If you can’t pay your debts, personal bankruptcy can help you get a financial fresh start. Depending on the type of bankruptcy you file, you’ll be selling assets to repay your debts or you’ll create a repayment plan you can afford.
Bankruptcy likely won’t eliminate all of your debts. But if you’ve tried to negotiate with creditors and looked for other ways to handle your debt without success, bankruptcy can provide relief from your financial distress.
Is filing for personal bankruptcy a good option, and if so, which type of bankruptcy is right for you? The answer depends on your current situation. In particular, you’ll need to review your assets, expenses and your income situation to help you decide.
This article will help you review your options as you decide whether you should file for bankruptcy and what you can expect when you do so.
When you can’t pay your debts, bankruptcy can help you by granting you relief on some debts through asset sales or through an extended repayment plan.
There’s a misconception that you get out of all debts if you declare bankruptcy. You don’t. Some obligations such as child support, most student loans, most taxes and fines cannot be discharged.
However, there are advantages to filing for bankruptcy. Filing automatically “stays” or stops creditor actions, including wage garnishments. You’re protected from lawsuits, garnishments and collection calls while the stay is in effect.
Filing for personal bankruptcy involves several steps:
- Receive credit counseling from an approved credit counseling agency
- Retain a lawyer or pursue the process on your own (not recommended)
- Determine whether you’ll file a Chapter 7 or a Chapter 13 bankruptcy
- Check your eligibility for Chapter 7 or Chapter 13 bankruptcy and start the process
- Complete post-filing debtor education
Get credit counseling
Bankruptcy legislation requires you to receive credit counseling before you begin the bankruptcy process. Many people don’t realize it, but you need to complete this counseling within 180 days before you file.
In addition, selecting the right credit counselor requires some preparation. Before choosing one, don’t hesitate to interview a few of them to make sure they’re the right fit.
Questions to ask a credit counselor
You may be wondering: what are some of the questions to ask before signing up with a credit counseling agency? Todd Christensen, an Accredited Financial Counselor with MoneyFit, provides some suggestions:
- How much does your service cost? Some services charge less than $20 per couple while others charge $50 per person. Beware, though. The cheapest services either pay their “counselor” close to minimum wage, or offer a service of little to no value. Or they may plan to push you into a more expensive service such as a referral to a specific bankruptcy attorney.
- What are my options for going through your service? Can I do it in person, by phone, via email, or online? The Executive Office of the US Trustee keeps a list of approved certificate providers. It clarifies whether the service is available in person, by phone or online.
- Can I talk to someone if I have a problem? Make sure you can talk to a human being if you have questions.
- How many certificates do I need? You need two: The first one is a pre-filing budget briefing from an approved, nonprofit credit counselor. The second one is a post-filing debtor education course from an approved service provider.
- How long does it take? The first certificate – a budget briefing with a credit counselor – will last anywhere from 30 to 90 minutes in total, both online or by phone. The second certificate has to last a minimum of 120 minutes by law. And agencies can take up to three business days to deliver a certificate.
- Can you submit my certificate directly to the bankruptcy trustee or court? Trustees and courts do not accept pre-filing certificates from credit counseling agencies directly. They must be filed by the consumer or his/her attorney. Many post-filing debtor education certificate providers will submit the second certificate directly to the bankruptcy court or to your attorney.
Selecting the best credit counseling for you
As you go through the process of selecting a credit counselor, you may be asking yourself: Is there such a thing as the “right fit” when it comes to credit counselors? Mr. Christensen elaborates:
- Feel comfortable. Like finding a good pair of shoes, the “right fit” means you’re comfortable with the price and the service while being confident the agency will get the job done as quickly as you need it done.
- Look beyond price. While bargain hunting is important, look at more than price. The cheapest services likely have no phone service (“leave a message and we’ll get back to you”) and can take a week to hear back from them if you have questions or problems.
- Get answers. The right fit will match your budget and your schedule. Does the service provide a phone number if you have questions or get stuck, and will it issue the certificate the same day?
- Have choices. Some people still want in-person counseling only, but very few agencies still offer this option. Decide if telephone, online, or email exchanges work best for you.
Retain a lawyer
Filing for personal bankruptcy can be a complex process with long-term repercussions both legally and financially. So it’s best to seek the advice of a qualified lawyer to help you navigate the process and get organized with the necessary paperwork.
You can hire a lawyer or find free legal help if you can’t afford one, at the American Bar Association’s website.
Choose a bankruptcy chapter
Consumer bankruptcies fall under Chapter 7 or Chapter 13 of the Bankruptcy Code.
When you file under Chapter 7, a court-appointed trustee will sell your non-exempt assets to pay off creditors and you’ll receive a discharge of your consumer debts. In general, these are debts you incurred primarily for a personal, family, or household purpose.
If you file under Chapter 13, you’ll get to keep your assets and propose a plan to repay creditors over time – generally a period of three to five years. Debt discharge is postponed until you complete all payments under the plan.
Check your eligibility
Prior to 2005, you could file under Chapter 7 bankruptcy regardless of your financial means. Your income or financial situation didn’t matter when filing. But this caused some people to abuse the system, helping them discharge debts they could afford in whole or at least in part.
This led Congress to pass the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. It requires the application of a “means test” if your monthly income exceeds a certain minimum level which varies by state.
This test doesn’t apply to Chapter 13, though. That chapter has other eligibility requirements which we’ll discuss later on in this article.
Complete a post-filing course
In order to complete your bankruptcy discharge, you’ll need to take an approved course in personal financial management, regardless of which type of bankruptcy you pursue. You can complete this course with any approved credit counseling agency.
Here’s how bankruptcies work
The federal law which governs all bankruptcy cases is the Bankruptcy Code, which has two chapters applicable to individuals: Chapter 7 and Chapter 13.
Both chapters clear your debts through a concept known as “discharge.” Bankruptcy discharge is a legal term that means that you’re released from personal liability from specific debts and your creditors can’t take any action against you to collect those debts.
Discharge happens in most cases. But depending on the type of bankruptcy you file, discharge can occur in a few months or in a few years.
Chapter 7 bankruptcy
Most Chapter 7 cases are called “no-asset” cases because the people who file under this chapter generally own little to no property. In this type of bankruptcy, whatever assets you own will be liquidated to pay creditors.
But you can count on a relatively fast process: you’ll receive discharge a few months after you go through bankruptcy and are honest with all the information you file.
If your monthly income is in excess of your state median, you’ll need to complete a means test calculation in order to qualify for Chapter 7 relief.
Chapter 13 bankruptcy
A Chapter 13 bankruptcy is also called a “wage earner’s plan” and it’s best suited for people who have a regular source of income.
If you own property such as a house, Chapter 13 is often preferable to Chapter 7 bankruptcy because it enables you to keep your assets. If you’re at risk of going into foreclosure, filing Chapter 13 will stop the process temporarily – but you need to file before your home is foreclosed.
In this type of bankruptcy, you’ll develop a plan to repay all or part of your debts over time – generally three to five years, depending on your income level.
Regardless of which type of bankruptcy you choose, you must first receive credit counseling from an approved credit counseling agency within 180 days prior to filing. In addition, you must meet the following eligibility requirements.
Chapter 7 eligibility
The first form is used to calculate the monthly income you received over the six calendar months prior to initiating your personal bankruptcy case. If your income is less than the median income that applies to your state, you qualify to file under Chapter 7 – you won’t have to complete the Means Test Calculation form.
But if your income is above your state’s median, you must file the means test. The means test can be summarized as follows: You’re eligible to file under Chapter 7 if your aggregate current monthly income over 5 years (60 months), net of certain allowed expenses is:
- Less than $8,175, or
- 25% of your nonpriority unsecured debt is more than $13,650.
The list of allowed expenses is quite extensive and includes living expenses and deductions for secured debt payments. In addition, the figures presented above are subject to adjustment every 3 years.
You can find your state’s median income information by visiting the U.S. Census Bureau. If you don’t qualify for Chapter 7, you can convert your case to a Chapter 13 filing.
Chapter 13 eligibility
As an individual, you’re eligible for Chapter 13 relief if your unsecured debts such as credit card debt, medical bills or personal loans, are less than $419,275. In addition, your secured debts such as a home mortgage are less than $1,257,850. These amounts aren’t static and will be adjusted for inflation every three years.
If this isn’t your first bankruptcy case, restrictions will apply. You’ll be ineligible for discharge under Chapter 13 if you’ve received a prior discharge in a Chapter 7 case filed four years before the current case.
On the other hand, if you had a previous Chapter 13 case filed two years before the current one, you’ll also be ineligible for discharge.
» Credit counseling is a prerequisite. Whether you file under Chapter 7 or Chapter 13, the law requires you to receive a credit counseling briefing from an approved credit counseling agency. If you’re filing jointly, you and your spouse must take the course.
In addition, after you file and start the bankruptcy process, you’ll need to complete a financial management course before you can receive a discharge of your debts. If you are filing jointly, your spouse must complete the course too.
» You’ll damage your credit score. Bankruptcy will have a negative impact on your credit score, and it’ll remain on your credit report for 7 to 10 years. Once you file, it’ll become public domain information. In other words, any interested party, such as a potential employer, can find out whether you’ve filed.
Also, if you file under Chapter 7, your bankruptcy will stay on your credit report for 10 years from your filing date. If you file under Chapter 13, it’ll stay on for 7 years since you’ll have repaid your debts at least in part.
While your credit score will be damaged after you file for personal bankruptcy, there are several ways you can rebuild your credit score, including through secured credit cards.
» Bankruptcy isn’t free. Bankruptcy involves several upfront costs. You’ll need to pay lawyer fees, filing fees and other administrative fees related to the bankruptcy process.
» You’ll need a lawyer. All bankruptcy cases are handled in federal courts under rules outlined in the U.S. Bankruptcy Code. While you can file for bankruptcy without a lawyer, it’s best to seek the advice of a seasoned professional.
When is filing for bankruptcy a good option?
If you’re struggling with your bills and indebtedness, you have several options you can explore before you file for bankruptcy. Consider the following:
- Craft a debt repayment plan with the help of a credit counseling agency
- Reach out and try to negotiate with your creditors
- Consolidate your debts with a personal loan
Since filing for personal bankruptcy requires you to hire a credit counseling agency, you might as well start there. A credit counselor can help you craft an action plan that fits your financial situation to help you get out of debt without filing for bankruptcy, when feasible.
Sometimes, though, filing is inevitable. If you have a regular source of income and are a homeowner, Chapter 13 is often preferable to Chapter 7 because it enables you to keep your home and other valuable assets.
Some reasons why you might consider personal bankruptcy
For some, personal bankruptcy is the only way to get a financial fresh start. Some reasons for personal bankruptcies include:
- You don’t have enough income to meet your debt obligations
- You’ve tried debt counseling without success
- Creditors are suing you and or have garnished your wages
- You’re in danger of going into foreclosure
- Repaying your debts will take you more than five years
- You’re considering dipping into your 401(k) to pay your bills
- You’re increasing your credit card debt and can only afford making minimum payments
Here’s what is involved in filing personal bankruptcy
When you file for bankruptcy, your case is turned to a court-appointed trustee whose job is to oversee your case. Most of the process is administrative and is mostly conducted away from the courts.
When you file for bankruptcy, there are multiple forms you’ll need to file with the clerk of your bankruptcy court. These are filed the same day you file your petition and include:
- A voluntary petition form, which opens your bankruptcy case
- A statement about your social security numbers
- A list of names and addresses of all of your creditors
- Your credit Counseling Certificate from an approved credit counseling agency
Additional forms you’ll file either the same day you open your case or within the next 14 days include:
- A schedule of your assets and liabilities
- A statement of financial affairs, explaining your sources of income
- Disclosure of compensation to your lawyer
- Copies of pay stubs received 60 days before you filed
You can find the full list of forms here.
Chapter 7 bankruptcy – Liquidation
A Chapter 7 bankruptcy is for people who agree to sell their assets to get their debts discharged. It contemplates the orderly sale or liquidation of your property to pay creditors, subject to your right to keep certain exempt assets.
In addition to the forms listed above, when you file under Chapter 7 you’ll also need to file a form indicating to the court your intention to file under this chapter, a statement of your current monthly income, tax returns and a means test calculation, if necessary.
Several weeks after you file your petition, you must attend a meeting with your creditors and trustee where they may ask questions regarding your finances.
The trustee will sell your non-exempt assets and use the proceeds to pay your creditors in accordance with the provisions of the Bankruptcy Code.
As you go through a Chapter 7 process, your main concerns are to retain ownership of your exempt property and to receive a bankruptcy discharge that covers as many of your debts as possible. In that regard, there isn’t a specific level of indebtedness you need to have to file under Chapter 7.
The bankruptcy discharge will relieve you from paying most of the debts you had pre-bankruptcy. But you’ll still be responsible for some debts. Debts which you won’t be able to discharge through bankruptcy include:
- Most taxes
- Most government-funded or guaranteed student loans
- Spousal, child support, alimony and property settlement obligations
- Most fines, penalties, forfeitures, and criminal restitution obligations and
- Certain debts not listed in your bankruptcy papers
Here’s a complete list of debt categories excepted from discharge under Chapter 7.
Chapter 13 bankruptcy – Voluntary repayment plan
Chapter 13 bankruptcy is for people with regular income who want to avoid selling their property to pay creditors. Under this chapter, you’ll pay all or part of your debts in installments over three to five years according to a plan you’ll develop.
If you file under Chapter 13 you’ll need to submit several additional forms including:
- A statement of your current monthly income
- A calculation of your disposable income
- Your most recent tax returns and
- A Chapter 13 repayment plan
Your Chapter 13 plan is a legal document that lays out how you’ll repay your creditors using your disposable income. This is the monthly income you have left after subtracting your and your dependents’ necessary living expenses plus certain allowed deductions.
In general, if your income is below the applicable median income for your state, you’ll file a three year Chapter 13 plan. Otherwise, you’ll submit a five year plan. The plan needs to address repayment of creditors considering three types of claims:
- Priority claims, such as taxes, must be paid in full
- Secured claims, such as a car loan, must at least cover the value of the collateral, subject to certain restrictions
- Unsecured claims, such as credit card debt, which need not be paid in full.
Regarding the last point above, if your projected disposable income is sufficient to repay unsecured claims, you must pay them in full.
Also, and similar to a Chapter 7 filing, you must attend a meeting with your creditors and appointed trustee to answer questions they may have regarding your finances and questions on your repayment plan.
Should you file for bankruptcy? Bottom line
Filing for personal bankruptcy is a difficult decision that will impact your life for years to come. If you’ve sought other debt relief alternatives without success and you can’t manage your financial burden, bankruptcy may be for you.
While filing for bankruptcy will discharge debts in most cases and provide financial relief, it has disadvantages. Under Chapter 7 you’ll lose assets and under Chapter 13 you’ll be following a strict budget for several years. Plus, you’ll wreck your credit score.
But sometimes, filing is unavoidable. Speak to a qualified bankruptcy lawyer to review your options.