Buzz
Bankruptcy might seem like the ultimate downfall, but many businesses that file for bankruptcy can keep running without missing a beat. What’s less known is that individuals too can survive bankruptcy and come out unscathed. Let’s explore how each bankruptcy type impacts your finances in distinct ways.
The distinctions between Chapter 7, 13, and 11
Typically, bankruptcy is a last resort for those who can no longer meet their financial obligations. While it’s often thought of as a result of overspending on credit cards, it can also occur after an unexpected financial setback—like a lawsuit or a sudden illness.
A common misunderstanding is that bankruptcy completely eliminates all your debt. That’s not true. You will still need to pay, and how much you owe depends on the type of bankruptcy you file: chapter 7, chapter 13, or chapter 11. Other bankruptcy types exist, such as chapter 12 for farmers and fishermen, but these three are the most frequently used.
Under chapter 7, you might need to liquidate certain assets (such as a second home or car) to cover at least part of your debt. Many of your assets are likely exempt, but this varies depending on your state, financial situation, and whether the asset is considered 'essential.' To file for chapter 7, you must meet certain eligibility requirements, with a lower-than-average income often being the most crucial factor.
Chapter 13 lets you repay your debts over three to five years through a structured payment plan, while allowing you to keep your assets. Some of your debts may be discharged. However, qualifying is a requirement: your secured debts (like your home or car) must not exceed $1,184,200, and unsecured debts must be less than $394,725.
Chapter 11 works similarly to chapter 13 in that you keep your assets, but it’s mostly used by businesses. Although businesses can file for chapter 7, liquidating assets often threatens their survival, so chapter 11 is a more viable option. Sometimes high-income individuals file for chapter 11 as well since they exceed the debt limits of chapter 13. Ultimately, chapter 11 allows you to retain your property, but a plan to repay or forgive some of your debt is necessary.
What happens when you file
When you file for bankruptcy, an automatic stay is put into effect, halting your debt obligations. This stay prevents creditors and collection agencies from pursuing payments. During this period, your wages can’t be garnished, and creditors cannot seize any secured assets.
Ironically, filing for bankruptcy isn’t without its costs. The filing fee alone for chapters 7 and 13 exceeds $300. On top of that, you’ll face attorney fees. While it’s possible to file without a lawyer, it’s not advised due to the complexity of bankruptcy laws. Average attorney fees for chapter 7 are about $1,500, while chapter 13 fees usually range from $2,000 to $3,000. As with many legal services, the more complicated your case, the higher the cost.
There are ways to reduce the legal fees associated with filing for bankruptcy. For example, the nonprofit Upsolve offers free assistance to help you generate your bankruptcy filing forms if your case is relatively simple. Additionally, your local legal aid society may offer affordable legal services.
As part of the bankruptcy procedure, you’ll be required to complete one or more courses. The government mandates that individuals undergo credit counseling within 180 days prior to filing, and you must also take a debtor education course if you wish to have your debts discharged.
A few weeks after filing, you’ll need to attend a 'creditors meeting,' which is exactly what it sounds like: a court session with you, your bankruptcy trustee, and any creditors who wish to attend. During this meeting, all parties will ask you questions regarding your financial situation and the reasons behind your bankruptcy filing.
Chapter 7 involves the liquidation of your assets
Nolo points out that in most situations, those filing under chapter 7 do not have to sell their property (unless it’s collateral), as it is often exempt or deemed not valuable enough. They further explain:
If the property is of low value or would be difficult for the trustee to sell, the trustee might decide to 'abandon' the property, which means you can keep it, even if it’s nonexempt. In fact, most assets held by chapter 7 debtors are either exempt or too insignificant to be sold for creditors’ benefit. As a result, few debtors end up having to give up any property, unless it's pledged as collateral for secured debt...
After the creditors' meeting, your trustee will assess whether your assets should be liquidated. If they are, you’ll either need to surrender the items or provide their cash equivalent to pay off your debts.
With chapter 13, you are provided with a payment plan
With chapter 13, you must adhere to a repayment plan to settle your debts, and some of these debts must be fully paid. These are called 'priority debts,' which include obligations such as alimony, child support, taxes, and wages owed to employees.
Your repayment plan is determined by how much you owe and your income, providing specific details on how much you need to pay and the deadlines for each payment.
What happens to your credit and your debt
Your credit score will take a significant hit after any bankruptcy filing. FICO explains that the more accounts involved in your bankruptcy, the more severe the impact on your score. Typically, a chapter 7 bankruptcy remains on your credit report for 10 years, while chapter 13 stays for seven years.
Once the bankruptcy process is complete, most debts are discharged, though not all. In certain cases, student loans may be discharged after bankruptcy, but you must pass a federal hardship test to qualify.
Other examples of debts that are hard to eliminate include:
Unpaid taxes
Spousal and child support payments
Debts from divorce, such as property settlement obligations
Bankruptcy is often a last resort for those facing extreme financial distress. However, understanding its process and knowing what to expect can help you navigate it more effectively.
