Bankruptcy is often used as a last resort because it comes with risks and downsides. To help minimize the risks, laws are in place to protect you while also providing creditors with a portion of debt repayment.
When you file for bankruptcy, you don’t have to give up everything you own. Bankruptcy is a process designed to help people and businesses get a fresh start. Nevertheless, all assets will be measured and evaluated and may be used to repay part of the outstanding debt.
What you keep when filing for bankruptcy
Laws were created to help protect your property during bankruptcy, called bankruptcy exemptions; however, exemptions vary depending on the process and the state.
Your state determines whether you must use your state’s exemptions or if you can choose the federal exemptions. If you live in one of the following states, you can choose the state or the federal bankruptcy exemptions:
- District of Columbia
- New Hampshire
- New Jersey
- New Mexico
- New York
- Rhode Island
If you do not reside in one of these states, you must follow your state’s bankruptcy exemptions.
Common federal bankruptcy exemptions are listed below. Married couples filing jointly can double the exemption amount and all amounts are shown for cases filed after April 1, 2016, and cases filed after April 1, 2019. These numbers will be adjusted again on April 1, 2022.
Your primary residence could be exempt when filing for bankruptcy if its equity is below the exemption limit. You can protect $25,150 of equity in your home under federal exemptions ($23,675 in cases filed before April 1, 2019).
The homestead exemption can apply to your primary residence, which may qualify as:
- A house or another dwelling
- Personal property used as a residence
Because your vehicle is an asset, creditors may pursue it when you file for bankruptcy. However, your vehicle may be counted as an exemption depending on the type of bankruptcy being filed, whether you own, lease or are financing the vehicle and its value. According to federal bankruptcy exemption law, you may be able to exempt part of your vehicle’s equity up to $4,000.
If your equity exceeds the limit, several things may happen:
- The trustee can sell your vehicle, give you the exempted amount and use the remainder to pay creditors
- The lender can repossess the car if you’re behind on your payments
- You can surrender the vehicle, which relieves you of the responsibility from the auto loan after bankruptcy
Personal items and household goods exemptions
Besides real estate and your vehicle, personal property may qualify for bankruptcy exemption. Here are some commonly claimed federal personal property exemptions:
- $1,700 for jewelry
- $2,525 for tools of the trade
- $$13,400 in aggregate ($625 for each individual item) for household goods and furnishings, appliances, clothing, animals, books, crops or musical instruments
- $13,400 in accrued interest, dividend or loan value of a life insurance contract
- Professionally prescribed health aids
Wages, benefits and retirement account exemptions
There are exemptions to protect the money you receive as a benefit, support or what you have in retirement savings, including:
- Alimony, support, or maintenance that you reasonably need for your support
- Life insurance payments that you need for support
- All Social Security benefits, unemployment benefits, veteran’s benefits, public assistance and disability or illness benefits
- Under most circumstances, you can keep proceeds from your retirement accounts up to the maximum aggregate value of $1,362,800
Injury recovery exemptions
Exemptions for personal injury recovery include:
- $25,150 for personal injury recovery, not including pain and suffering or pecuniary loss
- Compensation for loss of future earnings necessary for support
- Payment for the wrongful death of a person you depended on for support
- Compensation due to being a victim of a crime
The wildcard exemption can be used for any type of property. The exemption is $1,325 plus $12,575 of any unused portion of your property exemption.
Differences between Chapter 7 and Chapter 13 bankruptcy
There is more than one process whereby you can file for bankruptcy. The two types people most favor are Chapter 7 bankruptcy and Chapter 13 bankruptcy. The type of bankruptcy also affects what items may be kept or taken from you.
A chapter 7 bankruptcy enables you to legally discharge, or no longer be liable for, most debt that you owed as of the date you filed for the bankruptcy. This process takes about three months after you file the bankruptcy petition. You could lose some of your property by taking this route. If you had transferred property before filing for bankruptcy, the transfer may be reversed to you.
A chapter 13 bankruptcy enables you to enter into a payment plan to pay off your debt over a three-to-five-year period. Congress has even extended the plan period to seven years, with some exceptions, as a result of the covid crisis. This process protects your property and prevents wage garnishment, and you are able to pay back your outstanding debt through your payment plan. You have to make a payment out of your disposable income every month.
Things to do before going through the bankruptcy process
Before going through the bankruptcy process, you might want to consider certain factors. In a post for the Oregon State Bar, legal editor Richard Slottee advises:
- Make a list of your monthly income and expenses. Doing so can help you set up a budget.
- Get insurance. Even if you discharge your debts in bankruptcy, you could easily rack up new debt again if you don’t have medical insurance or automobile liability insurance.
- Gather information about your creditors. Make a list of all your creditors, with their addresses and the amounts of money you owe them.
- Find out if you are judgment proof. Some people may be “judgment proof,” in that they may not have property of adequate value to seize or sufficient income to garnish even though their creditors got a court order against them. Creditors may not think it worth their while to sue such people, but you may still want to file for bankruptcy to stop their harassment.
- Resolve financial issues. If you have a tendency to rake up debt, filing for bankruptcy may not be a permanent solution. You can file for another Chapter 7 bankruptcy only after eight years. It’s best to resolve your financial issues beforehand so that you don’t face the risk of bankruptcy again.
- Know which debts are not discharged with bankruptcy. Certain types of debts are exempt from bankruptcy protection. If you owe child support or support for your spouse, you can’t evade these responsibilities through bankruptcy. Criminal restitution and criminal fines are also among such debts that bankruptcy protection doesn’t extend to. If you owe personal income taxes, it can only be discharged in limited circumstances, and the same is true for your liability for passing bad checks or fraudulent credit card activity. Student loan debt is also notably difficult to rid yourself of.
What creditors can take in a bankruptcy
Your “bankruptcy estate” is made up of all your income and property that creditors could potentially get hold of. This includes all the property that you own at the time of the bankruptcy filing, as well as any income that you have earned, even if you haven’t received it yet.
Even some property that you don’t own at the time of filing, such as an inheritance you are expecting, the proceeds of a divorce settlement or decree that you won within 180 days of filing for bankruptcy, could be parceled into your bankruptcy estate. If you are owed a tax refund, that could also go into the pool.
If you have transferred, sold or given away some property two to four years before filing for bankruptcy, and did not receive a “reasonably equivalent value” in payment, your creditor could lay claim to such property as well.
If you paid $600 or more in debt to a creditor within 90 days before your bankruptcy filing, or paid off $600 or more to a relative or friend in the one-year period before your filing, your creditor could also lay claim to that amount.
Essential property exemptions
The law protects some essential property from being seized. For instance, such property could include your car, your home, furniture, your professional tools and retirement accounts.
There is a dollar limit for such “exempt” property, and you will have to follow the legal procedures to put in your claim for these exemptions. You could either opt for your state exemptions, which vary, or the federal exemptions.
If you file for Chapter 13 bankruptcy, all your property is usually exempt, considering that you will be paying off your debt on a time schedule.
What to know before filing for bankruptcy
As a fallout of your bankruptcy filing, your credit will be tarnished for a 10-year period if it is a Chapter 7 bankruptcy, and a seven-year period for a Chapter 13 bankruptcy.
Even though you are not legally required to hire a lawyer to handle your bankruptcy, it may be in your best interest to do so. You may even be able to find free legal services.