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Overwhelmed by Debt? The How and Why of Bankruptcy

Are you overwhelmed by your debts? Are you struggling just to pay your monthly bills, or, even worse, juggling your accounts so you can pay the bills with your credit cards? If you are doing your best, but your debts are only growing, there is a clean way out: filing bankruptcy.

Many people fear bankruptcy - but that is mainly because they don’t understand what bankruptcy actually is, or how it works. They have heard that filing bankruptcy means they will “lose everything” - when, in reality, many people don’t lose anything at all. (Through Chapter 7 bankruptcy, which is the chapter that most individuals would file under, you may exempt assets such as the family home, your car, jewelry, work equipment - in other words, keep them!).

If you are experiencing challenges in paying your debts, filing bankruptcy may be the fastest way for you to regain financial stability, and get on track to rebuild your credit score. And the moment you file, any collection actions (including foreclosure proceedings) are instantly stopped.

For many people, filing for bankruptcy is the quickest and most permanent solution to their financial woes. But, since there is so much misinformation out there, many people don’t even investigate bankruptcy as a possible option! That’s why I want to write this post: as a primer on bankruptcy. I’ll explain to you what bankruptcy is, and how it works. Then, in future posts, we can go through the details of Chapter 7, and Chapter 13 bankruptcy.

What is bankruptcy?

Bankruptcy is a legal procedure which allows you to reduce your debt or to eliminate it completely.

HOW DOES BANKRUPTCY WORK?

To declare bankruptcy, you file a petition with the bankruptcy court. The petition accounts for all of your assets and your debts. As outlined below, if you file for Chapter 7 bankruptcy (which is how the majority of individuals file), you may exempt many of your assets so that you will not lose them during the bankruptcy proceeding, including your house and your car.

As soon as you file for bankruptcy, all collection actions are instantly stopped. This means that any foreclosure proceedings and garnishments are immediately halted, and that your creditors may no longer contact you. No more harassing phone calls!

You then ask the court to either eliminate your debts completely (Chapter 7), or to allow you to enter into a repayment plan (Chapter 13).

The majority of individual bankruptcy filers can have their debts eliminated by filing Chapter 7. For those who enter into a payment plan, the plan will last between three to five years. How much you pay depends on what type of debts you have and your income. Afterward, the court will eliminate your remaining debt through a discharge.

Once you have received a discharge, you will no longer be legally obligated to pay your creditors anything else, and your creditors will not be able to contact you about the debt, garnish your wages, or try to collect in any way.

What are bankruptcy “chapters”?

There are three types or “chapters” of bankruptcy that individuals might choose to file under: Chapters 7, 11, and 13. (There are other bankruptcy chapters as well, but they are used by companies.)

Chapter 11 is intended more for companies, but it can also work for individuals, such as investors or developers, who have more than $1,149,525 in secured debt (this amount may change - be sure to get up-to-date figures) or more than $383,175 in unsecured debt and who do not qualify for Chapter 7. It is more expensive to do, and is structured so that individuals or companies can continue to remain in business while coming up with a repayment plan for their creditors.

In this post, we’ll focus on the two chapters commonly used by individuals: Chapter 7 (also known as “liquidation”) and Chapter 13 (or “restructuring”).

CHAPTER 7 BANKRUPTCY

Chapter 7 bankruptcy is the most common type of bankruptcy for individuals. It is the preferred way of dealing with debt since the process is much quicker and cheaper than a Chapter 13.

Chapter 7 involves appointment of a trustee, and liquidation and sale of non-exempt property in order to pay off creditors. Since most property that is considered “essential” is actually exempt, you usually get to keep most or all of your property, such as: home (up to a certain value in equity), household items, jewelry, “tools of the trade,” and some or all of your car’s value. The value of these exemptions varies from state to state.

In most cases, you don’t actually lose any of you property at all. However, it is important that you understand that losing some possessions is a possibility when declaring Chapter 7 bankruptcy. This is why it is important to seek professional advice.

To qualify for Chapter 7 bankruptcy, your income must be below the median for your own state, calculated using your income for the six months prior to filing. You’ll need to look up what the dollar value of that income threshold is in your own state (and there will be different thresholds, depending upon whether you are an individual or a couple, and whether or not you have dependents). The thresholds can change, so make sure you get current information. Median income data is compiled and produced by the Department of Justice.

All Chapter 7 filers need to pass the Means Test. The Means Test is a system used to ensure that those who file Chapter 7 are indeed those who cannot pay back their debts. If your income is below the state median, then you have passed the Means Test. If your income is above the median, you may still qualify for Chapter 7. The Means Test can also take into account certain deductions, such as any court-ordered support payments or health insurance payments, that could potentially lower your disposable monthly income and enable you to qualify for a Chapter 7.

CHAPTER 13 BANKRUPTCY

Chapter 13 is the other type of bankruptcy that individuals commonly use. It is usually the best choice for individuals whose income is too high to qualify for Chapter 7 or who have assets that are over the exempt limit. Chapter 13 bankruptcy is for individuals, not companies or partnerships.

Like Chapter 7 bankruptcy, Chapter 13 also involves the appointment of a trustee. In Chapter 7, the aim is to sell unexempt assets to pay the creditors. In contrast, in Chapter 13, the trustee ensures that any disposable monthly income is being paid toward unsecured creditors.

In Chapter 13, you may be able to keep property that is collateral on secured loans, such as your home or your car, as long as the plan accounts for paying those loans. Chapter 13 uses the Means Test to determine how much disposable monthly income you have, and there may be a portion of the payment that goes to your unsecured creditors. They may get a small percentage of what they are owed over the term of the plan, or they may not get anything. The plan may also include coming up with a way to deal with debts related to assets such as your home - for example, catching up arrears on your house or car, or a short sale inside the Chapter 13 plan.

The entire Chapter 13 plan is usually structured over a five-year period (or, in some cases, over three years). By the end of the plan, you will be caught up on payments for your secured debts (such as home and car), and any remaining unsecured debt will be wiped out.

Despite the preference for Chapter 7, there are some benefits to filing Chapter 13. It may be better for your credit score. It also allows for lien-stripping, which is a way to convert junior liens (such as second mortgages and HELOCs) into unsecured debts: we’ll talk in more detail about exactly how this works in an upcoming post specifically on Chapter 13 bankruptcy.

What effect will filing have on my credit score?

Your credit score usually goes down after filing bankruptcy. However, it’s important to remember that your credit score will also go down if you don’t deal with those mounting debts: from becoming delinquent on your mortgage payments, from having accounts go to collections, or from undergoing a foreclosure.

It is difficult to know in advance how much a bankruptcy could affect your credit score. The credit reporting agencies do not share how they calculate credit scores. How much of a hit your score could take depends in part on how good your credit was before the bankruptcy.

What does it cost to file bankruptcy?

The answer to this varies based on a lot of factors. Here are some typical fees:

CHAPTER 7

$335 court fee. Generally, the entire amount must be paid when your case is filed. However, some filers are allowed to pay only $100 at the time of filing, and the remainder within 120 days of the date of filing.
$50-$100 for credit counseling and financial management courses.
$1000-$2500 attorney fees. This depends on the attorney, the location and the complexity of the case. If your finances are complex, then your cost will probably be on the higher end of this range.

CHAPTER 13

$310 court fee. Some filers are allowed to only pay $100 at the time of filing, and the remainder as part of your Chapter 13 plan.
$50-$100 for credit counseling and financial management courses.
$3500-$4000+. Some jurisdictions have caps on this fee, which are typically about $3500. Many attorneys only ask for a portion of this up front, with the rest to paid out of your plan payments.

Don’t forget, here at Ark Law Group, we offer free no-obligation attorney consults. A chat with an attorney can be a great way for you to get a handle on your own situation, and find out exactly what options are available to you and how they would work.

How long does a bankruptcy take?

It typically takes a few weeks to prepare a petition and all of the necessary documents. This includes consultation, gathering credit reports, preparing and reviewing the petition, and taking the required credit counseling course (which takes about one hour) and financial management course (which takes about one more hour, but can be done up to 30 days after the filing).

Some people may opt to wait a bit before filing. Your bankruptcy petition is based largely on your income over the past 6 months. If you recently had an income reduction, it may be wise to wait, so your petition shows a lower income. However, in the case of a divorcing couple, it would be better to file bankruptcy sooner, before the divorce, so the husband and wife can file together, pay only one set of fees, and take care of all their debts before finalizing their divorce.

The whole Chapter 7 bankruptcy process generally takes about four months. For Chapter 13, it may take a few months to come up with a confirmed repayment plan, and then that plan is executed over either three or five years.

Who will know if I file for bankruptcy?

This is a common question many ask before they file bankruptcy. You may be concerned about ending up on a “bankruptcy list,” or that your friends and neighbors will find out.

Although bankruptcy filings are a matter of public record, they are not easily discoverable. The court goes out of its way to protect some of the private information for consumers. The information is not indexed on Google or other consumer search engines, and people must register for a Public Access to Court Electronic Records (known as PACER) account before accessing these documents online. This system enables users to retrieve case and document information, for a fee.

These steps make it difficult for anyone to find out whether you have filed bankruptcy - unless they already know when and where you filed.

When should you file for bankruptcy?

There are numerous strategies for dealing with overwhelming debt. Aside from bankruptcy, other strategies that may help include:

debt consolidation
debt settlement
loan modification
short sale

These solutions can be used individually or in combination. Everyone’s situation is different, and what works for one person may not be the best solution for someone else. That’s why, if you are struggling to meet your financial obligations, it is in your best interest to consult an attorney or financial professional as early as possible, while you still have many of these options available.

Here are some signs that bankruptcy might be the right solution for you:

if you add up all of your unsecured debts (credit card debt, medical debt, unpaid or overdue bills, etc.), and that total represents a significant portion of your annual income
if you are regularly using credit cards to pay off normal living expenses
if you have fallen behind on your mortgage payments and need time to catch up on arrears
if you are underwater with your mortgage (in other words, you owe more on the mortgage than what your home is currently worth)
if you have been affected by a layoff, or death in the family, or other unexpected loss of income
if mounting interest, fees and penalties are making otherwise normal debt unsustainable
if you have resorted to pay day loans or pawn shops or other high-cost consumer lending services
if you have received a summons and complaint for an impending garnishment

If you’d like to learn out more about bankruptcy, or find out more about options for dealing with your own debt problems, please don’t hesitate to be in touch. You can contact us directly to book a free, no-obligation consultation with one of our attorneys, or you can chat with an attorney online.

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At Ark Law Group, we know that being in debt is about so much more than just numbers. We understand the pain that debt causes, and the personal toll it takes on families and on relationships. We are here first to listen - because we know that everyone's situation is different. Once we understand your unique circumstances and your individual needs, our team of attorneys and financial professionals will help you find the best and quickest solution to your personal debt problems. For a free, no-obligation consultation, tell us about your situation or call us directly at 1-800-603-3525.