What you need to know about bankruptcy

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If your debts have become unmanageable and you feel there is no other way out, you may be wondering if bankruptcy is your next best step. While it’s true that nobody wants to leave their financial fate in the hands of the courts, there are times when bankruptcy really is the only solution that can work. Keep reading to learn the basics of bankruptcy, how to file and what to keep in mind before you do.

What is bankruptcy?

Bankruptcy is a formal legal process that can help absolve consumers of some of their debts or reorganize their debts so they can reasonably be paid off. Different types of bankruptcy can lead to different outcomes, and the unique types of bankruptcy are also geared toward different types of consumers.

With that being said, most consumers who file bankruptcy do so with the aid of a bankruptcy attorney. Either way, bankruptcy begins when a debtor files a petition for bankruptcy with a bankruptcy court. Individuals can file bankruptcy on their own, but couples can also file together. Businesses can also file for bankruptcy using their own separate processes.

Types of bankruptcy

There are two main types of bankruptcies for consumers to consider, each of which can make sense depending on a consumer’s financial situation:

  • Chapter 7 bankruptcy: With Chapter 7 bankruptcy, property is sold and the proceeds are used to pay off your debts. This type of bankruptcy is usually pursued by consumers who do not earn enough money to repay the debts they have.
  • Chapter 13 bankruptcy: With a Chapter 13 bankruptcy, some of your unsecured debts may be forgiven. However, remaining debts are reorganized and set up to be repaid over a specific length of time (usually three to five years). This type of bankruptcy is often utilized by consumers who earn enough to repay their debts but need assistance and a fresh start.

While Chapter 7 bankruptcy can stay on your credit reports for 10 years, Chapter 13 bankruptcy only stays on your reports for seven years. However, the impact on your credit score will lessen over time. For example, a bankruptcy filed last year will have a greater impact than a bankruptcy filed five years ago.

How bankruptcy works

How exactly your bankruptcy will play out depends on the type of bankruptcy you file. With Chapter 7 bankruptcy, for example, a trustee is typically appointed to take over your property and assess it for resale. Property of value you own can and will be sold in order to raise money for your creditors. With that being said, you may be able to keep important personal items and potentially even real estate, since the rules regarding your Chapter 7 bankruptcy vary depending on where you live.

By contrast, you usually keep your property when you file for Chapter 13 bankruptcy. However, you need to be earning a regular income and agree to repay most of your debts on a repayment plan approved by the courts. A trustee will work with you to collect payments from you, which they’ll use to repay your creditors according to the plan.

While bankruptcy can be a relief for consumers who are able to discharge some of their debts, keep in mind that not all debts can be discharged. According to the United States Department of Justice, most tax debts cannot be discharged in bankruptcy. You also typically cannot discharge child support payments, alimony, most types of student loans, court fines, criminal restitution and amounts owed due to personal injury caused by driving under the influence.

Why someone would file for bankruptcy

Filing for bankruptcy is usually seen as a last resort, and this is mostly due to the lasting impact filing can have on your finances. A recent bankruptcy can easily cause your credit score to plummet, which will likely make it difficult to purchase a home, buy a car or qualify for other types of loans. Filing for bankruptcy can also cause your insurance rates to creep up.

However, consumers who file for bankruptcy usually do so because they are unable to navigate their way out of a financial crisis on their own. While bankruptcy is a permanent and drastic move that has many downsides, the process is intended to get people on a sustainable path toward better finances. Since debts can be entirely discharged throughout the process, filing for bankruptcy can be seen as a godsend for those who are truly struggling and have few other options, if any, to consider.

How do I know if I should file for bankruptcy?

If you are overwhelmed by your financial situation and things only seem to get worse with each passing month, then you may want to consider bankruptcy as a way out. There are plenty of situations where it makes sense to file for bankruptcy despite the consequences.

Reasons to consider filing include:

  • You have so much debt that it would be impossible to pay it off during your lifetime.
  • You’ve experienced an extreme loss in income that makes it impossible to repay debts without any help.
  • You have been sued for an extraordinary amount of money you cannot repay.
  • Your financial situation is grim, and you need a fresh start.
  • Collections agencies and creditors are calling you around the clock and you need third-party help.

How to file for bankruptcy

If filing for bankruptcy sounds overwhelming, you should know that you can request legal help throughout the process if you’re willing to pay for it. All bankruptcies are ultimately filed with the United States Bankruptcy Court, and bankruptcy will cost an average of $300 to $400 in filing fees even if you file for bankruptcy on your own. If you work with an attorney, you can expect to pay between $1,500 and $4,000 or more depending on the type of bankruptcy you file.

Bankruptcy requirements

Not everyone can file for bankruptcy. You have to be able to exhibit an inability to repay your debts on your own, and you’ll also have to meet with a government-approved credit counselor first.

Other requirements must also be met. For example, most people are required to pass a means test before discharging debts through Chapter 7 bankruptcy. Generally speaking, you can qualify if your average gross income has been less than the median income for your family size in your state for six months before you file. If not, you may have to subtract allowed expenses from your income to determine eligibility, or you may need to reorganize your debts through a Chapter 13 bankruptcy instead.

There are also limits on how much debt you can have if you file for Chapter 13 bankruptcy. In 2020, those limits are set at $419,275 for unsecured debts (like credit card debt) and $1,257,850 for secured debts (like a home mortgage or an auto loan).

Final considerations

If you’re considering bankruptcy because you need third-party help to get out of debt, you may want to consider bankruptcy alternatives as well. For example, debt settlement and debt management plans can be used to reorganize and pay off debts or settle debts for less than what you owe.

Speaking with a credit counselor can also help you determine how bad your financial situation is and if you could potentially reorganize your finances yourself. At the very least, a highly qualified credit counselor could help you get another perspective on your situation and whether bankruptcy is right for you.

Next steps

If you aren’t sure which move you should make next, you may want to spend some time comparing all your options. Learn about the types of bankruptcy and what it takes to file, and consider all the bankruptcy alternatives you could pursue instead, along with their pros and cons. Also note that many bankruptcy attorneys offer a free consultation to help you determine your next best steps.

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