Personal Bankruptcy RealitiesIf you're ready to declare personal bankruptcy, there's a good chance you're either terrified of the consequences or convinced that this drastic step will be a cure-all. Unfortunately, there are many misconceptions about this topic. Many people tend to see it as an admission of financial failings and irresponsible behavior, which is often far from the case. In reality, loss of employment and medical emergencies are among the most common causes of bankruptcy. Before the passage of the Affordable Care Act in 2010, around 62% of bankruptcies were estimated to be caused by medical expenses. Under the new Trump administration, and with the future of the ACA in jeopardy, these conditions may return.
On the other end of the spectrum, many people who advocate filing for bankruptcy would have you believe that filing is nothing short of a miracle cure. Attorneys, for example, often describe filing as a quick and easy process, and a simple solution to get out of debt. Things are a little more complicated than that. Filing for personal bankruptcy is far from easy and can have long-term consequences.
To counteract these misconceptions, let's look at some sobering realities.
What is Bankruptcy?Despite all the negative connotations associated with the term, bankruptcy is just a court proceeding. If you file, a judge and a court trustee will examine your assets and liabilities to determine whether you are capable of paying your bills. If the court has decided that you can't pay, the judge may choose to discharge your debts, meaning you are no longer legally required to pay them.
The purpose of this proceeding (and the associated laws) is to give a second chance to people whose finances have completely collapsed.
Reading these words may have you doing backflips for joy, but hold on a minute! It may sound simple, but there's a lot more to learn before you make a decision. Let's look at the types of bankruptcy:
Chapter 7Under Chapter 7, your liquid assets will be used to pay off as much of the debt as possible. "Liquid assets" are any of your personal belongings that you can quickly turn into cash. Bank accounts are a good example of liquid assets. Your state laws will dictate which of your liquid assets are exempt and non-exempt. The courts cannot use exempt assets to repay your debt, but they will seize your non-exempt assets and use them as partial repayment of the debt through a process of distribution among your creditors. Bought yourself a Toyota Supra as a second car and decked it out like that sporty number in The Fast and the Furious? If you file for Chapter 7, somebody else is going to be driving that car.
After this distribution of your non-exempt liquid assets, the courts will discharge your remaining debt, and you will no longer be held legally liable for it. Neither the original creditors nor any third-party collection agencies can make any further attempts to collect the debt.
Qualifying for Chapter 7 involves passing a test designed to determine whether your income, which is relative to your family size, is less than your state's median. If you pass the test, the courts will approve you to declare Chapter 7 bankruptcy, and you'll be required to take credit counseling from an approved agency. If you fail the test, you won't be filing for Chapter 7. You can still file for Chapter 13.
Chapter 13With this option, you must submit a three to a 5-year repayment plan to the court. This plan needs to outline how you intend to repay your debt either partially, or in full within that period. Remember, you will begin making payments to the court right after you've submitted your plan, and the court then pays your creditors.
Important note: even if the court doesn't subsequently approve your repayment plan, you are still required to make these initial payments!
The court will decide on approval of your plan at a hearing a few weeks after filing. Your creditors can and probably will object to the amount you've offered to pay, but the final decision goes to the judge. If your plan is approved, you'll continue making those payments to the court. You must also receive credit counseling. Your remaining debt will be discharged as soon as you've completed the approved Chapter 13 payment plan.
Filing for Chapter 13 doesn't have to be a backup plan to Chapter 7; in some situations, it might be the better option. If you have a car loan or any other kind of secured debt that you'd like to keep paying, Chapter 13 should be your first choice. Why? Well, remember that Chapter 7 requires you to give up those non-exempt liquid assets. Chapter 13 is the way to go if you don't want to lose any of your personal possessions, or your income level is above your state's median.