To File or Not to File Bankruptcy…That is the Question

Man showing his empty pocket on grey background

If you are grappling with so much debt that you have little to no hope of ever being able to pay it all back, bankruptcy is an option that is definitely worth consideration.

According to the Bankruptcy Institute, in July of 2013 there were 87,684 bankruptcy filings in the United States. Even though thousands of people — including celebrities — file for bankruptcy each year, the mere mention of the word itself can make people uncomfortable. This is often based on a lack of understanding of what bankruptcy actually involves and how it affects one’s finances.

There are three main types of bankruptcy, typically referred to by chapter in the bankruptcy code. Chapter 7 and 13 are best for individuals, while Chapter 11 is mainly for businesses.

Filing for Chapter 7 involves selling nearly all of your assets in order to use the proceeds to eliminate your debt, while Chapter 13 involves restructuring debt in a way that allows you to pay it off over a three-to-five year period.

The bankruptcy laws for each state vary in terms of what property you are allowed to keep when filing for Chapter 7 bankruptcy. Usually, you aren’t required to liquidate essentials such as your home, vehicle, clothing and even some personal items such as photos, books, and even furniture.

Keep in mind that not all debt is created equal. Debt related to taxes, child support, liens, and student loans can’t be erased.

A “means test” is used to determine Chapter 7 bankruptcy eligibility by evaluating your location, income, and debts. If your income is too high, you may not qualify. However, the qualifications for means tests vary by state. Means tests calculators can be found online, or a bankruptcy attorney can help.

Once it’s determined that you qualify, a petition can be filed in bankruptcy court that includes financial statements for all of your debts, as well as your assets and possessions. Once this petition is filed, creditors can no longer pursue collection efforts. A trustee will be appointed by the court, and your creditors will be notified of your filing.

During the Chapter 7 bankruptcy process, you will be asked questions regarding your assets and debts under oath, after which your assets will be sold by the trustee. Any administrative expenses must be paid, and the trustee uses the remaining funds to pay your creditors in order of priority.

Now — time for the elephant in the room. Yes, filing for bankruptcy affects your credit score.

While Chapter 7 bankruptcy eliminates your debts, your lower credit score may make it difficult to obtain credit, or may result in lower credit limits and higher interest rates. Also, the bankruptcy filing will remain on your credit report for up to 10 years. There are, however, many ways to improve your credit once the bankruptcy process is finalized. For example, you’ll be be required to take a financial counseling course before the end of the filing process.

After the case is filed in court, bankruptcy is typically a four to six month process and can cost up to $1,500 for bankruptcy fees and a court of about $300. Court fees can be higher if your case involves alimony, contested debt, or child support.

It’s highly recommended to retain an experienced bankruptcy lawyer to help you through the process.

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