Personal bankruptcy can save you from lifelong financial loss but you need to understand the bankruptcy process and how to file correctly
I had a high school teacher that was fond of saying, “Show me an income and I’ll show you how to live above it.” It wasn’t until I got older and had to start paying bills that I realized how true it was.
Financial trouble can strike anyone, from the richest to the poorest. Walt Disney, rapper 50 Cent and even President Trump have all filed bankruptcy.
Hundreds of years ago, if you couldn’t pay your debts, you might be convicted as a criminal or sold into slavery. Personal bankruptcy was established as a last resort to save debtors from lifelong financial loss but that doesn’t mean the process is an easy one.
Going through bankruptcy can affect your life for years after but it might be the only solution. Understanding the bankruptcy process as well as the difference in types of bankruptcy can help you through the ordeal in the least amount of stress possible.
What is Personal Bankruptcy?
The Constitution of the United States authorizes Congress to pass bankruptcy laws which it has done under Title 11 of the United States Code, the Bankruptcy Code, and has amended several times since its enactment in 1978.
Ok, I promise no more boring legal-speak the rest of the guide.
The basic idea around personal bankruptcy is easy to understand even if the exact laws around declaring bankruptcy are filled with legal jargon and procedure. The Bankruptcy laws set out a formal way for dealing with debt problems for both individuals and businesses when debt.
Personal bankruptcy is technically when your debts are in excess of your assets and become unmanageable. Debts can include mortgages, credit cards, personal loans and student debt – anything requiring a regular payment.
Bankruptcy in the United States comes from the British experience during the industrial revolution. The debtor’s prisons talked about in Dicken’s ‘A Christmas Carol’ were a very real thing. If you couldn’t pay your debts, you were basically made a convict and a slave.
Personal bankruptcy still has a stigma of financial failure but you shouldn’t be ashamed of planning your way out of crushing debt. More than four million Americans filed for chapter 7 bankruptcy in the four years following the 2008 recession.
The United States has 90 bankruptcy districts, at least one in each state, which handles cases within its area. Even though a bankruptcy judge will have the final word on the case including eligibility and whether the debts are discharged, most of the work is carried out by a trustee that oversees each case.
When you file personal bankruptcy, the court will determine which of your debts are discharged and which you still need to repay. This will depend on your ability to pay as well as what type of bankruptcy you filed.
The Personal Bankruptcy Process
Let’s start by saying that filing bankruptcy should be a very last resort. It might sound great to just wipe out your debts and start over but bankruptcy isn’t starting over. You might not be digging yourself deeper into debt when you declare bankruptcy but you’ll still be in a financial hole from which you’ll have to claw your way out over the next several years.
Your official bankruptcy case begins when you file a petition in court. In reality, the process usually starts with finding a bankruptcy lawyer to help you with the case.
The bankruptcy filing will include:
- A list of all your assets, things you own, and your liabilities or debts
- A list of all creditors
- A budget of your current income and spending
- A statement of all your finances
- A schedule of all contracts and leases
- Tax returns for the most recent year
- A certificate of credit counseling
- Copies of any debt repayment plans worked out in counseling
Filing fees for bankruptcy vary by state but are generally between $250 to $500 including administrative and trustee fees. Lawyer’s fees for bankruptcy can cost several thousand dollars.
A bankruptcy filing creates a temporary ‘estate’ for all your assets and debts. An impartial trustee is put in charge.
The trustee will review all documents and may ask for more information. From three to five weeks after a bankruptcy petition is filed, the trustee will hold a meeting of creditors. The debtor is sworn under oath and may be asked to answer questions by the trustee or creditors.
Most states require the trustee to ask certain questions to make sure the debtor understands bankruptcy alternatives, the effect on their credit history and what a discharge of debts means. In most ‘no asset’ bankruptcy cases where the individual doesn’t have anything of value to be sold and distributed to creditors, creditors may decide not even to show up to the meeting.
Unless it’s found that you hid assets or lied on your bankruptcy filing, your debts will generally be discharged within 60 to 90 days after you file. It’s rare that chapter 7 bankruptcy doesn’t result in a discharge of debt and almost always as a result of fraud by the individual.
The process for filing chapter 13 bankruptcy is almost exactly like chapter 7 except you also file a repayment plan with the court. The repayment plan provides for fixed payments, either bi-weekly or monthly, to the case trustee to pay creditors.
Chapter 13 repayment plans generally must:
- Repay priority creditors in full unless the creditor agrees to a lessor amount
- Repay loans backed by collateral at least to the current value of the collateral
- Repay unsecured claims from a portion of disposable income left over after paying other creditors
- Payments are generally limited to a percentage of the individual’s income after paying necessary living expenses
Debtors under a chapter 13 repayment plan may not take on new debt without consulting the trustee. If the debtor fails to make payments, the court can dismiss the case or convert it to a chapter 7 liquidation. If the case is dismissed, creditors can once again try to collect on the unpaid debt.
Bankruptcy law is often changed and the process here might not be the exact rules in your state. You should always consult a bankruptcy lawyer for your own case. It’s going to cost you but will make sure you know exactly how to file bankruptcy and make sure your case goes smoothly.
Types of Bankruptcy
There are six types of bankruptcy under the law though personal bankruptcy is usually only filed in two types. I’ll highlight chapter 7 and chapter 13 bankruptcy but members of the military may also be able to file under the Service members’ Civil Relief Act which protects them from default judgements.
What is Chapter 7 Bankruptcy?
Chapter 7 bankruptcy, a liquidation of your debts, is the most common type of personal bankruptcy. A trustee is assigned to look over your assets, sell anything of significant value and pay off creditors. You are entitled to keep some assets like your home and usually a car for transportation to work. Any assets that were used as collateral for a loan will be sold to pay off that creditor first.
For most people, this means the trustee will sell any investments you have and anything else to pay your debts. There is a certain amount in each state a person can exempt from their bankruptcy, called a wildcard exemption. This isn’t very much and usually only covers clothes, household furniture and smaller items.
Most personal bankruptcies under chapter 7 are ‘no asset’ filings where the individual doesn’t have anything of value that can be sold to pay creditors.
Any debt remaining after your assets are liquidated by the trustee is discharged by the court, meaning you don’t have to repay it. There are some types of debt that will not usually be discharged such as student loans, alimony and some court judgements.
You will only be able to protect your car if the equity you have in it, the value above the amount you owe, falls under a certain amount in your state. Don’t expect to be able to keep your shiny new Porsche just because you need it to get to work. You might be forced to sell it and get a cheaper car.
Exempting assets like your home and car from the bankruptcy doesn’t mean you don’t have to repay the debt on them. Getting your other debts discharged usually means you are better able to make payments on your exempt assets.
Filing chapter 7 bankruptcy requires a ‘means test’ which is a calculation of your income and debts to see if you qualify for liquidation bankruptcy. If your current monthly income is higher than the state median, the bankruptcy court will require the test.
- If your household monthly income over the last five years, after accounting for a few allowed expenses, is more than $10,950 or 25% of non-priority unsecured debt – you may not be allowed to file chapter 7 bankruptcy.
- Debtors can argue that additional expenses are necessary or other special circumstances.
- If you fail the means test, you will only be able to file chapter 13 bankruptcy which will require a payment plan to repay your debts
What is Chapter 13 Bankruptcy?
Chapter 13 is an adjustment of debts rather than a liquidation. It’s designed for debtors with income high enough to repay some of their debt but still need help with the overall burden.
In a chapter 13 bankruptcy, the court will make a repayment plan that usually lasts between three and five years. Your monthly payments will be low enough that you can keep to the plan as long as you keep your income.
This type of bankruptcy allows you to keep other assets you might not be able to exempt in chapter 7 bankruptcy. If you keep to the payment plan, any debt left after the period is discharged. It still protects you from garnishments and collections by creditors and some of the debts that cannot be discharged under chapter 7 can be wiped clean in chapter 13 bankruptcy.
What is a Bankruptcy Discharge?
A discharge in bankruptcy is when you have no more personal liability for a debt. Contrary to what many people think, your debt doesn’t get wiped from your credit report in a bankruptcy. Discharged debt stays on your credit until it comes off after a few years just like any records.
A discharge prohibits creditors from trying to collect a debt from you including taking legal action or any kind of communications.
A discharge of a debt will not protect your property if you put it up as collateral for the loan. The creditor can still force you to sell your possession to pay for the debt. The only exemption here is usually your own home.
Discharging your debts in a bankruptcy depends on the type of bankruptcy you file. In chapter 7 cases, creditors generally have about 60 days to file a complaint in the bankruptcy. This is usually about four months after you file your initial petition with the bankruptcy court.
Since chapter 13 bankruptcies work out a payment plan where you repay a portion of your debts over three to five years, debts are not discharged until you successfully complete your plan. If you stick to your payments then the remaining portion of the debt at the end of the plan is usually removed.
How to Get Your Bankruptcy Discharged
The vast majority of chapter 7 bankruptcies are discharged without a problem. Usually the only thing that will keep you from getting your debts discharged is something on your part like trying to hide assets.
- You can’t sell or transfer assets before you file bankruptcy just to keep them out of creditors’ hands. The trustee will look through your bank records and other sources and THEY WILL find out if you sold or transferred property. This includes putting it in another person's name or in a trust.
- You can’t quit your job to avoid repaying creditors. The means test for chapter 13 bankruptcy takes into account your income over the last five years, not just current income.
- Don’t waste money just before a bankruptcy like going out on an expensive vacation or gambling it all away. The trustee may see this as trying to avoid creditors and force you into a repayment plan.
- Don’t take out any loans just before filing bankruptcy with the idea that you’ll just include it in the debts. If the creditor can prove you had no intent on repaying the loan, the court might not discharge it in your bankruptcy.
It is extremely important that you be completely honest on your bankruptcy filings. Do not try to hide anything. Keeping property or other assets off bankruptcy filings is one of the most common reasons courts refuse to discharge your debts.
Your creditors will receive a notice shortly after you file for bankruptcy and are given the opportunity to argue their case for the debt. If they can prove that you lied on your application, did not intend to pay the loan back or are hiding anything in your bankruptcy case then the court may side with them and make you pay the debt.
What Types of Debt are Not Discharged in Bankruptcy?
You won’t be able to walk away from all your debts in a personal bankruptcy. There are 19 categories of debt that are exempted from discharge under the different bankruptcy filings.
There are a few types of debt that are usually discharged in a chapter 13 bankruptcy but not in a chapter 7. These include debts for willful and malicious injury to property, debts from a tax obligation and debt from property settlements in a divorce.
Besides the types of debt that are generally not discharged, a creditor can ask the court to exempt any specific debt. If the creditor can prove you committed fraud when you got the loan, lied on the loan application, or intended to not pay it back then they might keep you from getting it discharged.
What Personal Bankruptcy Does to Your Finances
Bankruptcy is one of the worst things that can happen to your personal finances, that’s why it should only be used as a last resort.
Bankruptcy will be noted on your credit report, along with any debts that where discharged until they drop off after a certain number of years. Anyone that requests your credit report, including potential employers, landlords and creditors will see that you filed bankruptcy.
Most people underestimate the effect bankruptcy has on their financial lives and credit. I pulled two tables off the FICO website, the people that calculate your credit score. The first one shows how much a bankruptcy can hurt your credit score.
Even the best credit borrowers will have a sub-prime credit score after filing bankruptcy.
Don’t think that’s so bad?
- If you are able to get a loan, something that probably won’t happen for at least a year or two, you’ll probably be looking at interest rates of 30% or more
- Potential employers, especially in banking or finance jobs, will find it hard to give you a job after checking your credit report
- Insurance, cell phone and other subscription service companies can legally increase your monthly rates. Studies have found that people with bad credit pay nearly double the premiums on car insurance
- You won’t be able to buy a home and landlords may not want to rent to you after pulling your credit report
Bankruptcy can seem like a quick and painless alternative to repaying debts but the effects last a very long time. It takes up to ten years for all negative remarks to drop off your credit report. The second table from FICO shows the estimated time to recover your credit score after a bankruptcy, up to ten years.
Alternatives to Filing Bankruptcy
Filing bankruptcy means you aren’t able to keep up with payments on your debt so bankruptcy alternatives should either increase your ability to pay or decrease the debts you have.
1) Getting a second job or even a weekend side hustle could save your credit score and turn into a full-time job you love. I never would have believed how much I could make owning websites but now make six-figures after less than five years. You don’t need to make extra money forever, just until you can get your debts under control.
2) A chapter 7 bankruptcy is going to mean you have to sell anything of real value so you might as well do it before the bankruptcy to pay down debt. Selling the second car or anything else to pay down a few debts might keep your head above water without getting a night job.
3) Taking out a debt consolidation loan may be a way of lowering your payments and even saving money on interest. This is where you apply for a personal loan to pay off a group of debts, reducing your bills to just one payment. Debt consolidation can extend the time you have to repay and lower your rates but you need to apply before your credit score falls too low to qualify.
Notice I didn’t include debt negotiation as one of the bankruptcy alternatives. This is where you hire a company to renegotiate your debts, usually over a three-year process that destroys your credit and ends up costing just as much as the debt you owed. There may be instances where debt relief is a better solution but usually when it gets to this point, bankruptcy is actually a better path.
Personal Bankruptcy Common Questions
How often can I file personal bankruptcy?
A court can deny a chapter 7 discharge if you filed bankruptcy within eight years or if you filed chapter 13 bankruptcy within six years. You may file chapter 7 bankruptcy within six years of chapter 13 if you made all the required payments in your plan or if at least 70% of your payments and made your best effort to keep to the plan. A court can deny a chapter 13 discharge if you filed any other bankruptcy within four years.
Can I be made to pay my bankruptcy discharged debts?
Creditors generally have a year to prove that you got your debts discharged fraudulently, by failing to disclose assets or hiding something in the case. While creditors are not allowed to contact you after your debt is discharged, they can still investigate their case. This means that fancy new car you buy after bankruptcy, with money you hid in the case, could be discovered by old creditors and you could be heading back to court.
Can I repay my debts even if they’ve been discharged?
Yes. There is nothing that keeps you from repaying any of your discharged debts after bankruptcy. This is usually done when the debt is owed to family or a close friend.
What can I do if a creditor tries to collect a discharged debt?
If a creditor contacts you about a discharged debt, you can file a motion with the court. The bankruptcy court will reopen the case to make sure the discharge has not been violated. If the creditor is found guilty, they may be held in civil contempt of court and have to pay a fine.
Can my employer fire me for filing bankruptcy?
The law protects debtors from certain actions by governments or employers. Your employer may not discriminate against you based solely on your bankruptcy including termination. Government organizations cannot revoke, suspend or refuse to renew a license because of your bankruptcy.
Bankruptcy Terms You Should Know
These aren’t all the terms you’ll encounter during the bankruptcy process but some of the most important you’ll need to know.
Automatic stay is a court order that automatically stops lawsuits, collections, foreclosure and garnishments of debt by a creditor while the bankruptcy proceeds.
Bankruptcy code is the name for Title 11 of the United States Code (11 USC 101-1330), the federal bankruptcy law.
Bankruptcy judge is the court official for each United States district bankruptcy court
Bankruptcy petition is the document filed by the debtor that formally opens a bankruptcy case. It can be opened voluntarily or involuntarily by creditors.
Chapter 7 is a liquidation of assets in personal bankruptcy, the sale of non-exempt property to pay creditors.
Chapter 9 is bankruptcy reorganization for municipal governments like cities and towns
Chapter 11 is bankruptcy reorganization for corporations or partnerships
Chapter 12 is a special type of bankruptcy for farmers or those in the fishing industry
Chapter 13 provides for the adjustment of personal debts in a repayment plan, usually over a three- to five-year plan
Chapter 15 deals with cross-border bankruptcies and debts
Creditor a person or business owed money to by a debtor
Credit counseling is generally a requirement of filing personal bankruptcy and entails two events. The debtor must receive an individual or group briefing from a non-profit credit counseling agency and go through an instructional course in personal financial management.
Current monthly income is the average monthly income over six months before filing bankruptcy, not generally including social security income or certain other payments.
Debtor is someone that owes money to a creditor.
Discharge is the release from personal liability for a debt. The discharge releases the debtor from paying the debt and prohibits creditors from seeking to collect the debt including any form of communication.
Equity is the value of a possession beyond what is owed on a loan or by a lien. If your house is worth $100,000 but you still carry a $75,000 mortgage then you have $25,000 in equity.
Exempted property is certain assets that you can keep from creditors in a bankruptcy including your home and things directly involved in making an income.
Fraudulent transfer is selling or transferring any property before a bankruptcy to keep it from creditors. This can involve selling it for less than fair value or selling it then wasting the proceeds.
Joint petition is when a husband and wife, or partners, file bankruptcy under one petition.
Lien is a legal right against a property by the creditor for a loan.
Means test is a calculation of your income and debt payments to establish your right to liquidate debts in a chapter 7 bankruptcy or if you must repay them in chapter 13 personal bankruptcy.
Non-dischargable debt is debt that cannot be wiped in a personal bankruptcy and must be repaid. This usually includes debts from taxes, child support and alimony, debt incurred from a criminal conviction and student loans.
Post-petition transfer is when you sell or transfer assets after filing bankruptcy and is generally not allowed if it is to keep them from creditors.
Reaffirmation agreement is an agreement in chapter 7 bankruptcy by the debtor to continue paying dischargeable debt, usually to keep the collateral under the debt.
Schedules are lists filed by the debtor showing assets, liabilities and other financial information like income and expenses.
Secured debt is debt backed by collateral like a house or car.
341 Meeting is the gathering of creditors required by the bankruptcy code to ask the debtor questions under oath by the trustee, also called a creditors’ meeting
Trustee is a representative of the bankruptcy court that manages cases and supervises the liquidation of assets to pay creditors. Trustees are private individuals for personal bankruptcy cases and completely impartial to the debtor or creditors.
Filing personal bankruptcy doesn’t have to be a complicated and painful process but it is something you should think about before going through it. Declaring bankruptcy, especially chapter 7, will do more than just hurt your credit score for many years. The bankruptcy process is meant to help debtors when there is absolutely no other option but to try for a fresh start.
How to Avoid Personal Bankruptcy
Sometimes, the best piece of advice is also the simplest: avoid ignoring debts you can no longer manage. The longer you wait to address your debt issues, the more damage they will do to your credit score. Generally speaking, late or missed payments remain on a credit report for seven years. Even worse, not only will creditors see these delinquencies but so will potential landlords and employers.
This is why it's important to take action as soon as you start having difficulties paying on time. If possible, try to contact your creditors directly instead of just defaulting immediately by stopping all payments right away. Some groups are willing to work with consumers who are facing financial hardship in order to avoid filing for bankruptcy or other legal processes.
Negotiate with Creditors
If you are able to work with your creditors, there are some ways that you can attempt to negotiate more favorable terms in exchange for keeping up with payments. For example, if you have the ability to do so, paying more than the minimum amount due is better for your credit score since it reduces the balance owed even in cases where it's still high.
Alternatively, ask if they would be willing to extend their payment plans out further if you can't meet any deadlines currently on the table. These types of arrangements allow you to avoid at least some late fees and get back on track financially while also demonstrating responsibility by making an effort to pay off your debt.
If you are unable to come to terms with your creditor or they refuse to work with you, that doesn't mean all hope is lost. Continue reading to learn how filing for personal bankruptcy might be the best option for your situation.
When Should You Consider Filing?
If you've done everything possible to try and avoid personal bankruptcy but are still unable to meet your financial obligations, it might be time to take action. Whether you want to get more information ahead of making the decision or need legal assistance filing for bankruptcy, consider working with a lawyer specializing in bankruptcy law in order to make the process as smooth as possible.
Although the process can be intimidating, it might represent a fresh start for those who take meaningful steps to address their debt problems. For more information or assistance with the bankruptcy filing process, contact your local bar association and ask if they have any recommendations as far as attorneys in your area.
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