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What Happens When You File For Bankruptcy
A few nights ago, while deep into our 12th series rewatch of The Office, we ran across the episode where branch manager Michael Scott was spending his way into a second job. Upon advice of office accountant Oscar Martinez, Michael decides to declare bankruptcy in the most Michael-way possible:
That's when my wife turned to me and asked "What actually happens when you declare bankruptcy?" Me, realizing I had no idea, gave her the blank stare that every husband is intimately familiar with. So, with that, I did some research.
What Is Bankruptcy?
Imagine the gnawing pressure of mounting debt; credit card debt from impulse purchases, unpaid medical bills, personal loans that seemed like a good idea at the time but now loom like hungry wolves. Bankruptcy seems to offer a relief, a beacon of hope. You've heard the term "fresh start" thrown around, but what does it mean? Let's dive in, unpack the specific information you need, and explore different types of bankruptcy. And remember: while this post isn't legal advice, it'll give you a solid foundation to make informed decisions. Consult with a bankruptcy attorney for advice tailored to your situation.
The Legal Process of Filing Bankruptcy
Filing for bankruptcy isn't as simple as declaring, "I'm broke!" It's a legal process that starts with a bankruptcy filing, or more specifically, a bankruptcy petition, in federal court. Two popular types of personal bankruptcy are Chapter 7, also known as liquidation bankruptcy, and Chapter 13, which is more of a reorganization.
Chapter 7 Bankruptcy: A Clean Slate
Chapter 7 bankruptcy, as the name suggests, is about liquidation. The court-appointed trustee sells your nonexempt property (a key term that we'll return to) to repay your outstanding debts. This might not be a good idea if you have much equity in your home or own other luxury items, as you may lose these in the process.
However, the good news is that bankruptcy laws protect certain types of property through bankruptcy exemptions. Under these provisions, basic personal property and perhaps part of your home equity (subject to state law and the federal exemptions) can be protected. This is where understanding your state law becomes crucial, and where a good bankruptcy lawyer earns their attorney's fees.
Chapter 7's main selling point is the bankruptcy discharge. It absolves you of unsecured debt like credit card debt and medical bills. This gives you that coveted "fresh start" but keep in mind it won't absolve you of all types of debt. For instance, child support, student loans (unless you can prove undue hardship), and certain tax debts are off the table.
Chapter 13 Bankruptcy: A Structured Approach
Contrast Chapter 7 with Chapter 13 bankruptcy. Here, instead of selling your assets, you propose a 3-5 year repayment plan to the bankruptcy court based on your regular income. This plan addresses how you'll pay creditors over a period of time, making it a better option for folks with a consistent income source and who have too much money to qualify for Chapter 7 (determined by the means test comparing your income to your state's median income).
Chapter 13 also offers benefits like catching up on mortgage payments or car loan arrears without losing your property. It may also let you cram down debts, like paying the amount of equity in your car rather than the full car loan, and potentially reducing the interest rate.
The Immediate Effect: Automatic Stay
One immediate relief bankruptcy provides is the automatic stay. From the filing date, it stops most creditors from legal action, meaning those incessant calls and letters grind to a halt. The automatic stay also pauses foreclosure proceedings, eviction, or wage garnishment, giving you some breathing room.
Bankruptcy's Impact on Your Credit and Future Financial Health
As liberating as the debt relief can feel, bankruptcy does come with a cost. One of the biggest drawbacks is the blow to your credit score. The bankruptcy filing stays on your credit report for 7-10 years, which may impact your ability to secure future credit. However, it’s not all doom and gloom. Over time, with consistent, responsible credit use, your credit score can rebound. Consider secured credit cards or personal loans with a cosigner as ways to rebuild.
Some Caveats to Keep in Mind
One of the more challenging aspects of bankruptcy is the question of student loans. Generally, student loans can't be discharged unless you can demonstrate "undue hardship," a high bar to clear.
Additionally, you're still on the hook for certain debts. Obligations like child support and alimony, some tax debts, and any debts you forget to list in your bankruptcy papers aren't discharged.
Your Next Steps
Bankruptcy isn't a one-size-fits-all solution, and it's not the best way out for everyone. So, what's your next move? For starters, seek professional advice. Contact a reputable bankruptcy attorney for a free consultation. Discuss your financial situation, your potential to qualify for a bankruptcy chapter, your personal information, and whether you have enough income to make monthly payments under a Chapter 13 plan.
Next, consider credit counseling. A credit counselor can help you examine your financial situation and explore bankruptcy alternatives.
Remember, although bankruptcy is a public legal proceeding, the stigma is often worse than the reality. It's not a sign of failure, but a legal tool to help when you’re overwhelmed with debt. For some, it might be the only option. For others, it's one of several ways to regain financial control. So do your research, consult with professionals, and make the choice that fits your situation.
While we've done our best to provide accurate information, please review our terms of use and privacy policy for the use of this website. Note that this blog post does not constitute legal advice or the establishment of a law firm-client relationship, and that self-help services may not be appropriate for everyone. Always seek legal advice before making decisions that can impact your financial future.
In the game of life, it's not about avoiding all mistakes but learning from them. Bankruptcy is no different. It's not an end, but a pivot—a step towards a brighter financial future. Now, you’re better armed with knowledge to make the right decisions, because personal finance is about personal growth. And that's something we can all bank on.
