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The basics of bankruptcy

If the strain of your financial situation is causing problems at work, at home or with your health, it might be worthwhile to consider filing for bankruptcy.

The system was designed to help honest people who are in financial trouble get a fresh start. You certainly wouldn't be alone. Personal (and business) bankruptcy filings hit an all-time high in 2002, with more than 1.5 million Americans filing for relief from their debts.

If you're thinking about filing for bankruptcy, here is what you can expect from the process:

Choosing which chapter to file
There are several chapters of the bankruptcy code, and each covers a different process. For individuals, the chapters that are most applicable are 7 and 13. You can only file for bankruptcy once every seven years.

The majority of individuals file for Chapter 7 protection, under which their assets are sold to pay their debts. The assets that can be sold will depend on which state you live in. The chances are good that if you own a house, your creditors won't be able to take that. (It's called an exempt asset.) It's also likely that they won't take your car. But if you own more than one car, or any other kind of vehicle, those may be sold.

Most people who file for Chapter 7 bankruptcy choose that route because they don't have many assets anyway. They're renting an apartment, they're behind on their car payment and they don't have any money in the bank, so it becomes something of a non-issue. All the proceeds go into one pot and the creditors are paid according to their priority under the law. (The lawyers get paid first - surprised?).

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Regardless of how much of the debt is actually repaid, the entire amount is wiped clean - with some notable exceptions. For instance, you can't get rid of student loans, child support or alimony.

Chapter 13 is a repayment plan. Typically, people who file for Chapter 13 submit a plan to repay their debts (or a negotiated portion of them) over three to five years. During that time, you pay your current bills and turn over your disposable income to a court-appointed trustee, who sends the payments to your creditors. If the judge decides that your plan doesn't have a snowball's chance in Guatemala of succeeding, you may be forced to switch to Chapter 7 for liquidation.

To file for Chapter 13, you must have regular income, and your unsecured debts (such as credit cards) can't exceed $269,250 and your secured debts (such as a mortgage) can't exceed $871,550, says David Light, senior managing editor of Consumer Bankruptcy News, a trade publication for bankruptcy professionals, and a licensed bankruptcy attorney. If they seem like weird numbers, it's because they're adjusted every three years for inflation.

To decide which chapter is best for you, talk to an attorney who specializes in bankruptcies. A lot of people file for bankruptcy without using an attorney. Light says that's pretty risky given the seriousness of the proceeding.

"When you go into bankruptcy court, you're talking about discharging thousands of dollars in debt and the ability to buy a house in the future," he says. "You may have to remove liens from property and protect your wages. If I had that much at stake, I wouldn't want to make decisions out of a book."

The down side, Light notes, is that attorneys cost money "and that's a very real problem."
An initial consultation shouldn't cost you anything, and in a Chapter 13 filing, attorneys often will take their fees through the repayment plan.

In a Chapter 7 filing, your attorney may want to be paid up front in cash. Light says you should expect to pay between $500 and $1,000 to have an attorney handle a Chapter 7 filing. Chapter 13 could cost much more.

Your attorney will need a complete list of your assets and debts. If you don't include all the assets, your creditors can ask the court to discharge, or dismiss, your petition. If you don't include all your debts, you can't get them wiped out.

Which brings us to a related subject. Just because you file for bankruptcy doesn't mean it's going to happen. The court has total discretion in these cases. After reviewing your petition, the judge can decide that you have the resources to pay your debts.

The quickest way to get your petition rejected is trying to hide something. If you have assets and transfer them to someone else to keep them away from your creditors, the court will look on this as fraud.

"If someone thinks they can fudge their expenses and make it look like they have don't have money left over, the least of your worries is getting kicked out of bankruptcy," says Light. "It's a federal offense. It's something like a $250,000 fine and five years in prison. And they've been cracking down on it. Fudging expenses probably won't get you thrown in a federal pokey, but not listing a second car could get you prosecuted."

You'll need to prepare yourself to be asked some very personal questions about how you spend your money, especially if you're filing for Chapter 13. The court tends to frown on certain kinds of expenses, Light says, such as manicures, gym and country club memberships, tanning sessions, recreational vehicles, fresh flowers and jewelry.

Once you file, you can change your mind, but it doesn't mean the court will let you out of bankruptcy. But let's say you got an inheritance or a job with a big raise. You could ask for a discharge. If you've filed for Chapter 7, "you have to show the court there's cause to get out and that it wouldn't hurt your creditors," Light says. In Chapter 13, you have the right to get out at any time as long as the case has never been converted to Chapter 7 liquidation.

It usually takes three to six months to complete a Chapter 7 liquidation. In Chapter 13, the time frame depends on the length of the repayment plan, but it won't be more than five years.

The long-term effect
A distinct advantage of filing for bankruptcy is that once you file, your creditors can't try to collect payment anymore and you get to start over with a clean slate.

The major drawback of filing for bankruptcy is the impact on your credit report. A bankruptcy is the biggest black mark you can have, and it stays on your report for up to a full decade. It doesn't mean you can't get a credit card or a loan during that time, but you'll pay much higher interest rates because you're considered a high risk for not paying your bills.

Lenders looking at your credit report don't care which chapter you filed, says Chris Viale, general manager of Cambridge Credit Counseling, a nonprofit consumer credit agency in Agawam, Mass.

"The second lenders see any kind of filing," he says, "they'll charge the most they can."

It can also impact your ability to rent an apartment or to be hired for some jobs, especially those that involve handling money. Many employers do credit checks and can perceive a bankruptcy as a sign of irresponsible financial habits.

Dr. Tahira K. Hira, professor of family finance at Iowa State University, has done several studies on the personal impact of bankruptcy. Most often, people said they were surprised and shocked at how quickly and easily they went through the system. On the emotional side, she says couples who file for bankruptcy need to pay close attention to their relationship.

"Many times, people have struggled first to pay the debt, they're shocked to see how easy it was, and within months, those people are divorced," she says. "They hung in there, got through this and then fell apart. This circle is very well-documented."

If you have children, it's also important to have some kind of discussion with them.

"People think they don't know. For God's sake, they know and they think worse," she says. "They suffer much bigger than if you had talked to them."

Keeping the lines of communication open can reduce the impact and help keep the family working together in the aftermath.

"Know that it will be stressful," Hira says. "Yes, financially you will be better off, but emotionally, it's a failure. You have to deal with that. Acknowledging it and preparing yourself for it will minimize the negative aspects of it. It doesn't just go away."

-- Posted: Jan. 9, 2003

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