Financial Terms / A - B / Bankruptcy

What is bankruptcy?

Bankruptcy is a legal process that helps you when you can't pay your debts. It gives you a fresh start by either liquidating your assets or creating a repayment plan. This process also protects businesses facing financial troubles.

Types of Bankruptcy

There are different types of bankruptcies, each named after a chapter in the U.S. Bankruptcy Code:

1. Chapter 7: For individuals and businesses to liquidate assets
2. Chapter 13: For individuals to create repayment plans
3. Chapter 11: For businesses to reorganize
4. Chapter 9: For municipalities to reorganize
5. Chapter 12: For family farmers and fishermen
6. Chapter 15: For cases involving parties from multiple countries

Chapter 7 Bankruptcy

Chapter 7, also known as liquidation bankruptcy, is the most common type for individuals. Here's how it works:

1. You sell nonexempt assets to pay creditors
2. The court appoints a trustee to manage your case
3. The trustee sells your property and pays off debts
4. You keep exempt property (varies by state)
5. The court discharges remaining eligible debts

Chapter 13 Bankruptcy

Chapter 13, or wage earner's bankruptcy, allows you to keep your property and pay debts over time. Key features include:

1. You create a 3-5 year repayment plan
2. It can stop foreclosure proceedings
3. You may cure delinquent mortgage payments
4. It protects co-signers on consumer debts
5. A trustee distributes your payments to creditors

Remember, not all debts can be discharged through bankruptcy. Examples include child support, alimony, and some tax debts.

The Bankruptcy Process

Credit Counseling

You must complete a credit counseling course from an approved provider within six months before filing for bankruptcy. This course helps you decide if bankruptcy is the best option for your financial situation. It typically lasts one to two hours and involves discussing your finances and creating a personal budget.

Filing the Petition

Filing bankruptcy involves extensive paperwork. You'll need to complete over 20 forms, totaling up to 70 pages. These forms detail your income, expenses, assets, and debts. While you can file without an attorney (pro se), it's strongly recommended to seek legal advice due to the complexity of the process and its long-term consequences.

Meeting of Creditors

About a month after filing, you'll attend a meeting of creditors, also known as a 341 hearing. This meeting, conducted by the bankruptcy trustee, usually lasts 5-15 minutes. The trustee will verify your identity and ask questions about your financial situation. Creditors may attend but rarely do. You must answer all questions truthfully under oath.

Discharge of Debts

The final step is the discharge of debts. In Chapter 7 cases, this occurs about four months after filing, once the trustee reviews your case. For Chapter 13, discharge happens after you complete your 3-5 year payment plan. You'll receive a Notice of Discharge, which legally releases you from liability for the discharged debts.

Remember, not all debts can be discharged. Child support, alimony, and certain tax debts, for example, typically remain your responsibility even after bankruptcy.

Effects of Bankruptcy

Impact on Credit Score

Filing for bankruptcy has a significant effect on your credit score. You can expect a drop of 100-200 points, with those having higher initial scores experiencing a more substantial decrease. This negative mark stays on your credit report for 7-10 years, affecting your ability to obtain new credit. Chapter 7 bankruptcies remain for 10 years, while Chapter 13 filings stay for 7 years.

Exempt vs. Non-exempt Assets

Bankruptcy exemptions allow you to protect essential property. Most Chapter 7 filers keep all or most of their assets due to these exemptions. Exempt property often includes:

1. Your primary residence
2. A vehicle (up to a certain value)
3. Necessary household goods
4. Tools for your job
5. Some jewelry and personal items

Non-exempt assets may be sold to pay creditors. These can include:

1. Secondary properties
2. Luxury items
3. Valuable collections
4. Investments (except retirement accounts)

Future Financial Implications

Bankruptcy affects your financial future in several ways:

1. Higher interest rates on future loans
2. Difficulty renting apartments
3. Increased car insurance rates
4. Potential employment challenges in certain fields
5. Inability to get a guaranteed mortgage for two years

Despite these challenges, it's possible to rebuild your credit over time. Many people obtain credit cards shortly after discharge, though often with high interest rates.