To be “bankrupt” means “of a person or organization declared in law unable to pay outstanding debts.” Essentially, this means that you are legally declaring that you cannot pay back any of the debts you have—credit card, mortgage, a business loan, etc. This is your way of letting lenders know that you will not be paying them back, and that you have borrowed too much to be able to pay back in a reasonable amount of time.
If you find yourself in this position, you have a number of options of declaring that you cannot pay back what you owe. Luckily, Congress enacted the federal bankruptcy laws to give debtors a financial “fresh start” from any heavy debts. This doesn’t mean that your debt is just absolved (except in certain cases), but it means that you are asking for a longer period of time to pay back what you owe. But what happens when you file for bankruptcy?
Declaring bankruptcy is a big decision that could affect you, your credit score, or your business for years to come. The following sections will go over each of those parts in detail to enable you to decide if filing for bankruptcy is right for you, your family, or your business.
The Bankruptcy Process
The bankruptcy process begins with a debtor filing a petition with the bankruptcy court. This petition may be filed by an individual, spouses, a corporation, or other entity. All bankruptcy cases are handled in federal courts, under rules outlined in the U.S. Bankruptcy Code.
The entire process is overseen by a United States bankruptcy judge, who is a legal judicial officer of the United States district court. The judge decides on any matter connected with a bankruptcy case; such as eligibility to file and whether a debtor should receive a discharge of debts.
Though the process is a legal matter, much of the bankruptcy process itself is administrative and is conducted away from the judge and courtroom. In cases under Chapter 7, 12, or 13, the entirety of the administrative process is carried out by a trustee who is appointed to oversee the case on behalf of the debtor.
It is strongly recommended to seek the help of a qualified lawyer during this process to understand the long-term legal and financial consequences of filing for bankruptcy. Individuals can file on their own, or “pro se,” but it is advised to file with the help of legal counsel.
Types of Bankruptcy
In Title 11 of the United States Code, or the Federal Bankruptcy Code, there are four bankruptcy filings:
- Chapter 7: Liquidation
- Chapter 11: Reorganization
- Chapter 12: Debt adjustment for family farmer with regular annual income
- Chapter 13: Debt adjustment of an individual with regular income
|Chapter 7||Chapter 11||Chapter 12||Chapter 13|
|Type of Bankruptcy||Liquidation||Reorganization||Debt adjustment for family farmers, fishermen||Debt adjustment for individuals|
|Pre-Filing Credit Counseling||Must be completed by individuals filing within 180 days prior to filing for bankruptcy, with a few exceptions|
|Minimum Debts||None||None||50% of non-home mortgage debt must be farm related if a farmer; 80% must be fishing related if a fisherman.||None|
|Maximum Debts||None||None||Farmers: $3,792,650
|Secured debt: $1,149,525
Unsecured debt: $383,175 109(e)
|Debtor Status||Individuals or corporations (no railroads, banks, or insurance companies).||Individuals, corporations, and railroads.||Family farmers or fishermen, either individuals or corporations||Individuals only|
|Income Requirements||Below median unless special hardship.||None||Regular annual income, and 50% of income from farming/ fishing.||Regular income|
Chapter 7 filing is the most common one, because companies, individuals, and married couples are all eligible to file for bankruptcy under this chapter. When Chapter 7 is filed, the debtor is essentially scrapping all of their debts and starting over—making this the ideal option for those who simply cannot afford to pay back their debts.
What that entails is a trustee being appointed to oversee the sale of the debtor’s assets—i.e., their car, home, and any belongings. Federal and state laws both allow for certain assets to be exempt in this chapter filing, meaning that the debtor might be able to keep some assets including their home.
Once their assets are liquidated, the appointed trustee pays creditors a certain amount of the money raised from the liquidation of the assets. If not all creditors are able to be paid back, the financial obligation from those that were not paid back is “forgiven” or discharged.
However, there are some debts from which the debtor cannot be forgiven. These permanent debts include alimony, child support, and taxes, with student loans rarely being forgiven.
Once someone has filed under Chapter 7, they cannot file again for another seven years. Any debts that were not forgiven in a previous filing will not be discharged in the next one.
Chapter 13 filing is reserved for individuals alone, and is essentially the debtor asking for help and leniency in paying back their debts. A debtor can file for Chapter 12 or 13 as long as they have a steady, reliable income with:
- less than $269,250 in unsecured debt (meaning lenders have no rights to any collateral for the debt)
- less than $807,750 in secured debt (meaning this debt is secured by an asset, such as a house or car)
Once the filing is made, the debtor is assigned to a trustee who together develop a proposal for a repayment plan. The court then decides to accept or alter the given plan, or dictate another plan altogether. Once a repayment plan is decided on, it can last anywhere from three to five years.
Chapter 11 bankruptcy filing is very similar to Chapter 13 filing. The main difference between the two is that with Chapter 11, there is no limit regarding the amount of money owed by the debtor.
This chapter was originally intended only for large corporations, but is now open to allowing individuals to file as well.
Filing for Chapter 12 and Chapter 13 are essentially the same filing. The only difference is that Chapter 12 filing is reserved for family farmers or fishermen.
The main appeal for filing chapter 12 or 13 is that debtors do not need to liquidate their assets, and get to keep everything—not just the items legally exempted. In most Chapter 12 or 13 filings, the debtor is only repaying a percentage of what is actually owed, sometimes as little as 30 cents on the dollar.
When Should You File?
Deciding when, or if, to file is a big decision. There are many things to consider when deciding if filing is the best option to get you out of debt, but there are a few signs to look out for that may indicate it’s time to move forward and file for bankruptcy.
Signs it’s Time to File as an Individual
Some of the two biggest reasons to consider filing for bankruptcy as an individual include job loss and medical debt—in some cases, both can happen and put the debtor even further in debt.
The other situations that may warrant declaring bankruptcy for yourself or family include:
- Being sued by creditors for payment of debts
- Home is in danger of foreclosure
- Only being able to pay for things using a credit card
- Considering withdrawing money from 401(k) to pay bills
- Using one credit card to pay off another
Advantages of Filing
Though filing for bankruptcy is a heavy decision that will impact your credit for quite some time, there are advantages for filing if this is indeed the right course of action for yourself and your debts. These advantages include:
- Filing triggers the automatic stay, which prevents creditors from taking action to collect their debts, repossessing property, suing, or any other actions they may take to get a payment from you
- The automatic stay also puts an end to the threat of evictions, foreclosures, utility shutoffs, or wage garnishments
- Being able to discharge your obligation to repay any of your dischargeable debts
- When using bankruptcy exemptions, you may be able to go through the process of filing without losing any property
- Due to many debts being discharged in a bankruptcy filing, many debtors may see improvements to their credit rating after filing
- Not having credit cards can teach you to live within your income and prevent any future financial fallout
- Debtors who file personal bankruptcy are required to take credit counseling, meaning you have access to education to help you learn financial habits and make better decisions in the future
Disadvantages of Filing
Due to bankruptcy being such a serious and long-lasting decision, there are many disadvantages to filing. These include:
- Property and belongings being seized for liquidation
- Bankruptcy being noted on your credit report for five to seven years
- Many credit card companies automatically cancel your cards with them when you file, making it more difficult to get new credit cards or other lines of credit
- A recent filing could hinder or prevent your ability to obtain a mortgage or loan
- Tax refunds from federal, state, or local governments may be denied based on your filing
- Many employers and landlords look unfavorably on a recent filing
- Filing can drive up your insurance premiums
- Some debts become non-dischargeable after filing, including student loans, child support, and alimony.
The decision to file for bankruptcy is a big one. It can have a lasting impact on your personal life, finances, relationships, and credit score for years to come. There are many moving parts of declaring bankruptcy, including what filing for bankruptcy even means, which chapter to file, the process of filing, whether to file for your organization or personal self, and the advantages and disadvantages of filing.
Since the decision of whether or not to declare is such an important one, it’s very important to be thoroughly educated on the different aspects and processes of declaring bankruptcy before doing so. Using this guide, you will hopefully have a better understanding of the ins and outs of the bankruptcy process, the different chapter filings, and whether or not filing is the best decision for you.