Bankruptcy is a scary word. But it could offer the financial solace you need when a financial situation has become too overwhelming to bear. Keep reading to learn exactly what it is and how it may not be as terrifying as you think.
What is bankruptcy and how does it work?
Bankruptcy is the legal process that happens when someone or a business cannot repay their outstanding debts.
It’s overseen by federal bankruptcy courts and is there to help people and businesses eliminate their debt partially or completely, or sometimes help them pay part of what they owe. This is a very complex task to undergo and shouldn’t be done without legal help!
First, you’ll need to meet the requirements to file for bankruptcy, such as showing you can’t repay your debts and also that you’ve completed financial counseling with a government-approved credit counselor. The process starts when the debtor files a petition and their debts are measured and evaluated. Then, depending on which type of bankruptcy you are filing for, the rest of the process will have its own specifications. The goal is to give you a financial fresh start, but it will stay on your credit report for many years and could make borrowing money in the future very difficult.
Types of bankruptcy
There are several different types of bankruptcy all known as chapters. They all vary in filing costs, complexities, and more.
- Chapter 7 Bankruptcy, or Liquidation, is the most common form of bankruptcy chapter. This process does not include a repayment plan, instead, the debtor’s nonexempt assets are collected and sold to pay back the creditors. Nonexempt assets include family heirlooms, second homes, cash, and stocks or bonds. This option is applicable for people who don’t have regular income or who don’t want to use Chapter 13’s plan, which we’ll get to next.
- Chapter 13 Bankruptcy, or a Wage Earner’s Plan, allows individuals with regular income to create a plan to repay all of their debts. This is the second most common chapter and typically takes debtor’s three to five years.
- Chapter 11 Bankruptcy, or Reorganization Bankruptcy, is for businesses who wish to remain open during the bankruptcy process and become profitable once again. This chapter creates new ways to increase revenue and cut costs while under court supervision. For example, a business would raise their service rates or offer more services to become profitable.
- Chapter 9 Bankruptcy is for municipalities and political subdivisions, such as hospitals, airports, and school districts, who are in financial distress. These institutions do not have to liquidate their assets or close, but must create a plan for repaying them over a period of time.
- Chapter 12 Bankruptcy is available to provide relief for family farmers and fisherman. It enables them to carry out their business while coming up with a debt repayment plan.
- Chapter 15 Bankruptcy is for when the filings involve people from multiple countries. It is typically filed in the debtor’s home country.
Who Qualifies for Bankruptcy?
Whether or not you meet the requirements to file for bankruptcy is a good way to determine if it’s a good option. The most common types of bankruptcy for an individual are Chapter 7 and Chapter 13.
To qualify for Chapter 7 bankruptcy you must:
- Have a monthly income that’s lower than the median income for the same sized household in your state
- (if the above is false) Pass a means test to decide if you have enough money to make payments to your creditors
- Not have filed for Chapter 7 bankruptcy in the past eight years
- Not have filed for Chapter 13 bankruptcy in the past six years
- Complete a credit counseling course.
To qualify for Chapter 13 bankruptcy you must:
- Have a sufficient income to make debt payments
- Your unsecured debt must be <$419,275
- Your secured debt must be <$1,257,850
- Have filed federal and state income tax returns for the past 4 years
- Complete a credit counseling course.
When is bankruptcy a good option?
Oftentimes the word “bankruptcy” rings huge alarm bells in our brains. But, if you’re unable to repay your debts and provide necessities like food and shelter for you and your family, it may be your best option. And it isn’t the end of the world. Filing for bankruptcy means an end to collection calls, wage garnishments, potential lawsuits, and the best thing–debt!
The downside of filing for bankruptcy
Declaring bankruptcy is a scary move for many people. Yes, it can help you relieve your debts, but it has a very bad reputation–and possibly for good reason. The biggest being the fact that it lowers your credit score, making it more difficult to get a credit card, loan, mortgage, rent an apartment, or buy a business in the future. (Take a deep breath here, that was a long list!) And a Chapter 7 bankruptcy will stay public record for 10 years after you file. On the other hand, most debtor’s already have poor credit scores from late and missed payments.
Alternatives to bankruptcy
Bankruptcy is just one possible solution when it comes to unmanageable debt. These are some alternatives to consider. Keep in mind, most will still affect your credit score, but maybe not as much as bankruptcy.
- Ask for help. The government offers approved credit counseling or debt management plans that can work with your creditors so you can pay back what you owe.
- Opt for a debt consolidation loan. This is the process of taking out a new loan to pay off your current debts. They typically offer better terms such as lower interest rates and monthly payment options.
- Talk to your creditors. They don’t want you to not repay your debts either, so communicate with them to see if they’re willing to renegotiate a repayment plan you can actually manage.
How to file bankruptcy
All bankruptcy cases go through the federal court system as outlined in the U.S. Bankruptcy Code. You can file for bankruptcy on your own, however, it’s best to work with a bankruptcy lawyer. There will be filing costs and legal fees, but free services are available for those who qualify. The process includes:
- Compiling your financial records. This includes listing all debts, assets, income, and expenses to give the courts and whoever’s helping you a good sense of your situation.
- Getting credit counseling within 180 days before filing. You actually can’t file for bankruptcy until you’ve gone through this requirement. It shows the courts that you’ve done everything you could before filing bankruptcy as a last resort.
- Filing the petition. And if you haven’t found a lawyer, this is the time to do it if you want one. Without legal advice, you run the serious risk of not knowing all of the federal and state laws which could affect the outcome of your case.
- Meeting with your creditors. Once your petition is accepted, the case will be assigned to a bankruptcy trustee who will set up a meeting with your creditors. This will give them the chance to ask questions about your case.
How long does it take to file bankruptcy?
The amount of time it takes to file bankruptcy and complete the process varies by chapter. It will also depend on your financial situation and the amount of debt you have. Generally, a Chapter 7 Bankruptcy can take three to seven months, and Chapter 13 Bankruptcy is anywhere from three to five years.
Can you file bankruptcy on medical bills?
Yes! But you can’t limit your bankruptcy case strictly to your medical bills. When you file, be sure to list all of your debts, and that includes medical bills. They are considered non-priority unsecured debt, meaning it can be forgiven.
How long after bankruptcy can I buy a house?
The length of time it takes to buy a house after bankruptcy depends on the type of bankruptcy you filed for and the type of mortgage loan you’re applying for.
This is because bankruptcy can severely affect your ability to obtain unsecured credit, and even if you do get it, lenders may charge you higher fees and interest rates. Another option may be to reaffirm your current mortgage during the bankruptcy proceedings so you can keep your home and continue paying that mortgage.
Do you need a lawyer to file bankruptcy?
You don’t have to have a lawyer to file for bankruptcy, but the only person that comes to mind who represented themselves in a court of law without one is Ted Bundy. (Yikes.) Bankruptcy has long-term financial and legal consequences, so it’s very important you have a qualified lawyer to guide you along the way.