Filing for bankruptcy is often seen as a scary but necessary option. But it’s important to know that even when you’re facing what seems like financial ruin, you have choices. Bankruptcy laws have changed over the past few years and offer benefits as well as drawbacks to filing.
If you’ve talked with a lawyer about your finances and you’re sure that bankruptcy is the best option for your situation, here’s what you can expect throughout the process.
There Are Two Main Bankruptcy Options
Now that bankruptcy is the choice of action, you’ll need to determine which type is the best for you. The two main options of bankruptcy include:
Chapter 7 Bankruptcy
Chapter 7 is often referred to as “liquidation” bankruptcy because it will discharge most of your unsecured debt, including personal loans and credit cards. You’ll be required to pass a “means test,” have a certain amount of income, and may be forced to sell any non-exempt assets. For the most part, however, Chapter 7 filers are able to keep most of their assets. The entire process for this lasts about three or four months.
Chapter 13 Bankruptcy
Chapter 13 is often referred to as “reorganization” bankruptcy. This option will set you up on a repayment plan and force you to pay back your creditors over time. No property is required to be liquidated in the process, but it may take three to five years to finalize everything. To become eligible for this type of bankruptcy, you need to have regular income to make the required monthly payments.
Other Types of Bankruptcy
There’s an additional option called Chapter 11, which is a form of repayment bankruptcy, like Chapter 13, and only applies to certain creditors. In other words, you won’t be able to wipe the slate clean and start over like a Chapter 7 (or in some cases, Chapter 13) offers. Finally, Chapter 12 is the final option when considering bankruptcy, but is only available for fishermen and farmers.
The type of bankruptcy you end up declaring will mostly be based on two things: your assets and your income. If you make too much money, you won’t be eligible for a Chapter 7 bankruptcy filing. And if you want to protect your non-exempt assets, you may want to choose Chapter 13.
Figuring out the right choice for your situation is something you’ll want to discuss with a bankruptcy attorney. In some cases, you may be eligible for free legal services. Check out the American Bar Association to see what options are available to you.
Bankruptcy Will Affect Your Credit
One of the biggest deterrents to filing for bankruptcy is the fact that in one fell swoop it can wipe out any good history of credit. On top of that, it can stay on your credit report as a negative mark for up to 10 years.
You’re also required to declare your bankruptcy filing to future employers, on medical forms, and other state or government official reports. So even if it’s been several decades since you filed for bankruptcy, you will still have to check the little box on many official forms.
In other words, bankruptcy follows you around for the rest of your life, so you want to make sure this is absolutely your last option. It shows up as a negative mark on your credit report and can drop your overall credit score by a huge amount.
Since most lenders look at your credit score when approving your loan, filing for bankruptcy could drastically affect your chances of getting a mortgage to buy your dream home, or a college loan to pay for your child’s education.
Some Types of Debts Can’t Be Discharged
If you’re thinking bankruptcy is the cure-all to your financial problems, it’s important to understand that not all debts are eligible to be discharged during this process. If you owe back taxes or child support, bankruptcy will not be able to help you. Likewise, before taking on the task of filing for bankruptcy, you want to exhaust all of your options.
Here are some additional choices to consider instead of filing for bankruptcy, or if you have debt that can’t be wiped out:
- Credit counseling entails working with a professional credit counselor or financial coach who can help you work through your debt situation. This process usually offers access to financial education, budgeting tools, and other goal tracking tips for reducing your debts, changing your spending habits, and eliminating debt problems going forward.
- Loan refinancing or loan modification is a process where you’re able to negotiate a change to one or more of the terms in the loan, such as a lower interest rate or more affordable monthly payments.
- Credit card consolidation combines multiple debts into a single loan. Instead of having lots of different creditors and payments each month, you can consolidate them into a single monthly payment. This requires working with a debt consolidation or management company.
Paperwork Filings Are Public
The bankruptcy process involves a lot of paperwork, and your finances will likely be subjected to myriad hoops in order to be approved for your choice of filing. You’ll probably have to take time off from work to chat with your lawyer or encounter bankruptcy proceedings (which might mean missing out on vital income).
It’s also important to know that bankruptcy filings are public, so anyone who wants to look up your financial information can. The court will also decide which creditors you have to pay back, and in what order.
In addition, the names of everyone who’s in bankruptcy court are published in local newspapers and online. In other words, you will lose some financial control and privacy during this process, so you need to be prepared to face that.
Bankruptcy Comes With Requirements and Costs
Going through with bankruptcy means you’ll be subjected to the orders of your lawyer and bankruptcy court. You’ll likely be forced to hand over all credit cards, and told what you can and can’t spend money on.
For this service, some lawyers charge a flat fee, while others charge based on the amount of debt you owe. Either way, you are required by law to pay your attorney fees no matter what. And if you’re filing for Chapter 7, these fees can’t be added to your bankruptcy proceedings as a creditor, so you’ll have to pay this fee upfront before getting started.
Obviously, your choice of bankruptcy will determine the total cost and time required to complete the process. Data in a study performed in 2005-09 showed that the average cost of a Chapter 7 bankruptcy filing is between $1,080 and $1,200. Chapter 13 bankruptcies cost a bit more since they are stretched out over the course of several years, not several months.
On top of lawyer fees, the court filing fees usually come in around $200, unless you apply for a bankruptcy fee waiver.
Be alert about any unusually low fees advertised by bankruptcy lawyers. You want someone to represent you who is experienced and comes highly recommended. This is a time when you don’t want to skimp on the price in order to save a buck that ends up sacrificing quality.
Creditors May Challenge Your Request
During the meetings with your lawyer, you’ll have to list all your debts. Be sure to include everything so they can accurately portray your situation and get the best deal possible. You don’t want them to do research of your finances and find other debts. Be upfront and open about everything — remember that they are on your side!
To prepare for your first court meeting, they will also go over sample questions so you know what to expect. Once you’re sworn into the “meeting of the creditors,” the session will be recorded. Your creditors are allowed to attend and ask any questions they like related to your account.
Sixty days after the “meeting of the creditors” is complete, creditors have the right to file a lawsuit against you to challenge the discharge of any debts in order to receive their full balance owed. If you do not receive any notices of lawsuits by the deadline, it’s safe to assume that you have no more obligation to pay the debts to these creditors, as outlined in your specific bankruptcy filings.
Depending on which chapter you choose, simply follow the instructions of your lawyer. You may stop debt payments altogether, or begin your approved monthly debt repayment process.
Filing for Bankruptcy Won’t Fix Everything
As much as you might wish that bankruptcy will give you a fresh start with your financial problems, it’s not an instant fix for everything. You may lose some of your assets in the process, or have your money rifled through.
On top of all that though, you need to figure out why you ended up in this situation and how to avoid it in the future. As I mentioned, bankruptcy is something that follows you around for the rest of your life, so you don’t want to have a record of going bankrupt more than once.
Talk to your lawyer or financial coach about changing your spending habits, and what you can do in the future to establish smarter money choices. You may need credit counseling or help from a financial planner on a regular basis.
It’s also important to pay all your bills on time and not use credit cards or loans as an extension of your income. Live within your means and be thankful for what you can afford right now. This will ensure you don’t end up in this situation again.