Do you have severe debt problems? Are you underwater with credit card debt, have an untenable mortgage, unpaid medical bills, outstanding personal loans, and other unsecured debt, or have your wages garnished?
According to statistics released by the Administrative Office of the U.S. Courts, the September 2021 annual bankruptcy filings totaled 434,540. Filing for bankruptcy may hold the key to your debt relief.
Here are some bankruptcy basics.
Chapter 7 and Chapter 13 bankruptcy
If you’re considering filing bankruptcy, there are two primary types you’ll consider: Chapter 7 or Chapter 13. Chapter 7 is the most common type of bankruptcy, but several key differences exist.
Chapter 7 is a liquidation bankruptcy wherein individuals and businesses can file. There is no repayment plan, unlike in Chapter 13. A Chapter 7 bankruptcy can erase many types of consumer debt, the most common are credit card debt and medical bills, including car loans, payday loans, and utility bills. These are known as dischargeable debts.
This filing type removes all unsecured debt except student loans, government taxes, child support, and alimony.
A Chapter 7 bankruptcy is also able to discharge back income taxes. When you file for Chapter 7, the IRS is contacted, your credit card debts are immediately cleared, and wage garnishments cease. It is known as an automatic stay. The automatic stay halts all debt collection actions.
Chapter 7 bankruptcy procedure
When you file Chapter 7, a bankruptcy trustee will be appointed to oversee your case. You’ll have to sell off your non-exempt assets to pay off your debts. Anything determined by the court to be unnecessary to maintain a minimal standard of living is considered exempt. The non-exempt property includes:
- Vacation homes or real estate properties that aren’t your primary residence
- Car repossession
- Musical instruments, as long as you don’t need them for work
- Family heirlooms
- Investments, but not retirement accounts
- Jewelry with resale value
What types of debt can be erased?
The following unsecured debts are subject to bankruptcy discharge.
- Credit card debt
- Medical bills
- Car loans
- Personal loans and payday loans
- Judgments from credit cards and debt collection agencies
- Utility bills
If considering chapter 7, here are some things to keep in mind:
- The filer must be an individual or business.
- You are allowed to keep several types of property up to a dollar amount with “exemption limits .” Every bankruptcy filer can protect specific exempt property, so getting a fresh start doesn’t require them to start from scratch.
Can Chapter 7 stop a foreclosure?
No, but it can delay it. The automatic stay will halt the foreclosure process until your bankruptcy case is settled. There are some ways you can protect your house, but state laws and homestead exemptions for real estate differ.
Contrary to popular belief, most people filing Chapter 7 don’t lose their homes and, in many cases, get to keep their vehicles. Bankruptcy doesn’t ruin your ability to get credit, but your score will take a big hit after filing. Lastly, you don’t necessarily need to be behind on your bills to file for bankruptcy.
How long is the bankruptcy process?
The process of Chapter 7 takes about 4-6 months and stays on your credit report for ten years.
A means test will be required
The means test is designed to limit the use of Chapter 7 bankruptcy to those who can’t pay their debts. This bankruptcy test determines whether your income is low enough for you to file for Chapter 7. Its function is to keep high-wage earners from filing for Chapter 7 bankruptcy.
High-income filers who fail the means test can use Chapter 13 bankruptcy to repay a portion of their debts and can’t use Chapter 7 bankruptcy to wipe out their debts altogether.
Chapter 7 means tests aren’t only for the disadvantaged. You can still earn a significant monthly income and qualify for Chapter 7 bankruptcy if you have many expenses, such as a hefty mortgage, car payments, taxes, and other costs.
In the end, if the person has enough to pay down the debt, the judge is likely not going to allow a Chapter 7 filing.
A Chapter 13 bankruptcy is known as a wage-earners plan. Chapter 13 is for someone with a regular income who repays all or part of their debt through a repayment or installment plan over three to five years. Chapter 13 is used by individuals, including those self-employed.
There is no income requirement, but the debt must be below a certain amount and stay on your credit report for seven years.
Chapter 13 bankruptcy benefits
Chapter 13 offers protection against liquidation, most notably protecting the potential filer’s home from foreclosure. It gives you the chance to catch up on late mortgage payments.
The filer has the opportunity to structure a repayment plan under better conditions and at lower interest rates, except for a mortgage.
Any cosigners the potential filer has could have special protection as well.
The potential Chapter 13 filer makes their payments to a bankruptcy trustee, usually a bankruptcy attorney’s office. Filing bankruptcy immediately stops collection calls and letters.
The reorganization allows you to keep non-exempt assets such as collectibles and recreational vehicles.
A Chapter 13 filing puts an immediate end to litigation, wage garnishment, and other forms of harassment.
Even if self-employed or operating an unincorporated business, any individual is eligible to file for Chapter 13 as long as the individual’s unsecured debts are less than $394,725 and secured debts are less than $1,184,200.
If you had a bankruptcy petition dismissed in court due to failure to appear or comply with court orders within the last 180 days and didn’t receive credit counseling, you are ineligible to file.
How long is the process?
You have up to 5 years to repay your creditors.
Unlike Chapter 7, Chapter 13 will take longer to rebuild your credit, but the one benefit is it stays on your credit report for seven years versus the ten because you are rewarded for paying back some or all of your debt through a Chapter 13 filing.
To learn more about how bankruptcy works, check out this video:
Types of business bankruptcies
Most new small businesses don’t survive and are faced with deciding whether they should file for some form of business bankruptcy. Between 2005 and 2017, only about one-fifth of new small businesses lasted more than one year.
There are three types of bankruptcy filing options for business owners who aren’t sole proprietors: Chapter 7, Chapter 11, and Chapter 12.
Chapter 7 bankruptcy
The chapter 7 process for an individual versus a business is similar, but there are significant differences. Chapter 7 may be the best choice when no viable future exists. It is referred to as liquidation since its debts are overwhelming, and restructuring is not an option.
When a business files for chapter 7, it stops all operations and goes completely out of business. Chapter 7 is appropriate when the company doesn’t have any substantial assets.
Chapter 11 is a reorganization of a business with a plan to pay off its debt. It is a simplified definition, but in reality, it takes years of legal proceedings between the person filing, the Trustee, and creditors. It is the most complex form of bankruptcy and the most expensive. It is most expensive and typically used by businesses, but nearly anyone can file for this type of bankruptcy.
Under this filing, businesses remain open while they implement a reorganization plan.
According to the U.S. Courts website, some required documents for a Chapter 11 filing are:
- A list of all company assets and liabilities.
- A statement of all financial affairs (to include marriage status, previous bankruptcies, property purchases or sold, gifts, bank and money market balances, etc.) A list of all income and expenses.
- A list of all executable contracts and unexpired leases.
What are my bankruptcy options if I have a small business?
Small businesses’ primary types of bankruptcies are Chapter 7, Chapter 11, and Chapter 13.
Which type of bankruptcy you choose to pursue will mostly depend on how your business is structured, its assets, and plans for the future. For example, Chapter 13 can be a good option if you’re a sole proprietor. For Chapter 11, a small business with sufficient cash flow can remain open and make smaller payments to its creditors. In Chapter 7, a company with no cash flow can close efficiently and liquidate. Always consult an experienced small business bankruptcy attorney to learn which option is best for you.
Pro tip: If you are a service-only business like a writer, swim coach, accountant, handyman, and the likes, Chapter 7 is the best option since the Trustee cannot sell your future services. Most states exempt the equipment needed in your profession, and sometimes the Trustee will let you continue to work during the bankruptcy if you have liability insurance.
Chapter 12 bankruptcy
Chapter 12 bankruptcy is a reorganization for family farms and fishing businesses with a regular annual income.
Similar to chapter 13 bankruptcy, chapter 12 filings allow these businesses to propose a payment plan to their creditors over a 3–5-year period to eliminate debt. The repayment term will depend on a few factors, such as the debtor’s income, alimony, and child support.
The U.S. Courts website (uscourts.gov) states that to qualify for a chapter 12 filing, the prospective filer must:
- Have a farming or fishing business.
- All debts from the company must not exceed $4,153,150 (for a farming business) or $1,924,550 (for a fishing business).
- For a family farmer, at least 50%, and for a family fisherman, at least 80% of the total debts (not including the home) must be related to the farming or commercial fishing operation.
- More than 50% of the filer’s gross income for the preceding tax year must have come from the farming or commercial fishing operation.
Suppose the potential filer is a farm or fishing business that is a partnership or corporation. In that case, there may be additional criteria that need to be met if seeking a chapter 12 bankruptcy.
Other types of bankruptcies
The general goal of bankruptcy is to clear debt, but not all bankruptcies are created equal. There are six types of bankruptcies. We covered the three common types, Chapter 7, Chapter 11, and Chapter 13. But as an individual, you will be dealing with Chapters 7 and 13.
Chapter 9 bankruptcy
Chapter 9 bankruptcy is intended for municipalities to restructure their debt, including cities, towns, counties, and school districts. This type of bankruptcy can damage a community’s reputation and be heavily laden with paperwork.
While chapter 9 bankruptcy works similar to the other types of bankruptcies described, the significant difference with a chapter 9 filing is that the state cannot liquidate a municipality’s assets to settle a debt. Such a move would be a violation of the Tenth Amendment.
As with all bankruptcy filings, there are eligibility requirements. One is having permission from their state-specific government. Some states allow municipalities to declare bankruptcy on their own, while others require specific steps before filing, and some states do not allow Chapter 9 at all.
If the state grants permission for the filing, the municipality files a petition to the federal government to restructure the debt.
Chapter 15 bankruptcy
Chapter 15 bankruptcy is the new kid on the block, only being enacted into law in 2005, per the U.S. Courts website.
Chapter 15 bankruptcy allows foreign nationals to file for bankruptcy in the U.S. bankruptcy courts if they have assets, property, or business in multiple countries, including the United States.
This type of bankruptcy has five primary objectives:
- It facilitates cooperation between the courts, parties of interest, and other authorities in multiple foreign countries for international bankruptcy cases.
- It improves the efficiency of cross-border bankruptcies and includes protecting all parties’ financial concerns.
- Ensures that the filer’s assets are assessed at their fair and total value
- Creates legal stability for international businesses
- It helps companies with their financial struggles
What is bankruptcy?
According to the U.S. Courts website, bankruptcy is designed to help people who can no longer pay their debts. This works by either liquidating existing assets to pay their debts or by creating a repayment plan. There are also bankruptcy laws to protect financially troubled businesses.
All bankruptcy cases are handled in federal courts under rules outlined in the U.S. Bankruptcy Code.
Who declares bankruptcy?
Bankruptcy petitions may be filed by an individual, by spouses together, or by a corporation or other entity.
- 97% of filings are from individuals
- 62% of filings are due to medical debt. Other main reasons for filing are job loss, divorce, illness and student loan debt
- 8% of filers have filed before
- One in seven petitioners is over age 65
Consequences of bankruptcy
There are three primary consequences when you file bankruptcy:
- You likely will lose your property
- Others may be affected: For example co-signers on a loan could become financially liable for that loan when you file
- Your credit score will take a big hit. As previously mentioned, a bankruptcy will remain on your credit report for anywhere from seven to 10 years, and you should not expect to be approved for a loan or credit card for the first two years after filing
Why should you file bankruptcy?
You should only consider filing for bankruptcy for the following reasons
- You’ve already consulted with a bankruptcy lawyer who has advised you that bankruptcy is your best course of action
- You pass the Chapter 7 means test
- You are struggling to get by and cannot pay your day to day expenses
- You’ve lost your job
- You have more than $10,000 in dischargeable debt
- You already have a poor credit score (lower than 600)
- You’re facing court action or wage garnishment
- You don’t own any expensive real estate or other significant assets
How to file for bankruptcy?
Though you can file for bankruptcy without an attorney, it isn’t recommended. The process is complicated, and a single mistake could result in your case being dismissed. If you must proceed without an attorney, the U.S. Courts page provides information about the forms you need.
Once your initial forms are in order, you’ll need to determine which courthouse you need to visit, then file your paperwork in person with the clerk. At that time, you’ll have to pay your filing fee and a trustee will be assigned to your case.
If you simply cannot afford an attorney, upsolve.org is a nonprofit tool that will help you file bankruptcy for free. It offers free educational tools and customer support.
Costs of filing for bankruptcy
Filing for bankruptcy isn’t free, though there are ways to minimize the cost. At the very least, you’ll have to pay filing fees, fees for two mandatory credit counseling courses, costs incurred for the trip to federal court and charges to print your bankruptcy forms. You don’t have to hire a bankruptcy lawyer, but the bankruptcy process is complicated and you will want to consult an attorney for legal advice before you begin bankruptcy proceedings.
Considering bankruptcy? Here are the next steps
Sometimes your situation seems so hopeless that bankruptcy looks like your only option. You are scared and backed into a corner, and bankruptcy isn’t a decision to take lightly. It’s essential to know the different types of bankruptcies to make the best decision for your situation.
Bankruptcy can be a difficult time for any individual or business owner. Here are a few tips to consider before determining a bankruptcy plan:
- Get familiar with each type of bankruptcy chapter to determine the best fit for the filer’s needs.
- Consult a bankruptcy attorney. Bankruptcy laws are complicated, and there are a lot of federal rules. An experienced attorney will be familiar with the U.S. bankruptcy code and will be able to advise you on your best course of action.
- Consider the costs. Bankruptcy can be expensive for filers. It may not make financial sense to pay the various fees, depending on your financial situation and the amount of debt you have.
- Consider other debt-relief options, including a debt consolidation company or taking a loan from your savings or retirement plan.
- Call lenders and creditors and settle debt amounts, especially for consumer debt like credit cards.
- Prepare for a massive hit from all three major credit bureaus. And expect the bankruptcy filing to stay on a credit report for several years.
- Treat bankruptcy as a last resort. It will affect your financial situation for up to 10 years, depending on which type of filling you choose.
The bottom line
Bankruptcy is serious. You go before a judge and tell them you can’t pay your debts. Depending on the situation, they will erase your debts or develop a plan for you to pay them back. There are several reasons why people file for bankruptcy — things like job loss, a divorce, expensive medical bills, poor financial management, or unexpected emergencies.
Don’t let the final decision scare you. It may feel like Armageddon on your psyche, but bankruptcy can be a fresh start to a new you. Information is power.
Find a reputable bankruptcy professional who has empathy for your situation and understands you are feeling guilt and shame. The last thing you need is an advocate who ladles on judgment or condescension.
If you filed for a Chapter 7, the bankruptcy would fall off after ten years. If you filed for Chapter 13, it would fall off after seven years. It remains on your credit report for a lesser amount of time because you are being rewarded for paying back what you owe. Your score will drop dramatically and make it difficult to get new credit.
No. If a creditor is garnishing your wages, you might be able to stop the garnishment and even get some of your garnished wages back by filing for bankruptcy.
In Chapter 7 bankruptcy, the wages you earn after filing are not considered property of your bankruptcy estate, which means that they can’t take your wages to pay your creditors. As a result, you can keep all wages you earn for work performed after your filing date.
Insolvency means you’re unable to pay debts when they’re due. But there are solutions to resolve insolvency, including debt consolidation or taking on extra work. You also could work with a credit counselor or debt settlement company.
Ask for referrals from friends and family, ask your attorney, or you can search the database of the National Association of Consumer Bankruptcy Attorneys. Hit up your favorite search engine with “local bar association” and “bankruptcy attorney.” Ensure to vet the likely candidates by reading reviews, checking fees, and visiting them personally to get a feel for the person you are dealing with.