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Bankruptcy is rock bottom when it comes to your credit. But guess what that means? It means for those filing for bankruptcy, it can only get better for them and their credit. But bankruptcy can be a somewhat convoluted process. Simply using the term “bankruptcy” does not address all the complexities of the process. Bankruptcy affects many people across the nation, and most of it has nothing to do with being too lazy to pay or spending too much. In fact, there have been estimates as high as 50 percent of people filing for bankruptcy for something that was unplanned. Unpaid medical bills of people with health insurance causes a majority of all the personal bankruptcy filed in the most recent years.
There are four different types of bankruptcy that can be filed. This article will focus on the three that individuals can file (the fourth is for farmers only). Each type of bankruptcy is named after the chapter in which they are described in the United States Federal Bankruptcy Code. Also, depending on other factors, you could file for different chapters of bankruptcy. This also gets more complicated depending on whether your debt is secured or unsecured. An unsecured debt means that it is not backed by anything except your credit. Secured debts, however, are backed by something to serve as collateral. Your mortgage serves a secured debt, for instance. Should you fail to pay it, your home is foreclosed upon, and the bank ceases it.
Chapter 7 bankruptcy is the most common of all bankruptcy – when a person says “I'm filing for bankruptcy” you can generally count on them to file Chapter 7. This type of bankruptcy is considered to be “liquidation” bankruptcy. That is, if you fail to pay, the creditor can take away some of your assets, sell them off (or “liquidate” them) in an attempt to recoup some of the money they lent you.
They cannot take all of your possessions though – only the items considered “federal non-bankruptcy exempt”. This includes second cars, family heirlooms, second homes, expensive music equipment, cash, bank accounts, stocks, bonds and investments. Items like your primary home and car are exempt however, along with jewelry up to a certain value, reasonably necessary clothes, household items and appliances, items needed for your occupation up to a certain value, public benefits, etc. If all of your nonexempt property does not fulfill your debt, it is forgiven and is considered a “dischargeable debt”. Any income that the debtor makes following the bankruptcy filing belongs to the debtor.
Many states have their own set of rules when it comes to exempt items. State bankruptcy exemptions vary from state to state but many let you choose whether you want to keep what the federal exemption laws say you can or what the state allows. The majority of states, however, do not let you choose and you must follow their guidelines for bankruptcy exemptions. Also important to note before reading on – some states have different requirements and laws then others when it comes to filing for bankruptcy. There are usually debt and income limits that vary.
To confuse you even more, there are debts that are considered “non-dischargeable” with a Chapter 7 filing. These are debts and loans that cannot be forgiven with bankruptcy filing. For example, student loans cannot be forgiven with Chapter 7, nor can criminal fines, alimony, child support, taxes or debt incurred by fraud. In rare cases, student loans can be dischargeable with bankruptcy, usually with an older student experiencing seriouos financial hardship.
The most complex of all of the bankruptcy filings is Chapter 11. Although generally used by businesses, individuals can also file for it. With this type of bankruptcy, individuals can keep all of their property and assets while they negotiate a reorganization plan to pay back the creditor.
If you like the sound of Chapter 11, you should consider filing for Chapter 13 bankruptcy. It is similar to Chapter 11, but it is specifically designed for individuals, rather than businesses. It has certain requirements however. The debtor must have a certain level of income and there are also limits on the amount of debt incurred. The debtor may keep their assets, but they must work out a three to five-year repayment plan with the creditor. There are possibilities for dischargeable debt with Chapter 13.
Since April of 2005, it has become more difficult for consumers to file for Chapter 7. With the passage of the Bankruptcy Abuse Prevention and Consumer Protection Act, more debtors are forced to file for Chapter 13. This allows more debtors to get more of their money back since Chapter 7 often discharges a large amount of debt, while Chapter 13 has the repayment plan.
Because of this plan, people with higher incomes have a more difficult time filing for Chapter 7. Before the passage of the Bankruptcy Abuse Prevention and Consumer Protection Act, any income level was allowed to file. Now, debtors who rank higher than the median income of their state do not automatically qualify; instead, they are subject to a “means test”. A means test is only used for those whose debt is mostly consumer debt, and is meant to determine whether or not the debtor has the “means” to pay back some or all of what is owed.
Also, the Bankruptcy Abuse Prevention and Consumer Protection Act requires that individuals who wish to file for bankruptcy must obtain a credit counselor in the six months before filing. The agency must be an approved one, and if you complete the six months of counseling, they will provide you with a certificate which serves as proof of completion. The cost of the counselor will be the consumers expense but it is a very minimal charge.
So should you file for bankruptcy? In general, you should try to avoid it, as it is the worst thing possible on your credit report. However, it can be beneficial for those who have nothing to lose in terms of assets, already have terrible credit and can’t pay back their creditors. If you did not answer yes to all of those questions, you really should avoid it. Check out the U.S. Directory of Bankruptcy Courts website for more details.
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