What you need to know about bankruptcy
If your debts have become unmanageable or you are facing foreclosure on your home, you may be considering filing for bankruptcy. While bankruptcy may be the only way out for some people, it also has serious consequences that are worth considering before making a decision. For example, bankruptcy will stay on your credit report for seven or 10 years, depending on the type of bankruptcy. This can make it difficult to get a credit card, car loan, or mortgage in the future. It could also mean higher insurance rates and even affect your ability to find a job or rent an apartment. This article explains how bankruptcy works and also offers alternatives to bankruptcy.
Key points to remember
- Bankruptcy can cause serious damage to your credit score and should be viewed as a last resort.
- As an alternative, you may be able to negotiate with your creditors and work out a payment plan or other satisfactory arrangement.
- If you decide to file for bankruptcy, you have two basic options: Chapter 7 and Chapter 13.
- A Chapter 7 bankruptcy will sell many of your assets to pay off your creditors. In a Chapter 13 bankruptcy, you keep the assets but have to pay off your debts over a specified period.
What to do before declaring bankruptcy
Bankruptcy is generally seen as a last resort for people who are heavily in debt and see no way to pay their bills. Before declaring bankruptcy, there are alternatives that are worth exploring. They are less costly than bankruptcy and are less likely to damage your credit report.
For example, find out if your creditors are ready to negotiate. Rather than wait for a bankruptcy settlement and risk getting nothing at all, some creditors will agree to accept reduced payments over a longer period.
For a mortgage, call your loan manager to find out what options are available to you. Some lenders offer forbearance (postponing payments for a period of time), repayment plans (such as smaller payments over a longer period), or loan modification programs (which could, for example, lower your rate. interest on the remainder of the loan).
Even the Internal Revenue Service is often willing to negotiate. If you owe taxes, you may be eligible for an offer in compromise, in which the IRS will agree to accept a lower amount. The IRS also offers payment plans, allowing eligible taxpayers to pay what they owe over time.
How to declare bankruptcy
If you’ve decided to file for bankruptcy, your first step should usually be to consult a lawyer. Although it is possible to file a case without it, “seeking the advice of a qualified lawyer is strongly recommended because bankruptcy has long-term financial and legal consequences,” notes the Administrative Office of the United States Courts on his website. (Bankruptcy is governed by federal law, and cases are handled by federal bankruptcy courts, although some rules differ from state to state.)
Before you file your case, you will need to attend a counseling session with a credit counseling agency approved by the Department of Justice’s U.S. Trustee Program. The advisor should assess your personal financial situation, describe alternatives to bankruptcy, and help you develop a budget plan. The advice is free if you cannot afford to pay; otherwise, it should cost around $ 50, according to the Federal Trade Commission.
If you still want to proceed, your lawyer can advise you on the most appropriate type of bankruptcy for your situation.
Types of personal bankruptcy
For individuals, as opposed to businesses, there are two common forms of bankruptcy: Chapter 7 and Chapter 13. Here is a brief description of how each type works:
Chapter 7. This type of bankruptcy essentially liquidates your assets in order to pay your creditors. Certain assets, usually including part of the equity in your home and automobile, personal items, clothing, tools needed for your job, pensions, social security and any other public benefit, are exempt, which means you can keep them.
But your remaining non-exempt assets will be sold by a trustee appointed by the bankruptcy court and the proceeds will then be distributed to your creditors. Non-exempt assets may include property (other than your primary residence), recreational vehicles, boats, a second car or truck, collectibles or other valuables, bank accounts and bank accounts. placement.
At the end of the process, most of your debts will be discharged and you will no longer have any obligation to repay them. However, some debts, such as student loans, child support, and taxes, cannot be paid. Chapter 7 is generally chosen by people with low income and few assets. Your eligibility is also means tested, as explained below.
Chapter 13. In this type of bankruptcy, you are allowed to keep your assets, but must agree to repay your debts over a set period of three to five years. The trustee collects your payments and distributes them to creditors. Chapter 13 bankruptcy is normally chosen by people who want to keep their non-exempt properties intact or to save time against foreclosures or foreclosures.
The means test for chapter 7
Whether it is for Chapter 7 or Chapter 13 is not your only decision. The courts also impose a means test to determine if you qualify for Chapter 7. The means test first compares your average income over the previous six months with the median income of a household of your size in your state; if you earn less than the median, you should qualify for Chapter 7.
Even if your income is above the median, you may be eligible after subtracting some eligible expenses. But if the math shows you have enough disposable income left to start paying off your debts, rather than just wiping the slate clean, the court may decide that Chapter 13 is your only option. To help you determine your eligibility, you will need to complete this form 122A-2.
List your debts
When filing for bankruptcy, you will also be asked to provide the court with a list of all the money you owe. Your debts fall into two categories:
- Guaranteed debts. These include loans where the creditor has a security interest in the property that was provided as security when you took out the loan. Mortgages and auto loans are the most common types of secured loans, with the collateral being your house or your car, respectively.
- Unsecured debts: These debts are not secured by property or other guarantees. Examples include credit card debt, medical bills, and unsecured personal loans.
The bankruptcy court considers the secured debt to be a priority, because default on payment may allow the creditor to claim the collateral.
Once all of the essential information has been filed with the court, the court appoints a trustee, whose job is to ensure that your secured debt is repaid over a period of time. At this point, the court issues an automatic stay that prevents creditors from seizing assets through forfeiture or foreclosure.
Eliminate your debts
When the bankruptcy court issues a discharge, you are relieved of your obligation to repay the listed debts. This means that the creditors no longer have a legal claim against the debts, so they cannot pursue any collection activity, take legal action or even communicate with you in any way.
The court will send your creditors a notice that the debts have been paid. A copy will also be sent to your lawyer and to the US Trustee Program at the Department of Justice. Any creditor who attempts to collect a debt after receiving a discharge notice may be fined.
For a Chapter 7 bankruptcy, the discharge is usually issued between four and six months after filing the bankruptcy petition. The discharge under Chapter 13 bankruptcy is issued after the payment plan is completed, usually three to five years after filing for bankruptcy.
Once your debts have been discharged by the court, these creditors can no longer attempt to collect them or take further legal action against you.
Rebuilding Your Credit After Bankruptcy
As mentioned above, bankruptcy will stay on your credit report for seven years (in the case of Chapter 13) or 10 years (in the case of Chapter 7).This can make it difficult to obtain additional credit, such as a bank loan or a regular credit card. However, the effect of bankruptcy on your credit score will diminish over time, and your score will gradually improve if you show that you are using credit responsibly.
One tool for doing this is a secured credit card, where you make a deposit with the issuing bank, which then becomes your line of credit. By using this card wisely and making your payments on time, you can start building a new credit history. After a period of one-off payments, you may become eligible for a regular unsecured credit card.
The process of rebuilding your credit and restoring your financial life can take time. But bankruptcy, if you have no other viable choice, is not the end of the world.