Read this before filing bankruptcy
Filing bankruptcy should be a last resort in dealing with a critical debt situation. If you must file bankruptcy, though, here’s what you should know.
What’s bankruptcy?
Bankruptcy is a legal procedure filed in a federal court with some variations from state to state that helps people eliminate outstanding debts when they’re unable to repay those debts under the originally negotiated and agreed upon terms and conditions. It essentially gives you a “do-over” or “fresh start” if because of your own mistakes or circumstances outside of your control you’ve acquired more debt than you can possibly repay.
This is done through a combination of repayment plans, the liquidation of assets as another form of reimbursement and in some cases such as with a home or business, the protection of some assets to help the debtor survive beyond bankruptcy.
If you’ve found yourself buried in debt with nowhere to turn, bankruptcy may seem like the solution to all your problems. Too much debt can be stressful. It can harm your physical and mental health. It can strain relationships and even cause separations and divorce. But bankruptcy isn’t without its consequences.
Hear Debt.com’s chairman talk bankruptcy on Queer Money®:
Dvorkin of Debt.com on bankruptcy
For those of us who are struggling to pay off debt, the idea of having those outstanding balances forgiven and simply starting over sounds pretty good. But if you’re thinking about filing for bankruptcy to eliminate your debt, it’s important to know that it’s not that simple.
Howard Dvorkin is the Founder of Consolidated Credit and Chairman of Debt.com, an educational platform and news site covering consumer debt. He has 27 years of experience in financial services and is one of the most highly regarded debt and credit experts in the US. Howard is also the author of two personal finance books, Power Up: Taking Charge of Your Financial Destiny and Credit Hell: How to Dig Out of Debt.
On this episode of Queer Money®, Howard joins us to discuss the pros and cons of filing for bankruptcy, describing the two different kinds of bankruptcy and explaining why filing should be a last resort. He addresses the misconception that bankruptcy lets you off the hook, sharing the many adverse consequences of having a court filing on your record. Learn the variety of options available for getting out of debt and find out how Howard’s team of certified credit counselors can help you achieve a debt-free life!
Bankruptcy is a good tool for certain people, but not everybody. Howard Dvorkin of Debt.comClick To TweetWhat are the different types of bankruptcy?
There are three main types of bankruptcy, Chapter 7, Chapter 11 and Chapter 13. For your purposes, as most of our readers aren’t managing large organizations, we’ll focus just on chapters 7 and 13.
Chapter 7
With Chapter 7 bankruptcy, a bankruptcy trustee gathers and sells your non-exempt assets if you qualify for Chapter 7 subject to a means test. The trustee then uses the proceeds from those sales to refund your lenders according to the provisions of the Bankruptcy Code.
Chapter 7 is the most common type of bankruptcy, in part, because of its relative affordability and speed to get out from underneath your debts.
What’s a Chapter 7 means test? A Chapter 7 means test requires you to fill out Form 122A-2 and compares your average income over the previous six months with the median income for households of your size in your state. If you earn less than the median, you might qualify for Chapter 7. If you don’t qualify for Chapter 7 bankruptcy, you may be advised to file Chapter 13 bankruptcy.
What are non-exempt assets? Nonexempt assets are assets that aren’t protected in bankruptcy. The exemption statutes for each state are different, but essentially include:
- Household furnishings and clothing
- Tools and equipment for work
- Retirement assets
- Furniture and clothing
- Some home and auto equity
All other assets, such as nonretirement investments, recreational vehicles and boats, vacation homes and other real estate investments, collectibles and other assets, are potentially up for sale.
Same as with Chapter 13, when you file a petition for bankruptcy, all collections against you, including garnishment of wages, nasty phone calls and letters and potential lawsuits, should stop. Unlike Chapter 13, as we’ll discuss below, Chapter 7 doesn’t require a payment plan.
At the end of the sale and division of assets, most of your debts, excluding child support, taxes, etc., will be discharged and you won’t be under any obligation to repay them. Chapter 7 filings and discharges remain your credit report for up to 10 years, and filers can’t file for Chapter 7 again for another eight years or Chapter 13 for four years.
Discharges
Once you receive a discharge on any remaining debts, you’re under no obligation to repay them and all collections against you, including garnishment of wages, nasty phone calls and letters and potential lawsuits, should stop.
Chapter 13
Chapter 13 is the second most common type of bankruptcy. With Chapter 13, your assets are protected, but you’re required to create a payment plan that shows how you pay back your lenders in part or in full within three to five years. You make monthly payments to your bankruptcy trustee and they pay your lenders on your behalf.
As with Chapter 7, when you file a petition for bankruptcy, all collections against you, including the garnishment of wages, nasty phone calls and letters and potential lawsuits, should stop.
The strongest protection of Chapter 13 is that it stops foreclosure proceedings. If you don’t create and stick to your payment plan, though, your mortgage company can petition the courts to resume foreclosure proceedings. Chapter 13’s also a better, and most likely your only option, if you have a high income.
Chapter 13 filings and discharges remain your credit report for up to seven years, and filers can’t file for Chapter 13 again for another two years or Chapter 7 for six years.
Bankruptcy does have a major impact on your life, and anybody that says that ‘my life hasn’t changed because I filed bankruptcy’ isn’t being honest with themselves. - Howard Dvorkin of Debt.comClick To TweetWhat types of debts can be filed for bankruptcy?
There are two types of debt, secured and unsecured.
Secured debts have collateral that gives a lender financial interest in your loan and reduces the risk of lending to you. Collateral can include a house for mortgages and a car for auto loans. In these cases, lenders can repossess or sell your collateral to recoup some or all of your loan if you aren’t able to repay them.
Unsecured debt is just the opposite. It doesn’t have collateral to back up your loan. Unsecured debt includes credit card debt, medical, personal and student loans. In these cases, there’s nothing for a bank to reposses or sell in the event you can’t repay them.
Not all debts are eliminated through bankruptcy, though. Debts that can be eliminated include but are not limited to:
- Credit card debt
- Medical bills
- Payday loans
- Personal loans
- Most court judgments
Two types of debt, mortgage and auto loans, are unique. They can both be eliminated, except if you wish to retain either. If you wish to keep your house or car, you’ll likely need to continue making your mortgage and auto loan payments.
Debts that aren’t eliminated include but aren’t limited to:
- Child support
- Spousal support
- Most IRS taxes
- Student loans
- Court-ordered restitution
- Court judgments for injury or death as a result of a DUI
- Debts incurred fraudulently
Which’s better, Chapter 7 or Chapter 13 bankruptcy?
Neither Chapter 7 nor Chapter 13 bankruptcy is inherently better. The best of either option really depends on your personal situation.
For example, Chapter 7 is typically though not exclusively better for people with lower incomes, have fewer assets and have mostly unsecured debt. If you have assets you want to protect, such as a home or a car, whether you’re lower income or not, you may want to file for Chapter 13 as long as you can commit to the three to five-year payment plan.
A credit counselor, bankruptcy attorney and the federal courts can help you determine your best path. To the extent possible, though, the best option is to avoid bankruptcy altogether.
What are the consequences of bankruptcy?
While filing bankruptcy may relieve you of your legal obligations to repay your loans and it may help to protect your most important assets, such as a home, there are adverse consequences that come with bankruptcy.
Most immediately, bankruptcy will be the loss of your property. True, you didn’t own it outright, but that’s still an emotional and physical consequence, nonetheless. The loss of some of these items, such as your car could make life harder for you, i.e., not being able to easily go to a job.
Bankruptcies are listed on your credit report and will lower your credit score. Consequently, it will be harder, if not impossible for you to get another loan in the near future. Many mortgage lenders won’t approve a mortgage for an applicant who’s filed for bankruptcy within the last four years. It may also be harder for you to rent an apartment, as rental companies often look at credit ratings.
If and when you qualify for a loan, the interest rate you’ll be charged will be considerably higher than that of someone else who qualifies for the same loan but has a “Good” to “Excellent” credit score.
This can cost you hundreds of thousands of dollars over your lifetime, making everything you buy on loan, such as cars and homes, more expensive.
Another consequence is if someone signed on a loan for you, such as a family member, their credit report and score could be adversely affected. This could make getting a loan for them harder and more expensive, and it could strain your relationship with them.
Next, bankruptcies are a matter of public record. Though it’s not probable it is possible that friends, family, employers, colleagues and clients could learn of your situation. Depending on your industry or career, that could hurt you greatly.
Finally, filing for bankruptcy is often quite expensive, especially for someone who’s struggling to pay their bills. Attorney’s fees can range between $1,500 to $4,000. So, after all is said and done, you may still be on the hook for more bills.
Bankruptcy destroys your credit history. It takes away your personal assets. - Howard Dvorkin of Debt.comClick To TweetWhy is bankruptcy allowed?
You may be asking yourself at this point why bankruptcy is even allowed if can hurt you so much. It’s believed that relative to the amount of money that’s borrowed by consumers and the amount forgiven through bankruptcy, bankruptcy actually helps lenders, consumers and the economy by giving consumers a second chance, gaining access to more credit and continuing the buy/sell cycle of our consumer economy.
How can I avoid filing for bankruptcy?
There are many steps people can take to help avoid bankruptcy. The first is to avoid acquiring debt altogether. That’s harder to do in today’s consumer economy, but it’s not impossible.
Another option is to limit yourself to only using “smart” debt and, even then, limit the amount of smart debt you use. Loans, such as mortgages and student loans, are considered smart debt. Using these in limited quantities can help you avoid the need to file for bankruptcy.
Another popular method to help avoid filing for bankruptcy is to pay off all your credit cards and other revolving debt each and every month. Spending less than you earn and having a budget can help.
If your debt is out of control but you’re not quite sure if you should file for bankruptcy, there are other solutions.
For example, our Credit Card Pay Off Plan, which uses our Debt Lasso Method, can help you pay off all your credit card debt for as little as $97.
Hear what we told Good Morning America about the Debt Lasso Method:
If you can’t go it alone but aren’t quite ready to call a lawyer to file bankruptcy, your best bet is to hop on the phone and call your lenders, as it’s in everyone’s best interest if you pay all your debts in full.
For your mortgage and auto loans, credit card and medical debt and other types of loans, call your loan servicers to find out what options are available to you. With mortgages and auto loans, refinancing may be an option. With each, forbearance in which you postpone payments for a specified time or a modified repayment plan with smaller payments over a longer period of time may be options.
Of course, there’s debt settlement and credit consolidation, for those who feel their debt is out of their personal control.
How do I file for bankruptcy?
If, as a last resort, you’ve decided that filing for bankruptcy is your only option, your best first step is to contact a bankruptcy attorney.
Bankruptcies are governed by federal law; cases are handled in federal court and there can be variations from state to state. That is to say that filing for bankruptcy can be complicated and it’s not advised to try to file for bankruptcy on your own, hence the potential $4,000 attorney’s fee.
Can I file bankruptcy on my student loans?
It’s possible to file bankruptcy on federal student loans, but the filing process isn’t the same as with filing Chapter 7 or Chapter 13 bankruptcy and the consequences can be different.
First, you must file Chapter 7 or Chapter 13 bankruptcy. Then, in a separate bankruptcy proceeding that may include your lenders, you must show that your student loan repayment would impose an undue hardship on you and your dependents.
Plus, there’s more.
Hear us talk with attorney Jay Fleischman about filing bankruptcy on student loans:
To be very frank with you, probably half the people that file bankruptcy, they don’t have to file bankruptcy. There are BETTER options. - Howard Dvorkin of Debt.comClick To TweetPre- and post-bankruptcy counseling
Credit counseling from a government-approved organization must be completed within 180 days before you file for bankruptcy, either Chapter 7 or Chapter 13. Before any assets are discharged, you’ll be required to complete debtor education, which includes budgeting, managing money and using credit wisely.
Both pre- and post-bankruptcy counseling can take place in person, on the phone, or online, last between one to two hours and cost between $50 to $100. The fee can be waived if you can’t afford it.
Rebuilding your credit score after bankruptcy
Whether you file for Chapter 7 or Chapter 13 bankruptcy, you’ll want to repair your credit report and raise your credit score as quickly as you can. To be fair, that’s somewhat hare post-bankruptcy. But it’s not impossible.
There are steps you can take and tools you can use to help you which, over time, will get you back on track faster than if you do nothing at all. That’s where we can help you!
Sign up for our free ‘Build or Improve Your Credit Score Powered by Experian Boost’ here.
Which of these mistakes are you making with your credit score?
Resources for filing bankruptcy
- Debt Free Guys’ Free Debt Lasso Calculator
- Power Up: Taking Charge of Your Financial Destiny by Howard S. Dvorkin
- Credit Hell: How to Dig Out of Debt by Howard S. Dvorkin
- Jay Fleischman on Queer Money® EP091
- Queer Money Facebook Group
- Queer Money on Instagram
- Email [email protected]
More resources to help with your debt:
- Debt Lasso Method: Best Way to Pay Off Credit Card Debt
- Here’s How to Pay Off Credit Card Debt Fast!
- 4 Forgotten Principles of a Debt Free Life