Bankruptcy is a legal process through which you are declared unable to pay your debts when they fall due. You may file for bankruptcy (voluntary bankruptcy), or alternatively, creditors can apply to have you declared bankrupt. If you are declared bankrupt by either of the above means, you will be removed from managing your own finances, and a trustee will be appointed to manage your money and assets.
If your debts have become unmanageable or you’re facing foreclosure on your home, you might be thinking about declaring bankruptcy. While bankruptcy may be the only way out for some people, it also has serious consequences that are worth considering before you make any decisions. For example, bankruptcy will remain on your credit report for either seven or 10 years, depending on the type of bankruptcy. That can make it difficult to obtain a credit card, car loan, or mortgage in the future. It could also mean higher insurance rates and even affect your ability to get a job or rent an apartment.
What to Do Before Filing for Bankruptcy
Bankruptcy is generally considered a last resort for people who are deep in debt and see no way to pay their bills. Before filing for bankruptcy, there are alternatives that are worth exploring. They are less costly than bankruptcy and likely to do less damage to your credit record.
For example, find out if your creditors are willing to negotiate. Rather than wait for a bankruptcy settlement and risk getting nothing at all some creditors will agree to accept reduced payments over a longer period of time.
In the case of a home mortgage, call your loan servicer to see what options may be available to you. Some lenders offer forbearance (postponing payments for a period of time), repayment plans (such as smaller payments stretched over a longer period), or loan modification programs (which might, for example, lower your interest rate for the remainder of the loan). Even the Internal Revenue Service is often willing to negotiate. If you owe taxes, you may be eligible for an offer in compromise, in which the IRS will agree to accept a lower amount. The IRS also offers payment plans, allowing eligible taxpayers to pay what they owe over time.
How to File for Bankruptcy
If you’ve decided to file for bankruptcy, your first step should usually be to consult an attorney. While it is possible to file without one, “seeking the advice of a qualified attorney is strongly recommended because bankruptcy has long-term financial and legal outcomes,” the Administrative Office of the U.S. Courts notes on its website. (Bankruptcy is governed by federal law, and cases are handled by federal bankruptcy courts, although some rules differ from state to state.) Before you file, you’ll be required to attend a counseling session with a credit counseling organization approved by the Department of Justice’s U.S. Trustee Program. The counselor should evaluate your personal financial situation, describe the alternatives to bankruptcy, and help you devise a budget plan. Counseling is free if you can’t afford to pay; otherwise it should cost about $50, according to the Federal Trade Commission. If you still wish to proceed, your attorney can advise you on which type of bankruptcy is more appropriate for your situation.
Types of Personal Bankruptcy
In the case of individuals, as opposed to businesses, there are two common forms of bankruptcy: Chapter 7 and Chapter 13. Here is a brief description of how each type works:
• Chapter 7: This type of bankruptcy essentially liquidates your assets in order to pay your creditors. Some assets typically including part of the equity in your home and automobile, personal items, clothing, tools needed for your employment, pensions, Social Security, and any other public benefits are exempt, meaning you get to keep them. But your remaining, non-exempt assets will be sold off by a trustee appointed by the bankruptcy court and the proceeds will then be distributed to your creditors. Non-exempt assets may include property (other than your primary residence), recreational vehicles, boats, a second car or truck, collectibles or other valuable items, bank accounts, and investment accounts. At the end of the process, most of your debts will be discharged and you will no longer be under any obligation to repay them. However, certain debts, like student loans, child support, and taxes, cannot be discharged. Chapter 7 is generally chosen by individuals with lower income and few assets. Your eligibility for it is also subject to a means test, as explained bellow.
• Chapter 13: In this type of bankruptcy, you are allowed to retain your assets, but must agree to repay your debts over a specified period of three to five years. The trustee collects your payments and distributes them to creditors. Chapter 13 bankruptcy is normally chosen by people who want to keep their non-exempt property intact or buy time against foreclosures or property seizures.
What Happens After I File For Bankruptcy?
After you complete the process for filing personal bankruptcy, there is an immediate “stay of proceedings.” This part of the process protects you from unsecured creditors trying to begin or continue any legal actions against you, such as wage garnishees, lawsuits, or any type of contact with you to collect a debt. Within five days, your trustee will send a copy of the bankruptcy paperwork to all creditors so they can begin the process of filing a claim. Your trustee will also file any outstanding tax returns up until the date of bankruptcy. Any outstanding balances or penalties will be included. After your personal bankruptcy paperwork is complete, you will have obligations such as providing monthly income statements and attending credit counseling sessions. When your bankruptcy is discharged, your debts will be canceled. It is important to understand that there may be minor exceptions to the debt cancellations. A note about your bankruptcy will remain on your credit report for a minimum of 6 years after the date of discharge. Once your debts are canceled, usually 9 months after filing, you can begin rebuilding your credit.
When Should I File for Bankruptcy?
Despite what many think, filing for bankruptcy is not the end of the world. It can actually be the fresh start you have been looking for. The laws of bankruptcy were drafted with the purpose of giving people a second chance, and not to punish them. But that doesn’t mean you should file for bankruptcy at the first sign of financial distress. Declaring bankruptcy will have short- and long-term consequences and should only be done as a last resort.
Before You File, Evaluate Your Situation
When should I file for bankruptcy? This is a question most people under financial distress ask. You should probably consider other options before going this route. These options include:
• Getting credit counseling
• Trying to negotiate your debt or make a payment plan with your creditor
• Sticking to a budget
If, however, other options don’t seem feasible, filing for bankruptcy may give you the ability to get a fresh start. Bankruptcy is a process by which you can discharge some of your debt because you are unable to repay those debts. There are usually two ways bankruptcy is declared:
• You file for bankruptcy
• Your creditors ask the court to declare you bank
When Should I Declare Bankruptcy?
There is no “perfect” time, but there is a good rule of thumb to keep in mind when you’re asking yourself the question: should I file for bankruptcy? If it is going to take more than five years for you to pay off all your debts, it might be time to declare bankruptcy. The thinking behind this is that the bankruptcy code was set up to give people a second chance, not to punish them. If some combination of mortgage debt, credit card debt, medical bills and student loans has devastated you financially and you don’t see that picture changing, bankruptcy might be the best answer. If you don’t qualify for bankruptcy, there is still hope. Other possible debt-relief choices include a debt management program or debt settlement, but both of those typically need 3-5 years to reach a resolution and neither one guarantee all your debts will be settled when you finish. Bankruptcy carries some significant long-term penalties because it will remain on your credit report for 7-10 years, but there is a great mental and emotional lift when you’re given a fresh start and all your debts are eliminated.
Why Would You Declare Bankruptcy?
The primary reason for declaring bankruptcy is to start all over again with a clean slate. However, there is a secondary reason for filing that might ease some of the tension related to your problems. Declaring bankruptcy will stop the badgering phone calls, letters and other attempts to contact and collect from you. Legally, it’s referred to as “the automatic stay.” It means that creditors are prohibited from filing a lawsuit against you or entering liens against your property or constantly contacting you in an effort to get a payment on the debt. It also stops things like eviction, utility disconnection and wage garnishments. Bankruptcy is a long- tormenting situation. Once you have filed, the process usually takes six months or more to complete. Before, and during that time, you and possibly your friends or workplace, have received phone calls from debt collection agencies trying to settle your accounts. Those calls must stop as soon as you declare bankruptcy.
Consequences of Bankruptcy
Perhaps the most well-known consequence of bankruptcy is the loss of property. As previously noted, both types of bankruptcy proceedings can require you to give up possessions for sale in order to repay creditors. Under certain circumstances, bankruptcy can mean losing real estate, vehicles, jewelry, antique furnishings and other types of possessions. Your bankruptcy can also affect others financially. For example, if your parents co-signed an auto loan for you, they could still be held responsible for at least some of that debt if you file for bankruptcy.
Finally, bankruptcy damages your credit. Bankruptcies are considered negative information on your credit report, and can affect how future lenders view you. Seeing a bankruptcy on your credit file may prompt creditors to decline extending you credit or to offer you higher interest rates and less favorable terms if they do decide to give you credit. Depending on the type of bankruptcy you file, the negative information can appear on your credit report for up to a decade. Discharged accounts will have their status updated to reflect that they’ve been discharged, and this information will also appear on your credit report. Negative information on a credit report is a factor that can harm your credit score.
Getting a Credit Card or Loan after Bankruptcy
Bankruptcy information on your credit report may make it very difficult to get additional credit after the bankruptcy is discharged at least until the information cycles off your credit report. Lenders will be cautious about giving you additional credit, and they may ask you to accept a higher interest rate or less favorable terms in order to extend you credit. It will be important to begin rebuilding your credit right away, making sure you pay all your bills on time. You’ll also want to be careful not to fall back into any negative habits that contributed to your debt problems in the first place.
Getting a Mortgage After Bankruptcy
Just as bankruptcy can hinder your ability to obtain unsecured credit, it can make it difficult to get a mortgage, as well. You may find lenders decline your mortgage application, and those that do accept it may offer you a much higher interest rate and fees. You may be asked to put up a much higher down payment or shoulder higher closing costs. Rather than give up your home and try to get a new mortgage after bankruptcy, it may be better to reaffirm your current mortgage during bankruptcy proceedings. You would be able to keep your home, continue paying on your current mortgage free of other debts and stay in your current home.
Bankruptcy Alternatives
When you’re struggling with unmanageable debt, bankruptcy is just one solution; there are others to consider. Most will also affect your credit, but probably not as badly as a bankruptcy plus, these alternatives can allow you to keep your property, rather than having to liquidate it in bankruptcy proceedings.
Some bankruptcy alternatives you might consider are:
• Seek help from a government-approved credit counselor or debt management plan. A counselor can work with your creditors to help arrange a workable plan for repaying what you owe.
• Take out a debt consolidation loan. These types of loans can aggregate multiple high-interest, costlier debt into a single, lower-interest loan. Research debt consolidation loans to see if consolidation can lower the total amount you pay and make your debt more manageable.
• Approach your creditors and see if they’re willing to agree to a more manageable repayment plan. Defaulting on your debt is not something your creditors want to see happen to you, either, so they may be willing to work with you to arrange a more achievable repayment plan. Settling your debt will have a negative effect on your credit scores. Be aware that whenever you fail to honor the debt-repayment terms you originally agreed to, it can affect your credit. That said, bankruptcy will still have a more significant negative impact on your credit than will credit negotiation, credit counseling and debt consolidation.
Bankruptcy Terms to Know
Throughout bankruptcy proceedings, you’ll likely come across some legal terms particular to bankruptcy proceedings that you’ll need to know. Here are some of the most common and important ones:
• Bankruptcy trustee: This is the person or corporation, appointed by the bankruptcy court, to act on behalf of the creditors. He or she reviews the debtor’s petition, liquidates property under Chapter 7 filings, and distributes the proceeds to creditors. In Chapter 13 filings, the trustee also oversees the debtor’s repayment plan, receives payments from the debtor and disburses the money to creditors.
• Credit counseling: Before you’ll be allowed to file for bankruptcy, you’ll need to meet either individually or in a group with a nonprofit budget and credit counseling agency. Once you’ve filed, you’ll also be required to complete a course in personal financial management before the bankruptcy can be discharged. Under certain circumstances, both requirements could be waived.
• Discharged bankruptcy: When bankruptcy proceedings are complete, the bankruptcy is considered “discharged.” Under Chapter 7, this occurs after your assets have been sold and creditors paid. Under Chapter 13, it occurs when you’ve completed your repayment plan.
• Exempt property: Although both types of bankruptcy may require you to sell assets to help repay creditors, some types of property may be exempt from sale. State law determines what a debtor may be allowed to keep, but generally items like work tools, a personal vehicle or equity in a primary residence may be exempted.
• Lien: A legal action that allows a creditor to take, hold and sell a debtor’s real estate for security or repayment of a debt.
• Liquidation: The sale of a debtor’s non-exempt property. The sale turns assets into a “liquid” form — cash — which is then disbursed to creditors.
• Means test: The Bankruptcy Code requires people who want to file Chapter 7 bankruptcy to demonstrate that they do not have the means to repay their debts. The requirement is intended to curtail abuse of the bankruptcy code. The test takes into account information such as income, assets, expenses and unsecured debt. If a debtor fails to pass the means test, their Chapter 7 bankruptcy may either be dismissed or converted into a Chapter 13 proceeding.
• Reaffirmed account: Under Chapter 7 bankruptcy, you may agree to continue paying a debt that could be discharged in the proceedings. Reaffirming the account and your commitment to pay the debt is usually done to allow a debtor to keep a piece of collateral, such as a car, that would otherwise be seized as part of the bankruptcy proceedings.
• Secured debt: Debt backed by reclaimable property. For example, your mortgage is backed by your home, and for an auto loan, the vehicle itself is the collateral. Creditors of secured debt have the right to seize the collateral if you default on the loan.
• Unsecured debt: A debt for which the creditor holds no tangible collateral, such as credit cards.
Free Initial Consultation with Lawyer
It’s not a matter of if, it’s a matter of when. Legal problems come to everyone. Whether it’s your son who gets in a car wreck, your uncle who loses his job and needs to file for bankruptcy, your sister’s brother who’s getting divorced, or a grandparent that passes away without a will -all of us have legal issues and questions that arise. So when you have a law question, call Ascent Law for your free consultation (801) 676-5506. We want to help you!
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West Jordan, Utah
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