If 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.
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:
Under 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.
With 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.
It’s important to know the pitfalls. Knowledge is power, and you can’t make an informed decision or plan an effective strategy without it.
Here are some cold, hard facts about bankruptcy:
It’s going to stay on your credit report for 7 to 10 years, which could be disastrous for your future attempts to obtain credit.
This kind of legal procedure becomes public record, as will your name and personal information.
Your debt may be discharged, but any unpaid income tax that’s over three years old won’t be. The same applies to your student loans. Unless you get onboard a federal loan forgiveness program, you’ll be paying any student loans back in full.
The filing won’t be cheap! It might seem odd since you’re filing because you can’t afford to pay your bills, but both Chapter 7 and Chapter 13 require expensive legal representation.
Are you looking for a home loan? Well, good luck with that. Banks are worried about lending money to anyone who has filed for bankruptcy. If you do manage to get a mortgage, the interest will be more than double the norm.
Getting a credit card will be easier than getting a mortgage, but you’ll most likely be looking at higher interest rates.
Remember that Chapter 13 payment plan? Don’t miss a payment; it could be devastating. The trustee can do one of two things if you fail to make payments: convert your Chapter 13 to a Chapter 7 and liquidate your assets, or completely dismiss your case!
About those non-exempt assets — bank accounts, second vehicles, investments, and family heirlooms are all up for grabs. If you’ve got an antique table from your Great Grandmother, the next time you see it might be on The Antiques Road Show, where it’s up for auction.
You should not take the prospect of personal bankruptcy lightly. The points listed above are not intended to scare you off, but to educate you about realities most people either don’t know or don’t want to tell you. The laws that govern filing are quite complex. If this is a step that you are seriously considering, it’s highly advisable to talk to an attorney. Not only will this action ensure that you file all your paperwork properly, but it’s also the best way to be successful in your quest to get out of debt.
Remember: knowledge is power. You can’t make a viable strategy if you’re in the dark about the details, and unfortunately, bankruptcy happens to be shrouded in secrecy and taboo. That’s why you need to empower yourself by doing your research and thinking carefully about your situation. People have emerged successfully from this process in thousands of cases, but these people understood the benefits and risks and made informed decisions based on that knowledge. The key to joining their ranks is in making intelligent decisions.