Here’s the Skinny on Filing Bankruptcy and How it Affects Your Life
“I. Declare. Bankruptcyyyyyy!”
As Michael Scott learned in “The Office,” getting rid of debt isn’t as simple as that declaration. Wouldn’t that be nice?
Many people think of filing bankruptcy as an easy way out. These people have never filed bankruptcy.
Bankruptcy for Individuals
Individuals can file one of two types of bankruptcy.
Chapter 7 Bankruptcy
Chapter 7 is the most common. It’s for individuals who can prove they don’t have the means to pay off debts. After you file, a trustee could sell some of your assets to repay your creditors, but you’re otherwise discharged from responsibility for your debts.
Sometimes called “straight bankruptcy,” Chapter 7 is a three- to six-month process. It has no debt limits.
Chapter 13 Bankruptcy
Chapter 13 — or “wage-earner bankruptcy” — is for people with reliable income who are able to repay a portion of debt. In this case, a trustee sets up a payment plan so you can repay your debt over three to five years.
Chapter 13 bankruptcy comes with some debt limits. According the Federal Judiciary, you can only have:
- $1,184,200 in secured debt, i.e., debt that is secured by collateral, like a house or car.
- $394,725 in unsecured debt.
Other Types of Bankruptcy
You may have also heard of Chapter 11 — that’s usually for businesses.
The Federal Judiciary describes less common types of bankruptcy. Here’s a basic overview:
|Type||Typically Used by||Basic Requirements||Debt Limit||Filing Fee*|
|Chapter 7||Individuals||Prove you have the means to repay debts||none||$335|
|Chapter 13||Individuals||Have reliable income and the ability to repay debts||$394,725 unsecured; $1,184,200 secured||$310|
|Chapter 11||Businesses||Be engaged in commercial or business activities||$2,566,050||$1,717|
|Chapter 9||Municipalities, including cities, counties and school districts||Municipality must be insolvent||n/a||n/a|
|Chapter 12||Family farmers and fisherman||Individual or married couple whose primary income and debt are related to the farming or fishing operation||$4,153,150 farming; $1,924,550 fishing||$275|
|Chapter 15||Foreign debtors||Case must involve parties outside of the U.S.||n/a||n/a|
*Fees and requirements are accurate as of July 2018.
Why File Bankruptcy?
Wait, you might have to repay your debt, even after filing for bankruptcy? Then what’s the point?
The point is to get that “fresh start” you hear people talking about.
Bankruptcy should be a last resort for getting rid of debt, but for some people it’s better than having their wages garnished or their homes go into foreclosure.
It gives you a chance to get your debt under control and get creditors and collectors off your back (and out of your bank account).
What Happens When You File Bankruptcy
The process is pretty involved, and you’re probably going to want to consult with a bankruptcy attorney to make decisions for your individual case. Here’s a quick overview of what to expect.
First of all, expect to pay $335 (for Chapter 7) or $310 (for Chapter 13) in administrative and filing fees, according to this most recent schedule of U.S. bankruptcy fees.
You can apply to have Chapter 7 fees waived (with this form) or set up a payment plan for Chapter 13 fees if you can’t afford them upfront, says the Federal Judiciary. To be eligible for a waiver, your household income should be less than 150% of the poverty line (calculated for you here), and you have to be unable to pay the fee in installments.
Additionally, you’ll be responsible for legal fees, which will vary.
Once you file bankruptcy, creditors and collectors have to stop trying to collect the money you owe them while the case is open.
That’s called an “automatic stay.”
If a company continues to try to collect during the stay, it’s violating a court order, says the government. Let it know in writing, and the collections will likely stop. If they don’t, notify the bankruptcy court, which can punish the company for violating a court order.
Working With a Trustee
You’ll spend most of the process working with a trustee, who administers the case.
The trustee helps you file paperwork and oversee your estate (anything you own) during the case. They’re an impartial player who can challenge creditors’ claims or yours, based on conversations with both.
Ultimately, a bankruptcy judge decides whether to discharge your debts. They could deny you for a few reasons:
- You failed to keep or produce adequate financial records.
- You failed to explain any loss of assets.
- You committed a crime, e.g., perjury.
- You failed to obey a lawful order of the bankruptcy court.
- You hid property that would have been included in your estate.
But in general, if you were able to show your inability to repay debts, you should be granted a discharge.
If they grant in your favor, you’re released from personal responsibility for your debts, and creditors can’t take any more action to collect them.
Who Pays for Bankruptcies?
If you’re free of the debt without repaying… who does cover the cost? The debt doesn’t disappear — you just aren’t responsible for it anymore.
“A creditor may still have options to collect on a discharged debt,” explains HG.org.
A creditor could sue a co-debtor who hasn’t filed bankruptcy or collect any collateral you offered to secure the debt (but the latter is rare).
You’re also free to pay toward the debt as you wish, but there’s not much reason to do that after it’s discharged with bankruptcy.
Bankruptcy (Almost) Never Discharges These Debts
Debtors typically use bankruptcy to discharge credit card or medical debt. Many types of debt can’t be discharged this way, including:
- Student loan debt (except sometimes).
- Child support.
- Most tax debts.
- Debt you owe someone as a result of a criminal or civil charge (e.g. injury caused by a DUI)
For auto loans and mortgages, your debt may be discharged, but it could mean the creditor can seize the property you took a loan against, e.g., repossess your car.
You can instead choose to “reaffirm” the debt, or leave it out of the bankruptcy discharge, and you’ll remain responsible for paying it off. And you get to keep your property.
Will Bankruptcy Ruin Your Credit Score?
Bankruptcy will most likely be a black mark on your credit history — one that lasts up to 10 years.
But if you’re in over your head with debt, your credit is probably already pretty marred. Some experts say bankruptcy won’t hurt it significantly more than a poor payment history.
Just make sure filing bankruptcy is really your best option — because the aftermath is not fun.
Here’s one woman’s story on what it feels like to declare bankruptcy and how she recovered her credit afterward.
Dana Sitar ([email protected]) is a writer and editor at The Penny Hoarder. Say hi and tell her a good joke on Twitter @danasitar.
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