Generally speaking, the term “bankruptcy” brings to mind either a loser at Monopoly or an individual admitting failure to manage his or her own money. It doesn’t have to imply a catastrophe or personal carelessness with money. Choosing to file bankruptcy is a conscious decision to repay debts in a manner accepted by both debtor and creditor. For those whose wages are being garnished, those with medical debts they can’t afford, those who have exhausted their savings and wealth in assets but still can’t eliminate their debt, bankruptcy may be the best option to clear their financial slate and start over without the burden of past debt.
Before filing, consumers are required to take a credit counseling class and consider if an extended repayment plan, lifestyle changes or assistance from friends or family members may be able to resolve their debt problems. A debt consolidation program can help by combining all your debts into one monthly payments of a manageable size. The program handles all of the paperwork and negotiations with creditors so you won’t receive calls from collection agencies. Only unsecured debts are included in such programs, so your house and car payments will remain separate.
Bankruptcy is meant as a last resort option; first determine if you can negotiate alternate payment plans or loan modifications. Individuals with a steady source of income that is insufficient for a standard repayment plan are likely eligible for such plans. If you are not eligible or still can’t manage the payments, get help ASAP. Putting it off and hoping for a miracle will only dig your debt hole deeper. The National Foundation for Credit Counseling (NFCC) is a smart place to start. Their website has educational materials on financial topics such as bankruptcy, housing crisis counseling and money management advice in addition to credit counseling. The credit counseling class which debtors must take before filing for bankruptcy is available online, by phone or in person; the NFCC site can direct you to a certified counselor in your area. Most of their services and content are free. You’ve probably seen TV and internet ads for “debt settlement” organizations promising to cut your debt in half. Legitimate agencies work by collecting payments from you, setting them aside in an account and eventually offering a lump sum to creditors to settle your debts. While your payments go to the debt settlement agency, your creditors don’t see them and your credit score drops. Furthermore, your creditors are not required to accept the smaller lump sum and can simply demand continuing payment on the entire amount. Most of such agencies are scams, charging upfront fees and often never contacting your creditors at all.
Bankruptcy attorneys will often provide free initial consultation and work out a future payment plan. Debtors may file without an attorney, but the process and the paperwork are complicated and overwhelming for many. A good bankruptcy attorney will be worth the investment to know that the case will be handled according to procedure and not dismissed due to past deadlines or missing paperwork.
Multiple types of bankruptcy exist with different rules and procedures attached, named for the chapter of the Bankruptcy Code which lays them out. Chapter 7 and Chapter 13 are most common for individuals. Businesses typically qualify for Chapter 11 or 7 bankruptcy, and Chapter 12 applies to family farmers.
The purpose of Chapter 7 bankruptcy, by the Bankruptcy Code, is “to discharge certain debts to give an honest individual a fresh start.” Also called straight bankruptcy or liquidation, a trustee sells most of the debtor’s assets and repays creditors with the proceeds. The debtor can claim some property as exempt, most commonly a vehicle and residence, subject to limits on the value of exempted property and other policies that vary by state. Most unsecured debts are discharged, but exceptions include student loan debt, child support, property and recent income tax and court-ordered restitution for crimes committed by the debtor. Not all individuals will qualify to file Chapter 7 bankruptcy. Those with income above the median income of their state face a “means test” based on their disposable income. Abuse of the bankruptcy laws is presumed if the debtor’s disposable monthly income exceeds a specified amount portion of their debts. The bankruptcy case may then be dismissed or converted to Chapter 13 bankruptcy. A chapter 7 bankruptcy stays on the debtor’s credit report for 10 years from the date of filing the petition.
For a business wishing to remain in business or individuals with many assets, Chapter 11 bankruptcy allows reorganization of debts and does not require liquidation of assets. The debtor must prepare and present a plan to the court detailing a repayment plan of outstanding debts. This enables a business to continue operation and (hopefully) turn a profit to repay creditors. If not, the case may convert to Chapter 7 bankruptcy.
For individuals with regular income or for sole proprietorships (the self-employed), Chapter 13 enables them to preserve assets in exchange for regular payments to their creditors over a three to five year period. The debtor must create a repayment plan subject to the approval of the court and creditors. The law requires the payment plan to be submitted within 14 days of filing the bankruptcy petition, so it is crucial to prepare the plan before filing. The case may be dismissed if the debtor misses this or other deadlines in the process.
Bankruptcy is often stigmatized, but it is simply a financial tool offering a life raft for those drowning in debt. It gives debtors a chance to repay their debts to the best of their ability, no more, and move forward with a clean slate. So you lost at a game of Monopoly once. You can start a new game and have the benefit of learning from your mistakes without being haunted or hindered by them.