While many consider declaring bankruptcy as an “option of last resort,” it can be your best way to start getting out of debt after exhausting the other debt payoff strategies.
Filing for bankruptcy has several negative consequences for your credit and finances. However, you may not lose everything during bankruptcy proceedings. Here is a closer look at how bankruptcy works and how you can use this financial practice.
What is bankruptcy?
Bankruptcy is a legal process that individuals and businesses can pursue when they are physically unable to repay their outstanding debts.
Filing for bankruptcy provides legal protections that avoid unnecessary repossessions of physical assets and potentially discharge debts that cannot be repaid within a reasonable time.
Additionally, the bankruptcy proceedings (341 meetings) determine the remaining debt obligations, a repayment plan, and which assets the filer must sell to satisfy the requirements.
While bankruptcy can be a painful process that can take years to recover from fully, it provides a second chance at fixing your finances and rebuilding credit.
Types of Bankruptcy
There are four different sections of the Bankruptcy Code for individuals and businesses. Each one can provide various protections.
Chapter 7
Chapter 7 bankruptcy is also known as “liquidation bankruptcy” and can be better if you have a smaller income and minimal assets. For example, you might be a renter instead of a homeowner.
You must also pass a “means test” to verify you cannot pay back your debts.
After filing a bankruptcy petition, a legal court will review your income, assets, and liabilities. Next, the court classifies your assets as “exempt” or “non-exempt.”
A court order may require you to liquidate (sell) your non-exempt assets to pay off what you can and discharge the remaining balance. The liquidation and discharge process takes approximately 3-5 months versus 3-5 years for other bankruptcy options.
Individuals and businesses can file for Chapter 7. This bankruptcy method remains on your credit report for 10 years.
Chapter 11
Businesses may also decide to apply for Chapter 11 “reorganization bankruptcy” instead of Chapter 7. Individuals can also be eligible for Chapter 11 but Chapters 7 and 13 are more common.
You create a reorganization plan where creditors can vote on the revised repayment plan. The approved plan clarifies how much the debtor still owes and which assets or collateral are sold. Then, any remaining balance can be discharged.
Chapter 12
Chapter 12 bankruptcy is specifically for family farmers and fishermen earning regular annual income.
The repayment plan is from 3-5 years and can have more flexibility than the more common Chapters 7 and 13 bankruptcy codes.
Secured assets like a home loan or car loan must be repaid at the collateral value. Unsecured assets like credit cards will receive an amount similar to Chapter 7 proceedings.
Any remaining balance is discharged after completing the payment plan.
This bankruptcy chapter remains on your credit report for 7 years.
Chapter 13
Chapter 13 is “personal reorganization bankruptcy” and is also referred to as a wage earner’s plan. It can be the better alternative if you own a house or a car that you’re trying to keep. These secured assets are more susceptible to liquidation during Chapter 7.
You will also need to file a Chapter 13 petition if you don’t pass the Chapter 7 means test.
Instead of immediately selling your non-exempt assets like Chapter 7, you follow a payment plan lasting up to five years. Then, it’s possible to discharge the remaining debts after completing the repayment period.
Chapter 13 bankruptcy remains on your credit report for seven years.
Filing for bankruptcy
There is a step-by-step process to follow to file for bankruptcy properly:
- Credit counseling: Before filing a bankruptcy petition, you must undergo credit counseling no more than 180 days before your filing date. This requirement determines if you should pursue a bankruptcy alternative instead.
- Means Test: Chapter 7 filers must complete a means test to determine their eligibility. You’re automatically eligible if your income is below the state median. Having excessive expenses or being a military servicemember can also help you qualify if your income exceeds the median for your state.
- Compile financial records: You must catalog your current assets, debts, incomes, and expenses. A bankruptcy lawyer can help you gather the necessary documentation.
- File bankruptcy petition: After completing the pre-bankruptcy credit counseling, you can apply for the best bankruptcy chapter. You will pay bankruptcy filing fees ($310-$320) plus accompanying legal fees.
- Attend 341 meetings: You must attend the court sessions to complete the bankruptcy proceedings. However, your creditors are not required to show but have the option to negotiate a repayment and discharge plan.
- Follow bankruptcy court orders: After the hearings are complete, a court order determines which assets you must sell, what you must financially repay, and which balances creditors must discharge.
What is pre-bankruptcy credit counseling?
All bankruptcy filers must complete credit counseling with an approved agency no more than 180 days before filing their petition.
Bankruptcy is an option of last resort for getting out of debt and the counseling sessions review your various debt payoff strategies.
Your counselor may first try to trim your expenses, sell assets, and potentially renegotiate your debt for more affordable repayment terms. They may also recommend a debt management plan or debt settlement program to protect your credit.
These debt reduction outcomes are similar to bankruptcy proceedings but have potentially fewer expenses and negative credit report consequences.
Knowing how pre-bankruptcy credit counseling works can help you gain the most benefits from this experience. This session usually lasts one hour and occurs online or by phone.
One other thing to know about pre-bankruptcy counseling is its cost. You can expect only to pay up to $50 for this service. A non-profit counseling agency may also offer it for free.
Advantages and disadvantages
Knowing which bankruptcy chapter to file for depends on your circumstances. Here are some of the advantages and disadvantages to ponder before filing.
| Chapter 7 | Chapter 13 | |
| Means test | Yes | No |
| Protection from creditors | Automatic stay during proceedings | Automatic stay during proceedings |
| Asset protection | Will need to sell non-exempt assets to pay off non-discharged debt. Exempt assets don’t have to be sold. | Secured assets like your home or car or less likely to be liquidated. However, you may need to repay more debt overall. |
| Time to be debt-free | 5-7months | 3-5 years |
A bankruptcy attorney can help you choose the best way to file bankruptcy to protect your finances and family.
When should I declare bankruptcy?
You should consider filing for bankruptcy when you have exhausted all other debt payment options such as debt management or debt settlement programs.
It can also be worth trying to consolidate your debt or work with your creditors first as the credit and financial implications can be less.
It can be best to file for bankruptcy if you’re on the verge of foreclosure, repossession, or other lawsuits and debt collections. In addition, you will need to demonstrate financial hardship and the inability to pay your expenses with your current income.
Weighing the pros and cons of bankruptcy
Here are several pros and cons of bankruptcy.
Advantages
- Protection from creditors: Creditors and debt collection agencies may not submit lawsuits, conduct home visits, send letters, or collect payments. These legal repercussions are still possible with debt settlement plans.
- Asset protection: You receive an automatic stay when filing for bankruptcy. This benefit pauses all foreclosures and repossessions until the court sessions finish. The bankruptcy judge may also exempt certain assets such as your house or car from being liquidated.
- Legal guidance: A court-appointed trustee can make sure your debts are appropriately discharged to avoid future legal headaches. Your bankruptcy attorney can also provide hands-on support to prevent financial mistakes.
- Discharge debts: While you may need to sell some of your assets or follow a multi-year payment plan, some of your debts can be discharged within six months (Chapter 7) or five years (Chapter 13). As a result, the total amount of debt you owe is smaller.
- Potentially dismiss back taxes: Certain unpaid taxes can also be forgiven or worked into a flexible repayment plan. Usually, taxes are ineligible for other debt payoff plans.
- Can start rebuilding credit: The final legal decision lets you begin repairing your credit history sooner than continuing to avoid the problem or find a way to pay your bills without declaring bankruptcy.
Disadvantages
- Not every debt qualifies: Student loans and select taxes usually won’t qualify for bankruptcy benefits. As a result, you can still be responsible for repaying the total amount unless you experience severe physical or financial hardship.
- May need to sell assets: As your debts exceed your income and liquid assets, you may need to sell certain items to satisfy your obligations. You may need to sell a vehicle and even your house.
- Legal fees: There are court filing fees and attorney fees. These costs can be expensive if you have a limited budget and reduce your debt discharge benefits.
- Negative credit report marks: Bankruptcy remains on your credit report for 7-10 years and reduces your credit score. During this period, it’s more challenging to qualify for new credit cards and loans. It can also be difficult to rent an apartment or qualify for certain financially-sensitive jobs.
- Outcome is final: The bankruptcy outcome is final and you cannot reverse the decision. However, you can switch to a different plan with other debt payment strategies if your circumstances change to prevent losing your assets.
- Bankruptcy is publicly-known: Any person you owe money to may know that you’re declaring bankruptcy. Additionally, the local newspaper may also mention bankruptcy filings meaning friends and family may find out.
Can you file without an attorney?
You might be thinking about filing for bankruptcy without a lawyer to avoid attorney fees. After all, a bankruptcy lawyer can charge between $200 and $400 per hour. According to LegalMatch, your total attorney fees can cost between $500 (simple cases) and $2,000 (complex situations).
It’s possible to file without hiring a bankruptcy attorney and a non-attorney petition preparer can help you complete your forms. However, this person along with any court employee or judge is prohibited from providing legal advice so you must make every decision alone.
Having hands-on legal support from a knowledgeable lawyer can be worth the cost, even if it strains your spending plan. Their advice can help you avoid costly mistakes, unnecessary delays, and can reduce your stress levels.
Your lawyer can help navigate these topics:
- Which chapter to file
- What debts are eligible for discharge
- Which assets you may be able to keep
- Potential tax consequences
If you’re struggling to find an affordable bankruptcy attorney, you can also try finding free legal resources here:
How long does it take to file for bankruptcy?
It usually takes between five and seven months from start to finish for Chapter 7 bankruptcy.
The other chapters (11, 12, and 13) take three to five years because of the post-bankruptcy payment plan. However, the upfront 341 meetings are similar to Chapter 7 (4-6 months) while you, the creditors, and the judge hash out the repayment and discharge details.
Here is a basic timeline for how long it takes to complete the initial proceedings:
| Chapter 7 | Chapter 13 | |
| How soon 341 meetings start after filing for bankruptcy | 30 days | 30 days |
| How long creditors have to object after the 341 meeting | 30 days to file an objection or exemption and 60 days for discharges | 7 days for a payment plan |
| What to do after the 341 meeting | 45 days to reaffirm payment plans for secured assets | 75 days to complete a debtor education course |
| Total time until final discharge | 4-7 months | 3-5 years |
Discharge eligibility in bankruptcy
Debts that can be eligible for discharge under all bankruptcy codes include:
- Business debts
- Collections
- Credit cards
- Family loans
- Income taxes
- Medical
- Personal loans
- Rent (and other past due lease obligations)
- Utility bill
You may still decide to repay certain loans to preserve your reputation among family, friends, or medical providers if you owe money to any of these parties.
Chapter 13 Debt Eligibility
More debts qualify under Chapter 13 than the other chapters. Some of the qualifying debts include:
- Willful and malicious injury to property
- Obligations from paying non-dischargeable tax debt
- Debts stemming from divorce or separation of property settlements
Ineligible Debts
These debts most likely won’t be discharged during bankruptcy:
- Alimony
- Child support
- Court-ordered payments
- Government fines or penalties
- Student loans (federal or private)
Secured debts like your car loan or the home mortgage may not be discharged. However, you may need to reaffirm the payment to avoid repossession. Court-ordered liquidations will transfer the collateral to the creditor to satisfy the debt obligations.
Additionally, it’s not possible to discharge debts twice through Chapter 7. Creditors can also dispute court-ordered discharges before the decision finalizes.
Finally, debts you incur after filing for bankruptcy are excluded from the proceedings. So, these liabilities are subject to repossession as the automatic stay doesn’t apply.
Bankruptcy Rights
The Fair Debt Collections Act (FDCA) defines the best practices that debtors and creditors have to avoid abuse, deception, and unfairness.
Debtor Rights
Debtors filing for bankruptcy have these protections:
- No foreclosures or repossession: The automatic stay delays or stops any foreclosure or repossession requests from creditors until the end of the proceedings.
- Employers cannot fire you: Current laws prohibit employers from firing workers because of bankruptcy or for not paying debts discharged after the proceedings.
- Legal advice: Debtors can hire a lawyer to negotiate with creditors for a positive outcome to revise the repayment terms. They can also help you with debt collectors contacting you or using court petitions to collect payment.
- Debt collectors cannot contact you at work: You can send written requests to debt collectors not to contact you at work or other inconvenient places. Additionally, collectors can only try contacting you between 8 AM and 9 PM.
Creditor Rights
Creditors also have these protections to help reach a compromise with the debtor and bankruptcy court.
- Appeal Chapter 7 discharges: Creditors have up to 60 days to appeal court-ordered discharges for Chapter 7 filings. They can also appeal Chapter 11, 12, and 13 payment plans within seven days but discharge decisions can be final.
- Access to secured collateral: Secured loans like a car loan must either be sold, repaid during the 3-5 years bankruptcy repayment period, or settled with a separate plan. Creditors can repossess the asset if the repayment agreement is breached.
- Attend 341 meetings: Secured and unsecured creditors can attend the first meeting of creditors to file objections and request compensation. Secured creditors receive priority.
- Consult with trustee: Creditors can communicate with the trustee to verify there isn’t bankruptcy fraud or debtor abuse.
Rebuilding after bankruptcy
Here are some steps to rebuild your credit after bankruptcy:
- Keep your paperwork: Safely store your legal paperwork and discharge records for at least 10 years which is how long this event can stay on your credit report.
- Monitor credit reports: Review your credit reports monthly or quarterly for errors.
- Use credit building products: Consider using credit builder loans and secured credit cards that report your monthly payments to the credit bureaus. These services also don’t’ incur debt like an unsecured credit card or personal loan.
- Build cash reserves: Look for ways to save money each month to plan for expensive purchases to avoid borrowing.
Bankruptcy alternatives
You might consider these alternatives to bankruptcy to avoid fees and losing assets.
Consolidate
Debt consolidation can reduce your monthly payment by securing a lower interest rate or extending your repayment term. This option can have the fewest fees but doesn’t include hands-on help from debt counselors.
Negotiate
You can try asking creditors to modify your repayment terms to help you avoid missed payments and defaults. Settling your debt for a lower amount is possible.
A lawyer can also assist if you’re not comfortable negotiating alone or have a complex situation.
Credit Counseling/Debt Management
Enrolling in a debt management program lets a debt counselor negotiate a lower interest rate or longer repayment term for your debts to avoid credit score drops. Monthly plan fees apply but you also get access to credit counseling which can help improve your money management skills.