What is Bankruptcy?
Bankruptcy helps you get a fresh start after a financial shock. It is the legal process of erasing significant debt when you can’t afford to pay it back.
Bankruptcy can be a very important tool to improving your financial future.
Bankruptcy is a federal law that is designed to give you relief when you find yourself buried in a severe amount of debt. Bankruptcy can either eliminate (aka “discharge”) or reduce (aka restructure) your debts.
Despite its many benefits, some people have negative feelings toward bankruptcy simply because they don’t understand it.
Whether you’re considering filing for bankruptcy, know someone who has filed, or just want to learn more, this article is designed to give you a brief introduction to one of America’s oldest and most important social safety nets.
- The History of Bankruptcy
- Common Causes of Bankruptcy
- Types of Bankruptcy
- How Chapter 7 Bankruptcy Works
- Benefits of Chapter 7 Bankruptcy
- Chapter 7 Myths
Many people don’t know that bankruptcy appears in the Constitution. Our government created bankruptcy to give people a fresh start when they hit hard times.
It is an important tool for giving individuals a new lease on life, but it also plays a crucial role in our society. Bankruptcy keeps people from falling out of the financial ecosystem. It gives people a chance to rebuild their financial health and reenter the banking system.
Many well known figures in American history have used bankruptcy to recover from financial downturn: Abraham Lincoln, Walt Disney, Toni Braxton, Henry Ford and MC Hammer to name a few!
It’s a common misconception that bankruptcy is the fault of the individual who is in need of relief.
In fact, approximately 90% of bankruptcies in America are the result of sudden financial shocks due to job loss, medical illness, divorce, or small business failure that can’t be predicted. In 2017 789,020 bankruptcy filings were tracked nationwide.
Although the circumstances surrounding why you need to file may be out of your control, it is important to keep in mind that it is within your power to get back on track.
If you have below a 600 credit score and over $10,000 in debt, bankruptcy might be worth considering.
The two most common types of bankruptcy are Chapter 7 and Chapter 13. It’s important to understand the difference between the two when choosing the best option for your situation.
Chapter 7 Bankruptcy aka “liquidation” Most bankruptcy filings in America are Chapter 7. It it often the best option to get a fresh start.
In a Chapter 7 bankruptcy, you file paperwork asking the court to erase your unpaid debts. Most of your unsecured debts are erased, including credit card debt, medical bills, and most civil judgments. And in about 96% of cases, you get to keep all your property to restart your new life. Before you file, you should learn the differences between unsecured and secured debts.
But, there are a couple drawbacks to Chapter 7.
First, a few debts cannot be erased, including most student loans, child support, and mortgages.
Second, if you own real estate, an expensive car, or something else that costs a lot of money, it might be taken by the court to repay your debts.
If you're still confused with some of the language and legal terms in Chapter 7, read here for helpful definitions.
Chapter 13 Bankruptcy aka “the repayment plan”
Chapter 13 bankruptcy generally allows you to keep expensive property like a house or a luxury car.
It can also help you repay certain debts that can’t be discharged in a Chapter 7 case. These are called nondischargeable debts. These can include:
- many government fines and penalties,
- outstanding debts you may have from a prior bankruptcy filing,
- debts used to pay nondischargeable tax obligations,
- debts from divorce proceedings or settlements (except alimony or child support),
- retirement account loans,
- homeowners association or condo fees from after your filing date, and
- debts from willful damage to property.
Although Chapter 13 might allow you to discharge more types of debts, the trade-off is your debts aren’t erased like they are in Chapter 7. Instead, you must come up with a plan to repay some of your debts over a 3 to 5 year period.
Although Chapter 13 reduces the amount that you ultimately have to pay back to your creditors, you’re not eligible for a complete discharge of your debts until you complete the 3 to 5 year plan, which most people are unable to do. In addition, your case might be dismissed if you fail to do something required under the Chapter 13 rules.
You can also file for Chapter 11 as an individual, although these are more rare and are intended for much larger cases that exceed the limits of Chapter 13. Chapter 11 is also a reorganizations bankruptcy. You can read about every type of bankruptcy here.
As a result, filing for Chapter 7 bankruptcy is generally the best fit for those who need a fresh start. You can keep almost all of your property under the property exemptions and it permanently erases your debt instead of having to repay it.
There are a few important people involved in the Chapter 7 bankruptcy process.
First, there is the “debtor,” -- that’s you! You’re in debt and you need to file for bankruptcy to get a fresh start.
Second, there’s the “clerk” at the Bankruptcy Court. The clerk is the person that you give your bankruptcy paperwork to file it. Clerks handle most of the administrative tasks at the court.
Next, there’s the “trustee.” The trustee is someone who reviews your paperwork and makes sure that you really do need to file.
You will meet with the trustee for a short “341 Meeting” about a month after filing. The trustee determines whether or not you have any property that could be distributed to your creditors to help pay off your debts. If not, the case moves forward and a “judge” will sign off on the order to have your debts discharged.
Filing for Chapter 7 bankruptcy includes multiple steps and rules. In addition, there are certain costs associated with filing. You want to make sure you're very prepared. Although at first they can seem overwhelming, they are all manageable if you stick with them. In addition, you can even file for bankruptcy online. The steps are:
Prepare Your Chapter 7 Bankruptcy Forms. This is the most time-consuming step. The Bankruptcy Forms are 23 separate forms, asking you about everything and make, spend, own and owe.
Take Course 1. This is a one-hour financial course that is required by the court before filing for bankruptcy. You can take the course online or by phone from a number of different providers. Upon completing the course, you receive a certificate that you give the court when you file your forms.
File Your Forms. If you have prepared all your bankruptcy forms accurately, you’re almost there. It’s now time to bring the forms and your course certificate to your local bankruptcy court.
Pay the Filing Fee. Filing for bankruptcy normally requires a $335 filing fee. The filing fee must be paid to the court in person in cash with exact change or by mailing a money order.
If you don’t have the funds to pay for the filing fee, can you borrow them from a friend or a family member? If so, that’s the best option. If not, consider: (1) applying for a fee waiver or (2) paying in installments.
Attend 341 Meeting. As mentioned above, this is a meeting where the trustee reviews your case to check that everything is in order and to make sure you’re not hiding any assets.
Take Course 2. This course is very similar to Course 1, except it takes two hours to complete. It’s designed to help you make good financial decisions after your bankruptcy case is over.
Receive your letter of discharge. About two months after your 341 meeting, you normally receive a letter in the mail stating that you have a discharge of debts. Congrats! You have a fresh start.
Stops Debt Collector Calls As soon as you file for bankruptcy, a hold called an “automatic stay” is put in place. This means that debt collectors cannot contact you to collect the debts while your case is being processed. If they try to collect the debt, the court can penalize them.
However, if you are facing a debt collection lawsuit, you may want to consider a debt collection attorney. Like any other legal matter, you can represent yourself, but many people try to find an attorney for this issue.
In addition, people also use consumer protection attorneys to protect their rights under consumer protection laws. These laws protect debtors from creditor harassment and dishonest tactics.
Erases Most Debts Chapter 7 bankruptcy erases, or “discharges,” most kinds of debts such as credit card debt, medical bills, personal loans, civil judgments (except for fraud), past-due rent, past-due utility bills, business debts, and some older tax debts. A few debts can’t be erased, such as most student loan debt and certain tax obligations.
Stops Wage Garnishment Bankruptcy prevents creditors from garnishing your wages. In doing so, it can actually improve your income because you actually get to keep the money you earn at work.
Stops Utility Shut Off Bankruptcy stalls attempts to cut off your utilities.
Recover Your Driver’s License Filing for Chapter 7 can help you recover your driver’s license if: 1) it has been suspended due to failure to pay parking or driving tickets, or 2) if it was suspended for driving without insurance.
Most Filers Retain All Their Property Most people who are eligible to file for Chapter 7 bankruptcy don’t have property that is susceptible to seizure. Most of their day-to-day property is protected under the Chapter 7 property exemptions..
It’s Relatively Quick The bankruptcy process usually takes about 3 to 5 months to complete. Compare this to 3 to 5 years to complete a Chapter 13 repayment plan.
No Payment Plan Upon discharge, Chapter 7 bankruptcy erases debts. Meaning that you will no longer be obligated to repay the debts you once owed.
Easier to File Without a Lawyer Bankruptcy attorneys can be costly. It is easier to file bankruptcy for Chapter 7 using a free service like Upsolve or other legal aid organizations. By contrast, filing Chapter 13 without a lawyer is almost always a bad idea.
Fortunately, there are ways to find affordable bankruptcy lawyers. If you live in New York City, here are some options for you.
Myth: Bankruptcy Hurts Your Credit It is commonly thought that filing for bankruptcy damages your credit.
Although it is true that bankruptcy will appear on your credit report for 8 years and can temporarily limit your access to unsecure credit, bankruptcy can often help your credit score improve.
A report from the Federal Reserve Bank of Philadelphia showed that those who filed for Chapter 7 bankruptcy in 2010 had an average credit score of 538.2. But six to eight months after filing, their credit scores had jumped to 620.
Many people actually rebuild their credit after bankruptcy using secure credit cards and become more attractive to lenders because they no longer have a lot of other debt or creditors that they owe. Some people use credit repair lawyers when their credit ratings have been damaged.
Myth: Bankruptcy Hurts Your Chances of Employment Current employers cannot use your bankruptcy filing as a reason to terminate or change the terms of your employment.
It is unlikely that your employer will even find out about your bankruptcy unless your wages are being garnished by a creditor.
On the other hand, prospective employers will often find out about your bankruptcy when they run a credit check before hiring you.
It’s not uncommon for you to be nervous about how bankruptcy might impact your employment.
Keep in mind that an employee with a past bankruptcy and no current debt is often more desirable for employers than an employee that is currently buried in debt.
Myth: Bankruptcy Hurts Your Future Income As mentioned above, bankruptcy prevents creditors from garnishing your wages. In doing so, it can actually improve your income because you actually get to keep the money you earn at work.
Research from Princeton University shows that people who filed for Chapter 13 bankruptcy often earned up to 25% more money after filing with employment rising by approximately 8%.
Myth: Bankruptcy Hurts Your Ability to Rent an Apartment
Prospective landlords will be able to see bankruptcy on your credit report.
For a landlord, a tenant who has a bankruptcy on their record but no current debt might be more desirable than a tenant that hasn’t filed for bankruptcy.
This is because those who haven’t yet filed for bankruptcy are most likely buried in debt, and, therefore, unlikely they will be able to pay rent on time.
Myth: Bankruptcy Means You’re a Failure
As mentioned above, it’s a common misconception that bankruptcy is the fault of the individual who is in need of relief.
In fact, approximately 90% of bankruptcies in America are the result of sudden financial shocks due to job loss, medical illness, divorce, or small business failure.
There is no way to predict if you’ll need to file bankruptcy and there is no one reason why people need to. Many well known figures in American history have used bankruptcy to recover from financial downturn: Abraham Lincoln, Walt Disney, Toni Braxton, Henry Ford and MC Hammer to name a few!
Bankruptcy exists for a reason and is worth considering if you find yourself in need of a fresh start.
Bankruptcy is a financial tool designed to give people a fresh start after financial shocks like job loss, medical illness or divorce.
It is one of the most important social safety nets that is often misunderstood.
In addition to erasing your debt, bankruptcy can positively impact many other areas of your life to help you get back on your feet and stay there.
For example, filing for Chapter 7 bankruptcy is a 3 - 6 month process that can: stop debt collector calls, wage garnishment and utility shut off, help you recover your driver’s license, and let you keep most of your property.
If you need it, bankruptcy can be a very important tool for improving your financial future.