 case. If you have more equity in the home, then it can be protected by the exemption for real estate under Chapter 7. Further, Chapter 13 bankruptcy will automatically stay a foreclosure proceeding and will give you a chance to incorporate the plan that helps you keep your home. It also has an automatic stay provision that prevents collection against all the co-debtors for consumer debt. If you complete the payments under the Chapter 13 plan, the nonexempt assets will remain protected and not be turned over to creditors.
Can I file the bankruptcy case myself?
It is possible to represent yourself if you want to, but you do so at risk. A bankruptcy case should be handled and filed properly, and you should comply with all the rules. This is why it is recommended to work with a lawyer for your case. They can handle and submit all the detailed forms, which are tedious to do yourself.
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The bottom line
Bankruptcy is not your only option; consider all the alternatives and then make a decision.
Whether you choose to file Chapter 7 bankruptcy or Chapter 13 bankruptcy, you must be aware of the general information required and understand the bankruptcy basis so that you are in the right place to negotiate. You also must contact a credit counselor for legal advice and proceed with the filing.
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Editor
Vandita Jadeja is a financial writer and editor at Joywallet. She loves to read and write about money and brings a decade of experience from the financial industry.
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