What Does Bankruptcy Mean and Should You File For It?
I remember while I was growing up, I only really heard about bankruptcy when it came to celebrities like MC Hammer or big businesses like General Motors. I also thought that bankruptcy was something that you could never come back from and was a big admission of defeat and failure. People talked about it like the people who file were stupid and should be ridiculed. But as I’ve gotten older, as with most things, I’ve realized that it’s more complicated and nuanced than that. Sometimes bankruptcy can be the best choice for some people.
What Is Bankruptcy?
Bankruptcy is a legal process for an individual, family, or corporation that finds themselves unable to pay off their debts. In this scenario, the person or entity can have some or all of their debt erased.
There are two different kinds of bankruptcy for individuals: Chapter 7 and Chapter 13 (Chapter 11 is only for businesses). Chapter 7 is the simplest approach, also known as liquidation bankruptcy, that wipes out most of your unsecured debts such as credit cards and medical bills without requiring a repayment plan. In this scenario, any assets of value will be sold to help pay back your debts. If you have no assets of large value, it is called a “No Asset Case,” and the courts will not sell your property. In 2016, 63 percent of bankruptcies were Chapter 7. To qualify, you must meet income requirements that show that you literally don’t have enough money to pay back your debts.
If you make “too much” money, meaning you have a consistent income and have anything left over after paying your required monthly costs, you have to file under Chapter 13. This is an option for people who are struggling to pay back their debts and are being harassed by creditors, not those who don’t have the income to make any payments. Many people choose to file for Chapter 13 because it offers benefits such as catching up on missed mortgage payments without losing their home. Under Chapter 13, you have three to five years to resolve your debts.
What Is the Process for Filing?
Find a Good Attorney: You should find an attorney to help you through this process. Make sure they are experienced in bankruptcies and familiar with bankruptcy law. Your state bar association should have directories with bankruptcy attorney information. There are also online directories, such as the National Association of Consumer Bankruptcy Attorneys and the American Board of Certification, where you can find a qualified attorney.
Conduct a Bankruptcy Counseling Session: There are two mandatory credit counseling sessions that must be completed with a counseling agency that has been approved by the U.S. Justice Department. The first round of counseling happens before you file bankruptcy paperwork with the courts. During that session, the counselor will review your budget and look at the pros and cons of bankruptcy, as well as proposing alternatives to bankruptcy.
File for Bankruptcy With the Court: After completing counseling, you officially file with the court. At this point, the bankruptcy will appear on your credit report and creditors must stop attempting to collect on your debt. This is because bankruptcy invokes an “automatic stay,” which stops all legal activities the moment the bankruptcy is filed.
Liquidation or Repayment: Depending on which type of bankruptcy you file, the next step may involve liquidating any assets of value to repay your creditors (Chapter 7) or repaying a portion of your debt (Chapter 13). If you have secured debts that you wish to keep, like a house or car, you will need to keep making payments on those debts. You must tell your attorney about any secured debts that you would like to keep after bankruptcy.
Complete a Debtor Education Course: This is the second round of required credit counseling sessions. You must complete this before discharge.
Debt Discharge: At the end of this process, eligible debts will be discharged. This means that they will be wiped out and you will have no obligation to pay the creditors included in the bankruptcy.
What Are the Limitations of Filing?
Not everyone can file for bankruptcy. There are certain limitations in place. For example, you may not file if you obtained a discharge in a Chapter 7 case within the past eight years, or in a Chapter 13 case within the past six years. You may not file if a previous bankruptcy case was dismissed within the past 180 days because you violated a court order, you were determined to have engaged in fraudulent conduct, or you requested dismissal after a creditor requested relief from the automatic stay. There are also income and debt limitations.
There are several types of debt that will not be erased if you file bankruptcy:
Most student loan debt
Court-ordered child support
A federal tax lien for taxes owed to the U.S. government
Government fines or penalties
Court fines and penalties
So if you have any of these debts, you cannot get rid of them through bankruptcy. That’s important to know before you go through the process.
What Are the Benefits of Filing?
Of course, the obvious benefit of filing for bankruptcy is having some or all of your debts erased. This would allow you to start from scratch, financially speaking, and hopefully make better decisions moving forward. It can also be helpful to have a clear way forward, even if you are required to pay back your debts through Chapter 13.
What Are the Consequences of Filing?
As with most big financial decisions, you must weigh both the pros and cons. After doing that, you have to see if the benefits of a decision are worth the negative consequences of it. And the answer to that question will be different for everyone. But here’s what you need to know about the negatives of filing for bankruptcy:
Loss of property: If you file for Chapter 7, your assets will be liquidated to pay back your debt. If you cannot afford to continue paying on secured debts like a house or a car, those would be sold to pay back the debt.
Damaged relationships: If a family member or other loved one is a co-signer on any of the debt that you are trying to wipe, they might still be responsible for paying it back. If you are filing for bankruptcy and they aren’t, the responsibility could go to them. This could hurt your loved one’s financial situation, and damage your relationship with them in the process.
Damaged credit: Bankruptcies are considered negative information on your credit report, and can affect how future lenders view you. This may prompt creditors to deny you for credit or offer you higher interest rates and less favorable terms. Depending on the type of bankruptcy you file, the mark can appear on your credit report for up to a decade.
When Should You File?
Filing for bankruptcy is not a decision you should make lightly. And it’s not an easy solution to get out of a bad situation. However, like I said in the intro, sometimes bankruptcy is the right option.
Bankruptcy might be right for you if:
You’re being sued by creditors: If creditors are taking legal action against you for debts you haven’t repaid, you’re in a bad situation. Of course, if you’re being sued for debts you can afford to pay back, you shouldn’t file for bankruptcy; you should pay back the debt or settle with the creditor. But if you’re being sued for debts you couldn’t possibly pay back, bankruptcy might be a good option for you.
You’re at risk of foreclosure: If your other debts are making it so that you’re unable to pay your mortgage and you’re at risk of foreclosure, bankruptcy could be an option for you. You can request to keep your secured loans, like your mortgage, if you can afford to make the payments once your other debt is wiped out.
You’re using loans to pay your bills: If you’re relying on things like payday loans just to get by everyday, you clearly are in a bad financial situation. Taking out loans to pay for your everyday expenses is a bad practice that will only keep you in a cycle of debt and overwhelm.
You’re liquidating your retirement assets: Liquidating your retirement accounts should be the absolute last thing that you do to get ahead. As Social Security becomes less reliable, saving for retirement is really the only way we can ensure that we’ll be supported in our old age. If pulling from your retirement accounts is the only way you can think to afford your life or pay back your debts, it might be time to look into bankruptcy.
What Are Your Other Options?
For many, bankruptcy is not the right option. And it isn’t always necessary to do. There are other avenues you can take to get control over your debt and manage your payments more successfully. This is especially true if your financial troubles are temporary and you can see a way out in the future.
Talk to a Credit Counselor
This is an option that I’ve recommended to clients in the past. Working with a credit counselor allows you to create a plan to pay down your debt and move forward. Credit counselors can sit down with you to look at your entire financial situation, create a budget, and even help you come up with a debt management plan that helps you repay your debts. A debt management plan is when you and your creditors make an agreement for you to pay down your debts.
It’s important here to look for a nonprofit credit counseling organization that belongs to either the National Foundation for Credit Counseling (NFCC) or the Financial Counseling Association of America (FCAA).
Get a Second or Part-Time Job
Of course, this suggestion isn’t easy and it won’t be possible for everyone, but sometimes the solution is to bring in more income. I’ve had plenty of clients who have cut every expense that they possibly could, and they could still barely break even. In that case, the only way forward is to bring in more income. It’s the same when your debt is overwhelming you and you’re struggling to make a dent on it. If asking for a raise at work isn’t an option, look into getting a side job. If you do this, make sure you’re putting that income solely towards your debt payments. If you start spending the money somewhere else, you’ll still be stuck where you are.
Negotiate with Lenders
Did you know that we have more power as customers than we think we do? In a Capitalist society, businesses need their customers in order to survive. That’s why we can vote with our dollars. It’s true, then, that we can try to negotiate with our lenders when it comes to paying back debt. In fact, last week, someone in the Money Circle group said that they tried to set up a payment plan with their doctor for a big bill and the doctor’s office forgave the whole amount!
It’s certainly not a given that your debts would be reduced or forgiven, but it doesn’t hurt to ask. Reach out to your lender and tell them about your current financial struggles. After for a reduced amount to pay or a repayment plan that you can afford. The worst they can say is “no” and you’ll just still be in the same situation you’re already in. In the best case scenario, they will reduce or forgive your debt and you’ll be better off!
If you’re in a situation where you think that bankruptcy is right for you, it’s important to remember that you’re not a failure. Go talk to a lawyer and see if this is the right decision. Ask for help so that you can get your life back on track.