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On average, 1.4 million people claim bankruptcy every year. Declaring bankruptcy is a fact of life for many Americans. In fact, an increasing number of bankruptcy filers are well-educated, middle-class baby boomers with an overwhelming level of credit card debt. However, bankruptcy is not limited to this class. It can become an option for anyone who has reached a point where they can no longer support the debts they have incurred.
What is bankruptcy? Who is it for?
Bankruptcy is a legal process that allows individuals or businesses the opportunity to discharge or reorganize some, or all, of their debts. Discharging (i.e., freeing yourself from) your debts is another way of saying you no longer owe your creditors anything. Bankruptcy provides for the development of a plan that allows a debtor (person owing money), who is unable to pay his creditors, to resolve his debts through the division of his assets among his creditors. Another purpose of bankruptcy is to allow certain debtors to free themselves (to be discharged) of the financial obligations they have accumulated, after their assets are distributed, even if their debts have not been paid in full. Bankruptcy is for anyone who cannot pay back all his or her debts.
Types of Bankruptcy
You have two choices in declaring personal bankruptcy: Chapter 7 (a straight bankruptcy) and Chapter 13 (a wage earner plan) bankruptcy. Both choices are undesirable, and neither should be considered an easy way out.
Chapter 7 Bankruptcy
Chapter 7 is a liquidation form of bankruptcy. In a Chapter 7 bankruptcy, a debtor is required to draw up a petition listing his or her assets and liabilities. The debtor submits the petition to a U.S. district court and pays a filing fee. As mentioned previously, Chapter 7 is a straight bankruptcy in which many, but not all, debts are forgiven. Most of the debtor's assets are sold to pay off creditors. However, certain assets of the debtor are protected to some extent. For example, Social Security payments, unemployment compensation, and limited values of your equity in a home, car, or truck; household goods and appliances; trade tools; books; and so forth are protected.
The discharge of debts in Chapter 7 does not affect alimony, child support, certain taxes, fines, certain debts arising from educational loans, or debts that you fail to properly disclose to the bankruptcy court. At the request of a creditor, the bankruptcy judge may also exclude from the discharge debts resulting from loans you received by giving the lender a false financial statement. Furthermore, debts arising from fraud, embezzlement, driving while intoxicated, larceny, or certain other willful or malicious acts may also be excluded.
How do you file for Chapter 7 bankruptcy?
First, you must fill out a number of forms and applications listing your income, the amounts and kinds of your debts, and what assets you possess - house, land, car - above and beyond your debts. You must provide complete financial information in a petition for Chapter 7. If you forget a debt, or leave one out, it may not be erased. Even worse, if you fail to list all of your assets you could later be liable for fraud.
The filing of your petition for bankruptcy automatically stays, or stops, your creditors from garnishing your wages, emptying your checking or savings account, pursuing you, or attempting to sue you for nonpayment.
Not all debts are considered the same in bankruptcy court. In fact, by law, debts are divided into two categories: dischargeable and non-dischargeable. A court will determine how the law applies to your debts.
After the bankruptcy proceeding, you will not have to pay what is known as dischargeable debt. The most common kinds of dischargeable debt in Chapter 7 include back rent you owe a landlord; outstanding utility bills, including gas, electricity, and phone; some court judgments against you (but not child and/or spousal support, which cannot be discharged); credit card, charge card, department store card, and gasoline card bills; documented loans from your friends or family; any outstanding legal or medical bills; and most, if not all, unsecured loans (unsecured means debts that have no collateral attached to them).
You are responsible for what's called non-dischargeable debt, including any loan that was issued, funded, guaranteed, or insured by a government entity or a nonprofit corporation (such as taxes, government fines, all student loans, and FHA loans).
Chapter 13 Bankruptcy
In a Chapter 13 bankruptcy, a debtor with a regular income proposes to a bankruptcy court a plan for extinguishing his or her debts from future earnings or other property over a period of time. In such a bankruptcy, the debtor normally keeps all or most of the property.
During the period the plan is in effect, which can be as long as five years, the debtor makes regular payments to a Chapter 13 trustee. The trustee, in turn, distributes the money to the creditors. Under certain circumstances, the bankruptcy court may approve a plan permitting the debtor to keep all property even though the debtor repays less than the full amount of the debts. Certain debts not dischargeable under Chapter 7, such as those based on fraud, may be discharged in Chapter 13 if the debtor successfully completes the plan.
How do you file for Chapter 13 bankruptcy?
You will fill out the same papers as a Chapter 7 filing, pay a filing fee, and get a court-appointed trustee. But, in addition, you have to submit to the court a plan for the repayment of your unsecured debts, including credit card debt. The court will either accept or reject this plan. In the case of secured debts, you agree to pay back, at the minimum, the amount of the claim that the creditor is willing to accept, or else you agree to surrender the collateral.
Advantages of Chapter 7 Bankruptcy
From start to finish, from the date you file to the date your debts are discharged, Chapter 7 is faster to complete than Chapter 13. Also, this form of bankruptcy gives people a "fresh start". In a Chapter 7 bankruptcy, the amount of dischargeable, unsecured debt, such as credit card debt, you can erase from your life is unlimited, provided all assets and debts were declared and there is no suspicion of fraud in your filing.
Disadvantages of Chapter 7 Bankruptcy
The disadvantages of Chapter 7 bankruptcy are numerous. First, you must give up your nonexempt property - a second home, or second car - hand it over to the court, and allow it to be sold. Even after you file under Chapter 7, some of your debts may survive (those deemed secured and non-dischargeable, such as a car loan, and those that a creditor feels were incurred with the intention to defraud the creditor), and with respect to those debts you can still be approached by collection agencies. Once you have filed for Chapter 7, it is very difficult to reverse the process.
Advantages of Chapter 13 Bankruptcy
The main advantage of Chapter 13 is that you get to keep all your property, whether it is exempt or nonexempt. Your creditors can't garnish your wages or send collectors after you, and you are protected against foreclosure. In Chapter 13, you are allowed to separate your debts by class. Different classes of creditors are due different percentages of payment. You also have a lot longer to pay back your debts than you do under Chapter 7.
Disadvantages of Chapter 13 Bankruptcy
Your total debt, secured and unsecured, has to be under $1,077,000 (less than $807,750 of secured debt and $269,250 of unsecured debt). You pay back your debts out of your own income, which can tie up your income for a long time. If debts survive after your bankruptcy is closed, you have to keep on paying back on those debts. You could find yourself in this situation for many years, which could have a serious effect on your future income.
Chapter 13 vs. Chapter 7 Bankruptcy - Which One is Right for You?
The answer to this depends on your financial situation. Each form of Bankruptcy, Chapter 7 and Chapter 13, has its pros and cons. If you have really serious financial problems, no doubt you will prefer a straight Chapter 7 proceeding, if you're able to obtain one.
Should a Lawyer Represent You in a Bankruptcy Case?
You have the right to file your own bankruptcy case and to represent yourself at all court hearings. In any bankruptcy case, however, you must complete and file with a bankruptcy court several detailed forms concerning your property, debts, and financial condition. Many people find it easier to complete these forms with the assistance of experienced bankruptcy counsel. In addition, you may discover that your case will develop complications, especially if you own a substantial amount of property or your creditors object to the discharge of your debts. Then you will require the advice and assistance of a lawyer.
Choosing a bankruptcy lawyer may be difficult. Some of the least reputable lawyers make easy money by handling hundreds of bankruptcy cases without adequately considering individual needs. Recommendations from those you know and trust and from employee assistance programs are most useful.
What are the Costs?
The monetary costs to the debtor associated with bankruptcy include the following:
- Court costs (Chapter 7 and 13): The debtor must pay a filing fee to the clerk of the court at the time of filing his or her petition. The filing fee may be paid in up to four installments if the court grants authorization.
- Attorneys' fees (Chapter 7 and 13): These fees are usually the largest single item of cost. Often the attorney does not require them to be paid in advance at the time of filing but agrees to be paid in installments after receipt of a down payment.
- Trustees' fees and costs (Chapter 13): The trustees' fees are established by the bankruptcy judge in most districts and by a U.S. trustee in certain other districts.
Although it is possible to reduce these costs by purchasing the legal forms in a local stationery store and completing them yourself, an attorney is strongly recommended.
Chapter 13 and Chapter 7 bankruptcies must be filed in federal bankruptcy court. The current filing fees for an individual filing are approximately $185 for Chapter 13 and $200 for Chapter 7 bankruptcy. For a couple filing jointly, the fee can range from $500 to $1,500. Attorney fees are additional, of course, and can vary widely - as they tend to operate either on an hourly figure, although some will work for a flat fee. This expense could range from $100 and up.
There are also intangible costs to bankruptcy. For example, obtaining credit in the future may be difficult, since bankruptcy reports are retained in credit bureaus for 10 years. Therefore, you should take the extreme step of declaring personal bankruptcy only when no other options for solving your financial problems exist.
How often can you file for bankruptcy?
A person may have a high net worth but still run into financial difficulties. Having many assets with low liquidity means not having the cash available to pay current expenses. Insolvency is the inability to pay debts when they are due, and it occurs when a person's liabilities far exceed available assets. Bankruptcy, as we have discussed, may be an alternative for a person in this condition. Legally, you can file for Chapter 7 bankruptcy once every six years. Most Chapter 13 plans have three to five-year payouts, so while technically you can file Chapter 13 as often as needed, it is unlikely you will be filing more often than the term of your payment schedule.
There are ways to increase your net worth, in an effort to avoid bankruptcy. Those include: increasing your savings, reducing spending, increasing the value of investments and other possessions, and reducing the amounts you owe.
Effect of Bankruptcy on Your Job and Your Future Credit & Will I Ever Get Credit Again?
Different people have different experiences in obtaining credit after they file bankruptcy. Some find obtaining credit more difficult. Others find obtaining credit easier because they have relieved themselves of their prior debts or because creditors know they cannot file another bankruptcy case for a period of time. Obtaining credit may be easier for people who file a Chapter 13 bankruptcy and repay some of their debts than for people who file a Chapter 7 bankruptcy and make no effort to repay. The bankruptcy law prohibits your employer from discharging you simply because you have filed a bankruptcy case.
Chances are you will be able to re-establish your credit. One of the ways to do so is via secured credit cards. A number of banks now offer "secured" credit cards whereby a debtor puts up a specific amount of money (as little as $200) in an account at the bank issuing the card to guarantee payment. Usually, the credit limit is equal to the security.
Two years after discharge of debts, debtors are eligible for mortgage loans on terms sometimes as good as those of others, with the same financial profile, who have not filed bankruptcy. Of course, the size of your down payment and the stability of your income will have much more of an impact that the fact you filed for bankruptcy in the past.
The fact that you filed for bankruptcy does stay on your credit report for seven to ten years after the fact. In addition, filing for bankruptcy does have serious, long-term emotional as well as financial consequences. It is not referred to as the "ten-year mistake" for no reason.
