All You Need to Know About Bankruptcy Before You File
If you have debt piling up and are struggling to make ends meet, it’s easy to feel overwhelmed or anxious. After all, money is a critical part of most people’s lives, since it affords them the opportunity to provide food, shelter, and utilities for themselves as well as their family members.
Your ability to take out credit cards and loans that stretch your spending power beyond your actual means makes it easier than you’d think to create a precarious financial situation. The stakes get even higher when debt collectors start calling and threatening repossession.
With COVID-19 impacting millions of people’s jobs, it’s not unlikely that many Americans have been put in a stressful situation where it’s hard to make monthly payments to their creditors while also making ends meet.
As the pandemic continues into 2021, there’s some hope on the horizon thanks to a vaccine; however, that doesn’t change the fact that millions of people might be behind on their mortgages, car payments, student loans, credit card debt, medical bills, and personal loans. When you consider that the average Generation Millennial has $27,251 in non-mortgage debt and a mortgage of about $232,372, it’s easy to see how even losing one earner in a dual-income household can totally flip your life upside down.
If you really feel like you’re between a rock and a hard place, you may be considering bankruptcy as you weigh other options like debt consolidation. Growing up playing the board game Monopoly, you probably have negative connotations of the word bankruptcy — associating it with losing all your money, and, in turn, the game. However, that depiction isn’t exactly accurate.
There are two major types of personal bankruptcy, both of which could make sense in certain financial scenarios when you need a fresh start. Learn more about the pros and cons of filing for bankruptcy below.
Types of bankruptcy
Depending on your situation, you’ll likely be filing for Chapter 7 bankruptcy or Chapter 13 bankruptcy. While there are some corner cases where a different chapter (called this because of the corresponding section of bankruptcy code it refers to), most individuals find that they qualify for Chapter 7 or 13 bankruptcy more than any other type.
While both chapters offer debt relief, the means by which they provide that relief do differ, particularly in considering your personal property, secured debts, and unsecured debts.
Chapter 7 bankruptcy
With a Chapter 7 bankruptcy case, you’re specifically looking at liquidating your assets and personal property in order to pay off your debts. During the liquidation process, you’ll have your unsecured debts paid off first, followed by secured debts. Your property will be managed by a bankruptcy trustee who will auction off different belongings and assets in order to ensure that your creditors are receiving the amount they’re owed.
For example, if your car gets sold for $20,000, that money would be distributed across all debt collectors in order to cover your debt responsibilities. Any non-exempt property or assets you have will be tapped to cover these debts during liquidation.
Generally speaking, you’ll be able to keep any assets that are essential to living, which should include your home; however, whether or not your property is exempt or non-exempt varies from state to state. So-called exemptions ensure that you aren’t left with just the shirt on your back when all of the dust settles.
Even so, it is possible to lose your home in a Chapter 7 bankruptcy. This is why some people choose to file a Chapter 13 bankruptcy instead because it can eliminate any foreclosure proceedings and protect their home.
Prior to filing Chapter 7 bankruptcy, you’ll need to speak with a credit counselor. A credit counseling agency will offer you credit counseling services to help you rule out other options you may not have considered yet and get to the bottom of the poor financial decisions that have led you to this point.
Once you’ve received credit counseling, you can complete the necessary bankruptcy forms to begin the bankruptcy process—including your bankruptcy petition which lets local and federal courts know that you intend on taking your case to the bankruptcy court.
In order to avoid the abuse of Chapter 7 bankruptcy, you’ll need to be able to pass the means test first.
The means test is very simple to calculate: your monthly income - your monthly expenses from over the 6 month period of time prior to your bankruptcy paperwork being filed.
This gives you a number that constitutes your disposable income, or the extra money you could put to work paying down your debts but aren’t currently using in that way. Especially since Chapter 7 bankruptcy could potentially allow individuals to avoid foreclosure and still keep their home, the means test ensures that filing for bankruptcy isn’t ever used as a loophole for homeowners who are delinquent on their mortgage payments.
Chapter 13 bankruptcy
With Chapter 13 bankruptcy cases, you’re effectively agreeing to a repayment plan managed by a bankruptcy trustee at the direction of the court. Chapter 13 bankruptcy doesn’t require a means test, and rather than liquidating your assets to pay outstanding debts, reorganization of your finances helps to ensure your debts are repaid.
In this scenario, you and your bankruptcy lawyer will submit a plan to the bankruptcy courts and you’ll agree to pay a set amount of money to a trustee each month for 3 to 5 years that the trustee can use to pay down your debts.
One benefit of a Chapter 13 bankruptcy is that you may be able to reduce the interest rates on your existing debts since interest rates are lowered to the presumptive interest rate in a bankruptcy case.
You also can stop a foreclosure proceeding by filing for Chapter 13 bankruptcy, although a Chapter 13 bankruptcy provides much less of a fresh start than a Chapter 7 bankruptcy.
Pros and cons of filing bankruptcy
While there are certainly benefits of filing for bankruptcy, there are just as many drawbacks to consider, too. Determining whether or not you should file for bankruptcy isn’t a decision that should be taken lightly, so it’s a good idea to weigh the following pros and cons before you make your decision:
Benefits of filing bankruptcy
A major benefit of filing for chapter 7 or chapter 13 bankruptcy is receiving something called an automatic stay or bankruptcy discharge.
An automatic stay or discharge can be one of the most immediate benefits when you file bankruptcy since it prevents lenders and debt collectors from contacting you to try and collect on debts you may owe them. This can be a huge relief if you’ve been dealing with stress and harassment from debt collectors.
If you’ve just lost a major portion of your income or have fallen behind on your mortgage significantly, filing for bankruptcy may also be advisable since it could help you avoid foreclosure, too.
Drawbacks of filing bankruptcy
Obviously, losing a portion of your property or investment assets to a bankruptcy proceeding can really hurt your future financial prospects.
A bankruptcy can also negatively impact your credit score for many years, staying on your credit report for anywhere from 7 to 10 years. Since you need to meet certain income requirements in order to be eligible to file for bankruptcy, it’s also worth remembering that bankruptcy isn’t a one-size-fits-all solution for everyone struggling to stay on top of their debts.
Talk to an attorney
Due to the complexity of the bankruptcy code and the huge impact it can have on your life, it’s inadvisable to try filing bankruptcy without a lawyer.
A bankruptcy attorney will know the ins and outs of the process, offering you legal advice about whether it’s financially advisable to file for bankruptcy in the first place. From managing the meeting of creditors where your debts are checked for accuracy against your trustee’s paperwork.
Since bankruptcy is such a monumental decision to make, it’s definitely worth the attorney fees and filing fee to work with an experienced professional during your bankruptcy case.
The bottom line
Filing for bankruptcy is a serious and drastic financial step to take, and attention should be paid to this weightiness. Make sure that you’ve thoroughly exhausted your other options prior to considering bankruptcy.
If you still feel like bankruptcy is something worth pursuing based on your financial situation, reach out to an attorney and discuss your situation with them. Having some knowledge of Chapter 7 and Chapter 13 bankruptcy ahead of time will ultimately make these conversations with your lawyer more productive and ensure you’re on the right path.
With the right information and a team of trusted professionals on your side, you’ll be able to make the correct decision for your unique financial situation and get the relief you need.