Some Notes on Filing for Bankruptcy

A reader who asked for anonymity wrote in:

I’m visiting a lawyer next week to get started on filing for bankruptcy. I have no way to pay my debts or even make the minimum payments each month. My problem is that I simply can’t find a place online that actually explains what the different kinds of bankruptcy are and how they work in any terms I can understand. What’s Chapter 7 and Chapter 11 and Chapter 13?

I’ll attempt to explain these concepts in the clearest terms I can. Of course, when you do that, you tend to lose some details in the process, so if you want to know more about your specific situation, I suggest contacting a lawyer.

What Is Bankruptcy?
Bankruptcy simply means that you can’t pay off your debts and you’re asking the legal system for help. This event appears on your credit report and can have a negative impact on your credit score for seven years, though being diligent about following through with the plan developed in bankruptcy court means you can minimize that impact. It also means that the court system will come up with some sort of plan that works for both you and your creditors for you to pay back some portion of your debts. The exact way you do that differs depending on the type of bankruptcy.

Typically, bankruptcy is an option of last resort. It has legal costs which can add up to the thousands and a very negative long-term impact on your credit. You should only turn to this if you cannot come up with a successful debt repayment plan on your own. I suggest creating your own debt repayment plan and making a serious effort to execute it on your own before considering bankruptcy. Credit counseling can also help; in fact, it is legally mandated before you file for bankruptcy.

Chapter 11 Bankruptcy
Chapter 11 bankruptcy is usually the best option if you own a business. This form of bankruptcy typically allows a business owner to remain in control of their business while going through bankruptcy proceedings. This typically occurs if you own a business that isn’t able to pay its bills at the moment. If you do not own a business, Chapter 11 is not right for you.

Chapter 7 Bankruptcy
Chapter 7 bankruptcy is a “liquidation” bankruptcy. You can typically only use this type of bankruptcy if you have sufficient income – usually more than the median income in your state. If you qualify, what happens is that some portion of your possessions are sold and the money from selling those possessions are used to pay off your creditors.

You’re allowed to keep some of your possessions during this process depending on the specifics in your state. This usually includes your home, your clothing, minimal transportation, a few hundred dollars’ worth of personal possessions, your pensions, and a few other odds and ends. The rest of your assets are liquidated and used to pay off the creditors. At the end of this process, your creditors go away, but your credit report has a big black mark on it and you’ve lost many of your assets.

If you hear stories of people repeatedly filing for bankruptcy, that usually means they’ve adopted some form of lifestyle where they repeatedly file for Chapter 7 bankruptcy. They usually don’t accumulate assets and spend the debt money they accumulate on experiences. Then, when they file for Chapter 7, there aren’t many assets for the creditors to take.

Chapter 13 Bankruptcy
Chapter 13 bankruptcy is the most common type of bankruptcy. In this form of bankruptcy, you and your legal counsel come up with a debt repayment plan. During the process, the plan is usually adjusted a bit to match the creditor’s demands and your own ability to repay such debts. Often, these plans lower your monthly payments to the point that you can actually handle them within your income. Often, that also means that your total debt amount is lowered.

What’s the drawback? For starters, the cost usually is in the thousands – this is tacked onto the court-ordered debt repayment plan. The plan itself usually ties up almost all of your spending money for a few years as you’re paying off debts. It also damages your credit severely, as does any bankruptcy, but your successful repayments will help mitigate that damage.

Which Is Right for Me?
For most people, Chapter 13 is the best route. Chapter 7 is better if you’re a high wage earner with few assets. Chapter 11 is the one to consider if there’s a business involved.

Of course, the specifics of bankruptcy vary somewhat from state to state. If you’re considering any of these avenues, contact legal representation before you move forward and make sure you understand the specifics in your state.

Your best choice, of course, is to avoid being in a situation where you’re concerned about this in the first place. Hopefully, this advice helps those who need it – and encourages people heading in that direction to reconsider their path.

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23 thoughts on “Some Notes on Filing for Bankruptcy

  1. Johanna says:

    “Chapter 7 bankruptcy is a “liquidation” bankruptcy. You can typically only use this type of bankruptcy if you have sufficient income – usually more than the median income in your state.”

    Where are you getting this information? It sounds like you might be (rather severely) misunderstanding the “means test” laid out in the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 – which, as I understand it, makes it more difficult for *high*-income individuals to file Chapter 7 bankruptcy, but imposes no additional restrictions on low-income individuals. But I am not a lawyer.

  2. chuck says:

    what about the other chapters 1-6,8-10,12,14+ ?? are these other chapers other options that can be used? maybe one of those would be even better then 7,11,13? is there one where you get rid of all your debts but get to keep all your stuff?

  3. valleycat1 says:

    Trent, once again your answer shows some disregard for the actual question – the writer states they’re seeing a lawyer to file bankruptcy. First you suggest contacting a lawyer, and then at the end you suggest not getting in the situation in the first place.

  4. sasha says:

    Trent

    Actually, about 70% of those who attempt a Chapter 13 bankruptcy convert their bankruptcy to Chapter 7 before completing the payment plan because they cannot follow the terms of the Chapter 13 – due to their poor financial condition. Chapter 13 bankruptcy often just postpones the inevitable Chapter 7.

    This happens because people filing for bankruptcy are by and large decent people who want to be able to pay back what they borrowed. But by the time you reach the point of filing for bankruptcy, most people are in the worst position in their life and have no real means to complete a re-payment plan. They sign up for a Chapter 13 because it seems more honorable.

    However – when it comes to filing for bankruptcy – people should choose the option that will best put them in a position to succeed going forward. That is not very often Chapter 13. Please don’t recommend specific types of bankruptcy as a “better” type to file. If you aren’t a bankruptcy lawyer – don’t use your influence that may persuade someone to act against their own best interests with something as serious as bankruptcy.

  5. Johanna says:

    For a real explanation of bankruptcy, I recommend the chapter on the topic in “All Your Worth.” Elizabeth Warren is an expert on bankruptcy law, so she knows what she’s talking about. There have been changes in the law since the book was published (in particular, the 2005 law I mentioned above), but the explanation of the basics should still suffice.

    Some of the main points, as well as I can remember them:

    – If you can, it’s best to hold off on filing for bankruptcy until you’ve stopped adding to your financial troubles. If you’re filing because of medical bills, for example, wait until you’ve stopped racking up new medical expenses.

    – As sasha says, most people who opt for chapter 13 are unable to stick to the five-year payment plan, so they end up going through a lot of trouble for nothing. I *think* (and you should definitely check this) that the only real advantage of chapter 13 is that it makes it easier for you to keep your home. If you don’t own a home, there’s probably no advantage to chapter 13 over chapter 7.

    – Representatives from your creditors may pester you about reaffirming your various debts – that is, exempting them from being discharged in bankruptcy. Agreeing to this is probably not a good idea.

    – Since there are restrictions on how often you can file for chapter 7 bankruptcy, people who have just filed (and therefore can’t file again for several more years) are prime targets for lenders. Be aware of this, and do what you can to avoid falling into the debt trap again.

  6. Katie says:

    You can typically only use this type of bankruptcy if you have sufficient income – usually more than the median income in your state.

    I thought this sounded strange and just asked a bankruptcy attorney friend. She said it’s actually the reverse; you have to make under a certain amount to qualify.

  7. jesinalbuquerque says:

    I would emphasize the advice to check laws in your state. Much of the above is inaccurate in my state; don’t ask how I know.

  8. jim says:

    Johanna & Katie are correct. Chapter 7 is NOT available if you have higher income. Trent got that bit backwards.

  9. jim says:

    Chuck asked
    “what about the other chapters 1-6,8-10,12,14+?”

    I’ve wondered that too.

    Title 11 bankruptcy law currently has 9 chapters numbered : 1,3,5,7,9,11,12,13,15.
    The missing chapters 2,4,6,8,10,14 were removed at some point by changes in the laws.
    1,3,5 describe general rules of bankruptcy
    7,9,11,12,13 & 15 are different ways to declare bankruptcy.

    chapter 9 is for municipalities
    chapter 12 is for farmers and fishermen
    chapter 15 is for foreign companies with US debt

    all courtesy of wikipedia.

  10. Alice says:

    The OP should continue to search online for valid responses to the question, much of the information in the post is inaccurate.

    Try googling for bankruptcy forum, an excellent free forum where you can post questions and get responses from people who know what they are talking about. Go to the websites of various bankruptcy attorneys. Go to the folks at Dave Ramsey (anti-bankruptcy, but they might give accurate advice about the process).

    Go to the library and check out a book. Read a “how to file personal bankruptcy book” in the personal finance aisle of the bookstore. There’s a ton of free information if you look for it – elizabeth warren recently published a book and you can get a peek through amazon.

    If you are a regular consumer, your choices are usually chapter 7 or chapter 13. Chapter 7 is generally for people with no assets and not high income (household size and state of residence determines maximum income for a chapter 7). Chapter 13 is generally for people who have an asset (like a house) they want to exempt or who fail the means test. Even in chapter 7, you can likely keep things that are not high-end luxuries. There are required credit counseling courses (which can be done online). Chapter 7 can be completed in a few months, chapter 13 is usually five years of paying what the bankruptcy trustee (not you and your attorney) says you can afford to pay toward your debts.

    Student loans are generally non-dischargeable, but retirement savings are exempt. The type of debt, the state where you live and household size can impact how bankruptcy affects you. It’s important to understand the process before you file so you know what to expect and what it can (and cannot) do for you.

  11. ameliabedilia says:

    The how to file bankruptcy book by nolo is the best resource, and it can be downloaded from the nolo website. That book and the bankruptcy forum (I think there is only one big one on the web) were so helpful that my husband and I were able to file Chapter 7 without an attorney. While I don’t recommend this for everyone, knowledge is your best weapon. Asking a general personal finance blogger who, to the best of my knowledge, has never filed bk, is not the best choice for information.

  12. Stan says:

    Another error in the post: bankruptcies can remain on a credit report for either 7 *or* 10 years, depending on the type filed. Chapter 7 remains for 10 years from filing date, Chapter 13 is usually for 7 years, again from the filing date.

    I did file a Chapter 7 myself in 2004 and found it helpful to look over the Nolo Press book on Chapter 7 bankruptcy. Nolo does quite well with translating complex legal issues into plain English…much of the basic information can also be found on their website as well.

    And although it’s possible to file bankruptcy on your own, I don’t recommend it. Qualified legal advice is worth every penny in my book.

  13. Leah W. says:

    Stan:

    “Qualified legal advice is worth every penny in my book.”

    I am a lawyer. THANK YOU. I promise, we’re not trying to rob you blind, but the law is usually not something you can figure out on your own without training! This is ESPECIALLY true of bankruptcy law. Do not file a bankruptcy petition without an attorney!

    If you’re REALLY broke, and if you live near a law school or a large(ish) city, contact the law school and ask if they have a legal clinic. My law school allowed student practitioners to represent bankruptcy filers at no cost (supervised by a professor, of course). If you don’t live near a law school, find a Legal Aid office and ask for help.

    Maybe I’m biased, but I think everyone should have an attorney!

  14. deRuiter says:

    While bankruptcy filers do legally skate on large amounts of debt, this system of forgiveness is possible because those of us who pay are bills are then gouged even more to make up for the deadbeats. It’s extremely annoying to live within one’s means and see those who have spent unwisely be given a pass from repaying those whom they owe. Our state and Federal Governments have done the same thing, and now they are coming after the taxpayers with a vengeance, to strip us of our savings, in order to keep spending on their pet projects. Spend less than you earn, and you’ll not have to bankrupt. PLEASE, PLEASE, PLEASE, no moaning about massive medical bills. I’ve sat in bankruptcy court watching discharge after discharge, and it is amazing how many poeple had good jobs and spent all they earned and more on high times, then went bankrupt.

  15. Joan says:

    A friend went the bankrupcy route (owned a business). She was offered credit immediately after the bankrupcy was discharged. Reason, she couldn’t declare bankrupcy again for 10 years. It was a big surprise to her that credit was so easy to obtain.

    Do ask a bankrupcy lawyer about your situation. I believe this answer was to opininated instead of factual.

  16. Dan Brantley says:

    Anyone thinking of filing needs to keep in mind that, at least in Texas; child support, IRS and other tax liens, and student loans, cannot be discharged in bankruptcy. You can, however, modify some of them depending on your particular situation.

  17. Claire says:

    @ #14: PLease no moaning about medical bills?? If this country HAD affordable health insurance for all, we would all be better off. Thanks to the Bush Administration, medical bills are no longer dischargeable under current bankruptcy laws. It’s high time WE the people had affordable healthcare and not be screwed by the insurance companies. A friend of mine had a 4 yr old granddaughter (twin) who had cancer, her parents both worked, insured under the dad’s healthcare, who CANCELED their coverage because they did not want to pay for any more treatment. So not only was their dear 4 yr old daughter denied treatment, now they were going to lose their home! Luckily, they were able to file bankruptcy before the law was enacted and save their home, but sadly, not their dear daughter. Clearly, we can do better for our country’s health and well-being, not at the mercy of the insurance industry who have been pulling the strings for their selfish profit.

  18. Doug says:

    Claire (#17), medical debt is still forgiven in bankruptcy.

    As for the claim that the insurer canceled their plan . . . until you post a link to the story, I call shenanigans. Insurers don’t cancel plans because “they don’t want to pay.” They will cancel a plan because of fraud (lying about a preexisting condition), or failure to pay the premium.

  19. Kelly says:

    I’m at the beginning of a Ch 13 repayment bankruptcy. I only have to pay over three years because my household income fell under the median for my state and I passed the Means Test. With my husband having been laid off for the better part of two years now, we faced losing our house. I’m not proud of this fact but it is what it is. I do work a full time job and have for over 20 yrs now. I only have one kid and am not otherwise a drain on society. People who think that I’m a loser for having done a bankruptcy can bite me…I’m not the only person in this boat and I know there are others behind me who are now in their own BK process.
    BK forum dot net is an EXCELLENT online message board for bankruptcy information.

  20. luvleftovers says:

    Wow, I haven’t posted here in about 2 years.

    Thanks for the bankruptcy discussions. After being out of work for 2 years, it looks like I’ll be seeing a BK lawyer in a month or two. I’ll check out the Nolo info as well

  21. jim says:

    Doug, Before healthcare reform banned it, there is a practice called ‘recission’ where the insurance companies look for any little excuse to cancel a policy. “For example, because a Texas nurse failed to disclose a visit to the dermatologist for acne, her insurance coverage was dropped when she was diagnosed with breast cancer.”

    Insurance companies admitted to this practice under testimony before congress and refused to agree to curtail it.

    You’re right that it shouldn’t have happened. But it did happen to thousands of people a year.

    Healthcare reform stopped it.

  22. aj says:

    I know that I have been in a very bad financial situation – twice – where others would file bankruptcy, I have not.

    The first time it was due to my now ex-husbands irresponsibility. I eventually paid off all the old debt working with the creditors directly.

    Then my current husband’s mother had a heart transplant. We missed a lot of work, and had increased expenses to Cleveland Clinic & back a 100 times (5 hour drive each way every weekend).
    We had to live off our credit. We then had a son, and bought a house. It was too much for our income at the time but we cut everything and made sure we paid for the utiilities & house payment. The rest had to fall behind.

    We are still working on pulling ourselves out of this last hole but I have no doubt that we will be able to…A good number of old debts have gone to collection agencies. As I have the extra money, I pay them off one by one. They will work with you, and offer discounts of even up to 70% off. You do not need to use a credit counselor or file bankruptcy. You can work it out yourself.

    It makes me angry though that someone who has filed bankruptcy can get immediate credit, when someone who has worked hard for the last 5 years to pay off all their old debts won’t even be considered! Oh well…I like to pay cash now anyway or I don’t need it ;)

  23. Malcolm says:

    I’m late to the party in replying to this article, but it’s very disappointing to find such erroneous material in this article about a very important subject. Just a few items…

    [Chapter 7] “You can typically only use this type of bankruptcy if you have sufficient income – usually more than the median income in your state”

    That’s the opposite of what is true. The Means Test allows people a Chapter 7 whose income is not above their state’s median income, and forces the others to complete and “pass” the complete Means Test which many cannot pass.

    “stories of people repeatedly filing for bankruptcy”

    [Chapter 7] That might have been true before the 2005 bankruptcy laws. Now you have to wait eight years to get another Chapter 7 discharge of debts.

    “Chapter 13 bankruptcy is the most common type of bankruptcy”

    In 2010, there were more than twice as many Chapter 7 filings as Chapter 13.

    “Chapter 11 bankruptcy is usually the best option if you own a business.” Only if your business, or you, can fund the expensive and complex Chapter 11 process. Small businesses and most people who own them simply can’t afford the costs.

    “Chapter 7 is better if you’re a high wage earner with few assets.”

    Again, that’s completely backward. That high income will likely prevent you from getting a Chapter 7 discharge of debts.

    “For most people, Chapter 13 is the best route.”

    For most people, those who are not high earners and who don’t have a lot of assets, Chapter 7 is preferable to a 13 because it eliminates all unsecured debts and provides the Fresh Start quickly.

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