Filing for bankruptcy is a big decision. It’s important to understand what you stand to gain and lose by filing either type of bankruptcy.
Written by Attorney Andrea Wimmer.
Updated September 23, 2020
If you can’t pay your debts, or think you’ll soon be unable to do so due to a loss in income, you may be wondering whether bankruptcy is the right option for you. Bankruptcy is a powerful tool for Americans who have fallen on hard times and need a fresh start. But, it’s not right for everyone. Let’s take a look at some things you should consider when deciding your next steps.
What Can I Gain By Filing Bankruptcy?
At the end of a successful bankruptcy, you'll receive a bankruptcy discharge order from a United States bankruptcy court. Bankruptcy laws are clear that creditors can never again try to collect on a debt that's been discharged. After bankruptcy, you'll have the fresh start that you need.
Bankruptcy erases most common types of unsecured debts, which are debts not connected to any specific piece of property. Unsecured debts erased by filing bankruptcy include:
Credit card debts
Medical bills/medical debt
Older tax debts
Old utility bills
Old cell phone bills
Deficiency on a car loan after a repossession
Other dischargeable debts
While most debts are wiped out when your bankruptcy discharge is granted, some are not. Debts that can't be erased through bankruptcy are known as non-dischargeable debts. The most common non-dischargeable debts are recent tax debts (including income taxes), child support or alimony payments, and generally student loans. You will have to pay these types of debts back after bankruptcy.
2 Types of Bankruptcy: Chapter 7 and Chapter 13
Chapter 7 is the most common form of personal bankruptcy. Eligible filers receive their discharge within 3 - 4 months after filing their bankruptcy petition. The only limitation to Chapter 7 bankruptcy is that you can’t make too much money. If the Chapter 7 bankruptcy means test analysis - based on your income in the six months before filing - determines that you have the ability to repay at least some of your debt, a Chapter 13 bankruptcy filing is required.
Chapter 13 bankruptcy involves a 3 - 5 year debt repayment plan. Non-dischargeable and secured debts are paid off and - if the debtor owns nonexempt property - unsecured creditors receive the value of those nonexempt assets. In a Chapter 7 bankruptcy, on the other hand, the Chapter 7 trustee sells nonexempt assets and uses the proceeds from the sale to pay unsecured creditors. To keep property backing a secured debt (like a car loan), Chapter 7 filers typically sign a reaffirmation agreement in which they agree to continue to pay on the loan secured by the property.
Filing Bankruptcy Stops Collection Actions
As soon as you file for bankruptcy, the automatic stay takes effect. This means your creditors must stop all collection actions against you. Collection phone calls must stop. Wage garnishments must stop. A bankruptcy filing also prevents utility shut offs and can help the filer recover a driver's license that was suspended because of unpaid debts.
The Bankruptcy Discharge Eliminates Eligible Debts Forever
The primary goal of all personal bankruptcy cases is the bankruptcy discharge. This is the court order that bans creditors from trying to collect the discharged debt from you. Ever. Again.
Filing Bankruptcy Can Improve Access To Credit
No, filing bankruptcy will not ruin your credit forever. That’s a myth. Although your credit score will likely drop a few points when your bankruptcy petition is first filed, the effect on your credit report is short term. Bankruptcy, and the fresh start it grants you, is a path to a better credit score. With some smart financial management, your credit score can be better than when your case was filed within a year of getting your bankruptcy discharge.
What can I lose by filing bankruptcy?
The United States Bankruptcy Code allows you to keep your property as long as it is protected by an exemption. Typical personal belongings, including cars, furniture, and similar items are generally protected. Expensive or luxury items are not protected.
These types of nonexempt assets are sold by the Chapter 7 bankruptcy trustee, who uses the proceeds to pay creditors. In a Chapter 13 bankruptcy, the filer is able to keep all of their belongings because they’re essentially “reimbursing” their creditors for it through the repayment plan.
It's important to consider the timing of your filing. The Bankruptcy Code limits how often a person can receive a bankruptcy discharge. If you file for Chapter 7 bankruptcy right now and receive a discharge, you lose the ability to file another Chapter 7 bankruptcy for 8 years. Similar restrictions apply for Chapter 13 bankruptcy cases, though the time required between cases is shorter if one of them is a Chapter 13 case.
Only Chapter 13 Bankruptcy Protects Your Cosigners
Your Chapter 7 bankruptcy does not protect your cosigners and they will not receive a discharge. Anyone who cosigned a debt for you will have to pay back that debt. In a Chapter 13 bankruptcy, on the other hand, the automatic stay protects your co-signer’s personal finances while you pay off the debt as part of your Chapter 13 repayment plan.
Should I File Bankruptcy?
Folks looking for a fresh start typically fall into one of three categories:
Those who should file bankruptcy right now;
Those who should wait a little bit of time and then file bankruptcy; and,
Those who should not file bankruptcy.
Should I File Chapter 7 Bankruptcy Right Now?
Do you have more than $10,000 of dischargeable debt and keeping up with payments is making it impossible to make ends meet every month? Are you worried about being sued or having your wages garnished? Do you pass the Chapter 7 bankruptcy means test? If so, right now may be the right time to file for Chapter 7 bankruptcy.
What About Chapter 13 Bankruptcy?
Did you have a temporary lapse in income which caused you to fall behind on your mortgage or car loan, but your income is steady again? Typically, once someone has fallen behind on their secured debt payments, the only way to prevent a foreclosure or repossession is to pay the full amount in a lump sum. That is not a realistic option for most, even if their income is back to normal. Filing Chapter 13 bankruptcy allows you to catch up on the missed payments over 3 - 5 years instead.
Who Should Not File Bankruptcy Right Now
Deciding the best time to file bankruptcy is critical to getting the most out of your fresh start. Depending on your specific situation, it may be best to wait or not file bankruptcy at all. If you're in any of the following situations, then you probably should not file bankruptcy right now:
You have less than $10,000 in debt.
Your income allows you to pay at least the minimum payment (or more) on all of your credit cards and other debts.
You filed Chapter 7 bankruptcy less than 8 years ago.
Most of your debt can’t be discharged.
Your only source of income is social security, which creditors can’t touch even without bankruptcy.
Another important factor is whether you’re eligible for Chapter 7 bankruptcy under the means test. The means test is based on the last 6 months of your income. If you don't pass the means test, you can file a Chapter 13 bankruptcy but not a Chapter 7 bankruptcy right now. Below we'll explore if you should file for Chapter 13 bankruptcy protection.
Who Should Wait To File
Certain activities can complicate a bankruptcy and waiting a little bit of time can help. If you're still using your credit cards on a regular basis or you've made large purchases in the last 6 months, then it's best to wait to file and pay off your most recent charges first.
If you paid back or transferred property to a family member or friend in the last year, then it’s best to wait to file, if you can. You have to disclose these activities in your bankruptcy paperwork and you'll be asked about them at your meeting of creditors.
If you're suing someone or planning to sue someone, then it’s best to hold off on your bankruptcy filing until you know the final outcome of that case, if possible. Also, if you owe your landlord money and you don't plan to move, try to catch up on missed rent payments before filing. The same generally goes for car loans that you want to reaffirm.
I Failed The Means Test. Should I File Chapter 13 Bankruptcy?
Not everyone who files Chapter 13 bankruptcy does so to catch up on a mortgage payment. Sometimes, it’s simply the only option for someone who needs bankruptcy relief, but makes too much to qualify for Chapter 7 bankruptcy.
Chapter 13 bankruptcy works differently than a Chapter 7 bankruptcy. The main difference is that Chapter 13 requires you to propose a 3 - 5 year repayment plan. Chapter 13 is a powerful debt relief option, especially for those who can't file for Chapter 7 bankruptcy.
If you're considering filing Chapter 13 because you don't pass the means test, look at the reasons you aren't passing. The look back period is 6 months, so the outcome of the means test can change. If you recently experienced a drop in household income, then you might qualify for Chapter 7 in the near future.
Keep in mind, too, that bankruptcy isn't the best solution for everyone and it's not a bad idea to consider all of your debt relief options before deciding what's right for you.
Do I Have Other Debt Relief Options?
A number of debt relief options are available to give people the fresh start they need. The one that's right for you will depend on your specific financial situation and types of debts you have. Let's go over each option to explore.
Debt Settlement: You can negotiate with your creditors. If you've fallen behind on payments or are about to, you can contact your creditor to discuss the issue. You may be able to work out an affordable payment plan or negotiate a debt settlement for less than the full amount owed. This is especially true with credit card debt. Typically, a settlement needs to be paid in a lump sum.
Repayment Plan: Entering into a debt management plan with an agency is another option. It's important to look into the reputation of any debt management agency. Check them out through the Better Business Bureau and read online reviews. Typically only unsecured debts can be included in a debt management plan.
Debt Consolidation: Taking out a debt consolidation loan to pay off your debts is another debt relief option. You would then have only one monthly payment to make to the new creditor. These loans often offer lower interest rates than what you're already paying.
Whether you should file for bankruptcy depends on your financial situation and what other debt relief options are available. It's also important to consider the timing of filing. If you’re not sure what’s right for you, taking a credit counseling course is a great place to start.
How Can Credit Counseling Help?
Credit counseling is a great place to start. It can help you learn more about your debt relief options. Since it’s a requirement for anyone filing for bankruptcy, taking a credit counseling course from an approved counseling agency allows you to check that step of your to-do list early on in the process.
It's free and takes less than an hour to complete. Together with a trained credit counselor, you'll review your financial situation. While they can’t give you legal advice, they will then explain the different debt relief options and make a recommendation on what solution is best for you.
Filing for bankruptcy is a big decision. It’s important to understand what you stand to gain and lose by filing either type of bankruptcy. A free consultation with a bankruptcy attorney can help you clarify what’s best for you.
Upsolve’s free web app helps people who can’t afford an attorney prepare for their Chapter 7 bankruptcy. Our free Learn Center provides information about how to navigate the Chapter 7 bankruptcy process. Eligible filers can use Upsolve's free web app to prepare their bankruptcy forms. Read about how Upsolve works to explore if our free web app is the solution for you.