The term is familiar to almost everyone, however, there is a lot of confusion about what bankruptcy means.
Bankruptcy is designed to be a fresh start that allows you to develop a court-approved plan to pay off or erase debts when they get to be overwhelming. If you are having difficulty paying your debts, declaring bankruptcy is one (but not the only) approach to finding alternative ways to handle them.
Deciding to go through the process of bankruptcy is a very personal decision. It’s not just a simple way to get out of what you owe, although in some instances it can be a fast and relatively painless process. You should know that not all debts can be resolved through bankruptcy, but the process exists for a reason: to help people who have gotten in over their heads financially find a way to get out. There are some pretty major downsides to consider as well.
First, it's important to understand what filing bankruptcy will and will not do for your finances.
What bankruptcy will not do:
It won't eliminate child support and alimony you owe.
- It won't get rid of tax debts.
- It may not resolve student loans (although some may qualify).
- It won't alleviate debts that you do not list in your filing.
- It won't get rid of your mortgage or car loan if you wish to keep the home or vehicle – you'll have to find a way to keep paying or lose the property.
What bankruptcy can do:
Once you've filed, you can anticipate relief in the following ways:
- Collection calls and other activities will stop.
- Foreclosure, repossession, wage garnishment and eviction will be halted until you've settled your case, which means you've worked out a way to pay the debt or you'll have to move on.
- Get rid of unsecured debts like credit cards and personal loans.
Is bankruptcy right for you?
Only you can know if filing bankruptcy is the best way for you to get your finances straight, but there are a few things to know before you decide:
- Filing for bankruptcy can affect your credit score for up to 10 years (it stays on your history forever).
- You may be able to take out a mortgage within 12 months of filing, depending on the type of home loan you are pursuing.
- It's not free – at a minimum there are court filing fees, but most people also choose to work with a lawyer who has to be paid as well. Your workplace Employee Assistance Program may be able to help with this but know that you'll still have this bill after all is said and done.
- You're not REQUIRED to use an attorney, so beware of any lawyers who may try to collect fees from you before you've decided – you can always go back and engage an attorney after you've done some research.
What are the types of bankruptcy?
There are two types of personal bankruptcy, each one named after the section of the law that governs it. If you decide to file bankruptcy, you'll have to choose which type.
- Chapter 7. This type of bankruptcy is the tougher one to qualify for, which may also require you to sell items of value that you already own. It basically allows you to pay off what you can with your available cash or liquid assets (aka things you can easily sell) and be released from paying all or some of the rest. To qualify for Chapter 7 bankruptcy, you must pass a test that evaluates whether your income is below certain limits. If you don’t pass, you can file for Chapter 13 bankruptcy.
- Chapter 13. This type of bankruptcy essentially helps you work out a new payment plan to use your monthly income to pay off some or all of your debts in a way that still allows you to fund basic living expenses. The payments are typically spread out over three to five years.
How do you get started on filing?
Before filing under Chapter 7 or 13, you must receive credit counseling from an approved agency. Part of the point is to determine whether you have other options besides bankruptcy. This can also mean taking required debtor education, or a personal finance management course. You can take these courses for free through a not-for-profit agency – check www.NFCC.org for free courses and counseling.
Once you've determined that you really do want to declare bankruptcy, you (or your attorney) will file a petition and other paperwork with the bankruptcy court. The court will then appoint a trustee to review your documents and direct the process. Both types of bankruptcy involve a meeting of creditors, in which you answer questions about your finances and related topics, but then the next steps can vary based on the type of bankruptcy involved.
What happens after your bankruptcy process is complete?
After your bankruptcy is completed, that means you have generally either been released from paying debts (in a Chapter 7 case) or you have finished with your repayment plan (under Chapter 13). It’s a good idea to get a confirmation letter that your debt has been discharged and to check your credit reports after about three months to make sure that the end of the bankruptcy is recorded correctly.
What are some good steps to rebuild credit after bankruptcy?
While both types bankruptcy may remain on your credit reports for several years, you should be able to raise your credit rating gradually if you avoid accumulating new debt and pay your bills on time. One of the best things you can do for your credit score is pay your bills on time every time, but this is especially important post-bankruptcy.
Another step in rebuilding your credit is to apply for a secured credit card, in which you deposit money in a bank account as collateral for your purchases. Many banks and credit unions offer a card specifically to help people after bankruptcy, but you may need to wait a few months before applying. Using and promptly paying off this card over time can help repair your credit rating.
Many people are eager to improve their credit scores in order to buy a home, and certain types of home loans, like an FHA loan for first-time homebuyers, actually allow you to apply for a mortgage as soon as 1 year after filing Chapter 13! It's best to make sure you are in a place where you can afford a home before you jump back into borrowing, but knowing that you don't have to wait up to 10 years for the bankruptcy to fall off your credit report can make the process of filing and getting back on your feet slightly less stressful.
Above all, keep your eye out for scams preying upon people in financial distress. “Credit repair” companies that offer to help you get a new start on your credit history and rating are usually scams, and anyone that pressures you to make a decision quickly while also getting money is likely preying on you.