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The 5 most common types of bankruptcy

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When you can’t get out from under your debt without adversely affecting your livelihood, you may want to consider bankruptcy.

The U.S. Bankruptcy Code includes five types of bankruptcy for debts owed in the U.S. (the sixth, Chapter 15, deals with debt encompassing more than one country). Each one applies to a specific type of debtor. Each chapter has a goal: either liquidation, in which certain assets are used to repay creditors, or restructuring, when a payment plan is created to pay a part or all of the debt owed.

Chapter 7 and Chapter 13 bankruptcy are the most commonly filed types of bankruptcy, likely because they’re available to individuals. Other types of bankruptcy apply to businesses, individuals and other entities. Here’s what to know about each bankruptcy option.

Chapter 7

Chapter 7, also known as liquidation, allows individuals or businesses to give up nonexempt assets and walk away from most debts. To qualify, debtors must pass the means test — their income must be less than their state’s median income.

Not all debt can be discharged, and discharge is not automatic in Chapter 7 bankruptcy. Individuals who successfully discharge eligible debt are no longer liable for the debt.

Who this is best for: Individuals or businesses who can pass the means test.

What happens to the debt: The debt is discharged.

Primary advantage: The bankruptcy process is relatively quick.

Primary disadvantage: It causes the loss of non-exempt assets, and some debt might not be discharged.

Chapter 9

This section allows municipalities to reorganize debt. Whether it’s a school district, city or county facing financial hardship, Chapter 9 bankruptcy allows it to restructure the debt and create a plan without selling its assets.

Municipalities that file for Chapter 9 can reorganize debts by lowering the interest rate on existing debt, reducing the principal amount, extending the repayment term or refinancing.

Who this is best for: Municipalities that are in financial distress.

What happens to the debt: The debt is reorganized.

Primary advantage: It imposes an automatic stay, halting collections while the municipality reorganizes its debt.

Primary disadvantage: It’s costly and can be hard to get approved.

Chapter 11

Also known as reorganization, Chapter 11 bankruptcy is for individuals — and, more commonly, businesses — to restructure debt. It allows the filer to draft a plan to repay some debt while retaining assets.

Corporations filing Chapter 11 bankruptcy don’t risk putting shareholders’ assets at risk since the business is considered a separate entity from shareowners. In a sole proprietorship business, on the other hand, the owner and debtor are the same person, so both personal and business assets are considered in a Chapter 11 filing.

Chapter 11 is much more complicated and expensive, making it financially feasible mainly for businesses and wealthy individuals.

Who this is best for: Corporations or business partnerships.

What happens to the debt: The debt is reorganized.

Primary advantage: Businesses can remain operational with an automatic stay in effect during bankruptcy.

Primary disadvantage: It’s costly and can be time-extensive.

Chapter 12

Chapter 12 allows family farmers and fishermen with regular income to reorganize debt. Although it works similarly to Chapter 13, this option is more advantageous to farmers with larger debts who don’t meet Chapter 13 wage-earner classifications. It’s also more straightforward than the Chapter 11 process. Repayment usually stretches out over three years, but a court can also decide to extend the repayment period up to five years if it finds this time justified.

After the debtor fulfills all payments in the reorganization plan, their debt is discharged. Certain debts, like child support or alimony, aren’t dischargeable through Chapter 12 bankruptcy.

Who this is best for: Family farmers or family fishermen.

What happens to the debt: The debts are repaid with a repayment plan.

Primary advantage: Can repay the debt over a maximum of five years.

Primary disadvantage: It might be more favorable to some creditors than Chapter 7, and the process is simpler than chapter 11 for some businesses.

Chapter 13

Similar to Chapter 11, Chapter 13 is available to individuals who need to restructure their debt loads. Some creditors will be paid back in full with interest, while others will be repaid a percentage of the debt. Typically, the repayment period is from three to five years.

This type of bankruptcy requires debtors to have regular income, and there are debt thresholds that restrict eligibility. Unsecured debt under this filing must be less than $394,725, and secured debts must be less than $1,184,200. A benefit of Chapter 13 is that the debtor’s home is not at risk of foreclosure during these proceedings.

Who this is best for: Individuals with regular income.

What happens to the debt: The debts are repaid with a repayment plan.

Primary advantage: Can keep home from going into foreclosure.

Primary disadvantage: Repayment plans can take up to five years.

What to do if you have too much debt

If your debt feels overwhelming, you have a few options:

  • Negotiating directly with creditors. Creditors would rather get some of the money you owe rather than risk getting nothing (as in the case with Chapter 7 bankruptcy). Be transparent about your financial situation, and see if they’re willing to work with you on a payment plan, debt amount reduction or other solution.
  • Credit counseling. If you need more guidance, a nonprofit credit counseling agency can help. They’ll help stop collection calls and create a debt management plan for your financial situation. You can find out more from the National Foundation for Credit Counseling.
  • Bankruptcy. Filing for bankruptcy is an option if you’ve tried all other ways to address your debt. This path has long-lasting effects on your credit record and can adversely affect your credit anywhere from seven to 10 years.

Bottom line

Bankruptcy is a complicated process, so if you decide it’s your best option, you should consult with a bankruptcy attorney. Regardless of which bankruptcy chapter you file, you’re required to undergo credit counseling from an approved agency within 180 days before formally filing bankruptcy.

And remember, not all debt is discharged in bankruptcy, so this option isn’t guaranteed to wipe out everything you owe. Make sure you consult with an unbiased bankruptcy or credit professional before moving forward with this life-changing decision.

Written by
Jennifer Calonia
Contributing writer
Jennifer Calonia is an L.A.-based writer and editor. She's covered topics like debt, saving money and credit cards. You can find her work on Business Insider, Forbes and more.
Edited by
Loans Editor, Former Insurance Editor