What is Bankruptcy and How Does It Work?

If you are in deep debt and have no other options, bankruptcy may be an option. You should be aware of the risks and benefits associated with such a drastic move. We will explain how bankruptcy work and help you decide if it is the right option for you.

What is bankruptcy?

Bankruptcy allows people or businesses who are unable or unwilling to pay their debts to file for bankruptcy. You can petition for bankruptcy as a person, company, or municipality.

What are the steps to file for bankruptcy?

Your debts will be either restructured or completely wiped out when you file bankruptcy. This means that you won’t have any to pay. The process varies depending upon the bankruptcy chapter you file.

What are the best times to file bankruptcy?

If your obligations are so overwhelming that it is impossible to make your payments on time, you might consider declaring bankruptcy. Bankruptcy is designed to give individuals, businesses and governments the opportunity to either wipe away a portion of their debts or start over.

It is not a good idea to consider bankruptcy if you have a lot of debt or are in a temporary financial crisis. Filing bankruptcy can have serious consequences and you will not be able to get out of jail. If you have tried to pay your debts but are still finding yourself in a financial bind, bankruptcy should be considered as an option.

There are many types of bankruptcies

Bankruptcy is not a solution that fits all. There are many bankruptcy chapters that can be applied to different situations. There are two options for filing personal bankruptcy: Chapter 7 and Chapter 13.

Bankruptcy under Chapter 7

Chapter 7 is personal liquidation bankruptcy. Chapter 7 is a personal liquidation bankruptcy. The trustee appointed by the court to manage your assets will pay all of your obligations. 

Any remaining unsecured debts will be discharged. The amount of assets that can be exempted depends on the state. Unsecured debts include credit card balances or medical expenses that don’t have collateral.

The means test will make it more difficult to qualify for Chapter 7 than Chapter 13. If your income is below the state’s median income for your family size (depending upon how many dependents you have), then you will pass the means test to be eligible for Chapter 7. 

You can subtract certain costs from your income to determine whether it is below the minimum income threshold.

You can either pass or fail the means test to see if you are eligible for Chapter 7 bankruptcy. Or, file a Chapter 13 bankruptcy.

Bankruptcy under Chapter 13

Chapter 13 is a personal restructuring of debt. If your wages are too high for Chapter 7, you may be eligible for Chapter 13. If your wages are too high to qualify for Chapter 7, you may apply for Chapter 13. Your debts will then be restructured, possibly reduced, so that they can be paid off within three to five years. To oversee the process, a trustee will be appointed.

You can keep your assets during the bankruptcy process by filing Chapter 13 instead of Chapter 7. Let’s suppose you want to keep some artwork or electrical equipment. These items may be sold by a trustee to repay your creditors under Chapter 7, but they are yours to keep under Chapter 13.

Chapter 13 is a great option if you own a home and want to keep it. To keep your house, you’ll have the opportunity to pay off any outstanding mortgage payments through Chapter 13. 

Keep in mind that Chapter 7 bankruptcy will allow you to keep your home, provided you are able to make your mortgage payments. Chapter 7 filings do not include provisions that will help you make up missed payments. If your property is in good enough condition, your trustee might decide to sell it to repay your creditors.

A second point to remember is that Chapter 13 filers are more likely to have enough money to pay their mortgages than Chapter 7 filers. This is why Chapter 13 filers should not lose their house.

There are other forms of insolvency

There are two options when filing personal bankruptcy: Chapter 7 and Chapter 13. While you are considering your options, you might come across one more type of bankruptcy.

Chapter 9

Chapter 9 is available to towns, states, or other public entities, like school districts, that are unable to meet their financial obligations. Chapter 9 debtors attempt to restructure their debts to make creditors pay as little as possible. The extent to which creditors are paid is determined by the filer’s income and assets.

Chapter 11

A Chapter 13 is the same as Chapter 11, but Chapter 11 allows businesses to restructure and pay their debts. A Chapter 11 plan of restructuring is filed by a business that details how it will pay its current obligations. 

Chapter 11 is designed to allow the business to continue to function. Chapter 7 liquidations are available to companies, however, in this case the filing firm doesn’t try to stay in business but instead shuts down operations and pays creditors as much as possible.

Chapter 12 

Chapter 12 is a debt restructuring procedure that’s specifically for fishermen and farmers. This works in the same way as Chapter 13 bankruptcy except that you must be involved with commercial farming or fishing to qualify.

Chapter 15

Chapter 15 of the United States Bankruptcy Code is a relatively new chapter. Its purpose is to promote collaboration between international and US courts in the event of a foreign company declaring bankruptcy.

What are the steps to declare bankruptcy?

An attorney can help you decide if bankruptcy is right for you. To assist your attorney in making this decision, you will need to gather the following documents:

  • Tax returns for the past several years
  • For the past six months, pay stubs and other evidence of income (or a lack thereof)
  • Statements from bank accounts
  • Statements about retirement or investment accounts
  • You will need copies of your mortgage and vehicle registration if you have a house or car.
  • A list of all your current outstanding debts
  • List of all other important assets, including artwork, jewelry or other valuable items.

Before you can file for bankruptcy, you will be required to take a credit counseling class. The goal of that course is help you decide if bankruptcy is right for you.

After you have completed the course, you will need to file the bankruptcy paperwork related to the chapter you are pursuing with your local courts. An attorney may help you complete this stage. 

A bankruptcy trustee will then be appointed to your case. This trustee will oversee the necessary activities such as the sale of your assets under Chapter 7 and the implementation of your Chapter 13 personal debt restructuring plan.

How much does declaring bankruptcy cost?

Filing bankruptcy can be very expensive. Cost of a bankruptcy lawyer will depend on where you live, what chapter you are filing, and how complex your case is. A Chapter 7 bankruptcy attorney will charge between $1,000 and $1500. A Chapter 13 attorney will cost between $2,500 to $3,500. These are only estimates.

The court costs to file bankruptcy are $335 for Chapter 7 or $310 for Chapter 13. A small fee will be charged for credit counseling. This charge can range from $20 to $50 depending on your income.

Bankruptcy’s Repercussions

You might think that bankruptcy is the best solution to your financial problems. You should be aware of the consequences. One, Chapter 7 can lead to the loss of your house if you have it. You also have other precious possessions like family heirlooms and jewelry.

Additionally, bankruptcy proceedings are public records, so anyone who knows you could theoretically get all the details of your assets and how much you owe. You may also say goodbye to privacy.

What happens to credit scores if you don’t pay your bills on-time?

If you file for bankruptcy, it means that your finances are not in order. Your credit score will suffer. Surprisingly though, the more damage your credit score suffers the longer it isn’t. You’ll feel less of an impact if your credit score isn’t great. If your credit score is 700 or more, you may see your credit score drop by 200 points. You may lose less than 150 points if your score is lower.

How does bankruptcy affect your credit score?

Chapter 13 bankruptcy filings will be on your credit report for seven year. Chapter 7 filings, however, will be kept on your credit report for ten years. It is possible that you will have difficulty borrowing money at a reasonable interest rate or obtaining money. It is possible that you have difficulty getting a rental property approved.

If bankruptcy is not an option

While bankruptcy can be a great way to address unsecured obligations, it will not eliminate all of them.

These are just a few:

  • Internal Revenue Service – Back taxes
  • Child support payments
  • Alimony payments
  • Late fees and debts that are a result of breaking the law.

If you are unable or unwilling to make your mortgage payments, bankruptcy won’t protect your home.

There are other options

You can see that filing bankruptcy has serious consequences. It may be worth exploring other options to help manage your debt.

These are just a few.

1. Consolidation of debts

Debt consolidation is the act of consolidating multiple debts into one loan.

It has many benefits.

Your new loan will have a lower interest rate than the existing debt so you can repay it faster and for less money.

A single loan is easier to track and eliminates the risk of missing payments.

These are some ways you can combine your debts:

  • A balance transfer is the process of transferring your existing debts to one credit card.

Balance transfer cards may offer 0% introductory APR, but this varies depending upon the deal you are eligible for.

  • Personal loans are loans that you can take out to pay your current debts and then repay them over time.
  • A home equity loan allows you to borrow money on the equity in your house, and then repay it all at once.

Excellent credit is required to be eligible for a personal loan or balance transfer.

Your house will be used as collateral for a home equity loan so you don’t need to have excellent credit.

You could lose your home if your payments are not on time.

2. Debt negotiation

Negotiating with creditors and lenders to reduce your debt to a manageable amount is called debt settlement.

Why would creditors do that to you?

They want to be paid. If bargaining involves getting something in return, they might be willing to take that risk.

A creditor might offer to take 50% off your current debt knowing full well that it will only receive 10% if it files for bankruptcy.

With the help of either a debt settlement company or a lawyer, you can settle your debt yourself.

If you have a lot to negotiate, these two options are worth looking into.

Although debt settlement can be a useful option to address large amounts of debt, it could also lower your credit score. Any debts charged by lenders may stay on your credit report for seven years, similar to Chapter 13 bankruptcy.

You will also have to pay fees for settling your obligations. This could deplete your funds.

Additionally, forgiven debt is generally considered taxable so if you settle, you might be subject to an IRS payment.

The Bottom Line

The United States Bankruptcy Code was created to protect people (and other files), who are in financial trouble and require assistance.

You may find filing for bankruptcy the best option to resolve your debts. However, it could also prove costly.

A lawyer is a good choice if you are considering filing bankruptcy. A lawyer can help you make informed decisions and evaluate the pros and cons of each option.

 

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