The B Word: Bankruptcy

What is bankruptcy? Simply put, it’s when you have more bills/debt than you can afford to pay.

A person may voluntarily file for bankruptcy or may be ordered by the court to declare bankruptcy at the request of creditors.

Primarily governed by federal law, bankruptcy was created to help “honest” debtors regroup and start anew. The two most common types of bankruptcy for individuals are:

  • Chapter 7
  • Chapter 13

Chapter 7 liquidates, or sells off, non-exempt assets to pay off some or all of your debts. These assets can include certain types of property. A condition of Chapter 7 is that any unsecured debt (any debt not secured by collateral) is written off by its lenders as unpaid and uncollectable. By federal law, property that cannot be seized and sold includes your car, clothing, or furniture, among others. Generally speaking, this is the option for people with little income and large amounts of unsecured debt (such as high medical or credit card bills).

Secured debts are treated differently in Chapter 7 filings. While some can be wiped out, for those that can’t you as the debtor must decide which payment path to take:

  • Allowing the creditor to repossess the property that secured the debt;
  • Pay the creditor a sum equal to the value of the property that secures the debt; or
  • Continue to make payments

Additionally, before filing you must determine whether you are eligible for Chapter 7, including not making enough money (minus specific expenses and monthly debt payments) to be able to fund a Chapter 13 bankruptcy plan. Because Chapter 7 liquidates almost all your assets to pay off as much debt as possible, it isn’t right for everyone. If you own a company, a family home, or other personal assets you wish to keep, this is not your best option.

Who files for Chapter 7? Most likely people with high medical debt, a mountain of overextended credit, the unemployed, and even those experiencing marital issues. After successfully filing, in roughly four months you receive a notice of discharge while the bankruptcy remains on your credit report for 10 years.

With personal assets, a better choice might be Chapter 13 which enables people to pay off their debt over the course of three to five years. If you have a stable, consistent income, it provides a “grace period” and what debt remains at the end of it is discharged. One of the benefits of Chapter 13 is that once approved by the court, creditors must cease contact with you as you work to pay off your bills over time. Plus, you are not required to forfeit your personal property and belongings. The amount that you need to pay is based upon individual income, how much debt you owe, and how much the creditors of any unsecured loans would have received if you had instead filed under Chapter 7. A record of your Chapter 13 bankruptcy remains on your credit report for seven years.

You do have alternatives

All that said, bankruptcy is not a miracle cure to wiping out debt. It will wreak havoc with your credit rating and affect your future ability to secure loans and credit cards. It can also affect the rates you pay on insurance and the amount you are charged for security deposits. It can even factor into whether or not you can secure a rental or be hired for a job. Bankruptcy is not something to enter into lightly, or alone, which is why people turn to legal help when filing. And, you do have other options.

Mortgage servicers often hold an escrow account for you, which is used to pay your property taxes and homeowners insurance as they are due throughout the year. If you do not have an escrow account with your servicer, you must make these payments yourself.

On his website, financial consultant Dave Ramsey suggests people staggering under the weight of seemingly insurmountable debt, but who don’t want to declare bankruptcy, should do four things:

  • Cover your basic needs.
  • Sell everything in sight.
  • Live on a budget.
  • Get a second job.

He admits these are not easy steps, but necessary if you want to maintain control of your financial situation and avoid filing for bankruptcy.

Other options include reducing your debt or working out a favorable payment plan with creditors. There is a wealth of alternatives to explore first, including:

  • Credit counseling
  • Financial coaching
  • Negotiating with creditors
  • Credit card consolidation
  • Debt settlement
  • Loan modification
  • Loan refinancing

Before choosing bankruptcy, tighten your belt, do your research and know how much you owe. It isn’t the end of the world to declare bankruptcy, but it shouldn’t necessarily be your first choice when dealing with long-term financial problems.


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