In a perfect world, we would all have enough money to pay our expenses and we’d never need to worry about debt. Unfortunately, we don’t live in a perfect world, and sometimes we need help to get our personal finances in order.
At Addition Financial, we work with our valued members every day to help them manage their finances and understand their options. One question that many of our members ask frequently is this one:
“What does it mean to declare bankruptcy?”
With that in mind, we’ve written this post to help you understand the basics and intricacies of bankruptcy, so you can decide if it’s something you want to pursue.
Why Would a Person File Bankruptcy?
There are several reasons why a person might want to consider declaring bankruptcy. Here are some of the most common:
- Loss of employment or reduction of income. If you lose your job unexpectedly or take a cut in pay, you may not have the income you need to make monthly debt payments and meet your financial obligations.
- Medical expenses. People who don’t have insurance or who have limited coverage may accrue a lot of medical debt due to an illness or injury.
- Home foreclosure. If you are behind on your mortgage and you’re worried that your mortgage lender may foreclose on your house, filing for bankruptcy can put a hold on the foreclosure.
- Eviction. The same circumstances that apply to home foreclosure may apply to eviction from a rental property. Keep in mind that if a landlord has already obtained an eviction order from the court, filing for bankruptcy will not stop the eviction.
- Credit card debt. If you have a high amount of credit card debt, whether you incurred it by using credit cards to pay for basic needs or spent more than you could afford, filing for bankruptcy can help you to reorganize your debt.
There are additional reasons to declare bankruptcy that are less common, such as inheriting property, moving to a state with less favorable bankruptcy exemptions or avoiding a lawsuit. However, the five reasons we have listed here are the most likely to apply to the average person.
Are There Different Types of Bankruptcy?
There are a lot of misconceptions about bankruptcy and these include some confusion about the various types of bankruptcy. You should know that there are three different types of bankruptcy and each has its own rules and advantages.
Chapter 7 Bankruptcy
Chapter 7 bankruptcy is sometimes referred to as straight bankruptcy because it is the most straightforward option. When you file for Chapter 7 bankruptcy, the process involves liquidating all your assets to pay as much of your outstanding debt as possible. A Chapter 7 filing will stay on your credit report for ten years.
Chapter 13 Bankruptcy
Chapter 13 bankruptcy is also known as reorganization bankruptcy. This form of bankruptcy is ideal for individuals who have assets they want to keep. Unlike Chapter 7, a Chapter 13 filing requires repayment of some debt. The person filing must submit a repayment plan to the court and the court appoints a trustee to repay the debts. Typically, debt payments are spread out over a period of three to five years after which any remaining debt is discharged.There are limits on debt for Chapter 13 filings. You may not have more than $1,184,200 in secured debt and $394,725 in unsecured debt to qualify.
Chapter 11 Bankruptcy
Of the three types of bankruptcy that may apply to individuals, Chapter 11 bankruptcy is the rarest. It is most commonly used by businesses in need of restructuring and like Chapter 13, it includes a debt repayment plan. An individual would only choose Chapter 11 under two circumstances. The first would involve real estate investment reorganization, and the second would involve reorganizing secured debts that are too high to qualify for Chapter 13.
What Happens When a Person Declares Bankruptcy?
If you’re considering the option of declaring bankruptcy, one of the biggest questions that may occupy your thoughts is about what happens once a bankruptcy declaration is filed.
Filing for bankruptcy initiates an automatic stay on debt collection. That means collection agencies and creditors may not contact you and your wages may not be garnished to pay your debts. It also means your creditors are prohibited from going after any secured assets, including your home and car. A bankruptcy filing provides immediate debt relief.
After your initial filing, the court will set up a creditors’ meeting for you, your bankruptcy attorney and your creditors to discuss repayment of your debts. The meeting may happen as soon as three weeks after your filing and must take place no more than 40 days after your filing. From there, it may take several months for your debts to be discharged.
The final thing you need to know about the bankruptcy process is that you will be required to take some classes. You will need to take a credit education course within 180 days before filing and you also need to take a debtor education class.
It’s important to note that there are some types of debt that may not be discharged through bankruptcy. You may discharge student loan debt, but only if you can prove to the government you have experienced hardship that qualifies you for debt relief. Tax debt may not be discharged under bankruptcy and the same is true of alimony, child support and other divorce-related debt.
How Much Does It Cost to File Bankruptcy?
One of the ironic things about filing for bankruptcy is that it’s not free. In most states, the fee is about $300 to $500 to file. You may want to hire a bankruptcy lawyer to help you navigate the ins and outs of filing and discharging your debts.
On average, hiring an attorney for Chapter 7 bankruptcy costs about $1,500, while the costs for a Chapter 13 bankruptcy average between $2,000 and $3,000.
For obvious reasons, a more complex filing with many outstanding debts may take longer and cost more than a simple filing. However, there is low-cost legal advice available if you need it.
How Quickly Can You File Bankruptcy?
If you’re considering bankruptcy – and particularly if you are being pursued by debt collectors – you may wonder how quickly you can file bankruptcy.
For a Chapter 7 filing, the process is simple. You will need to take a one-hour credit education course before you file. Once that happens, here’s the timeline:
- Complete bankruptcy forms. This step may take several hours if you do it on your own. In complicated cases, it may take some time for an attorney to sort through your documents and complete the filing.
- Submit filing. Depending on where you live and whether courts are open, you may need to file in person, via mail or electronically.
- 341 meeting of creditors. The creditors’ meeting typically happens within 30 days of the court filing and usually takes only a few minutes.
- 341 meeting + 30 days. This is the deadline for your trustee or creditors to object to an extension.
- 341 meeting + 45 days. This is the deadline for dealing with secured debts such as car loans – if you want to keep your car.
- 341 meeting + 60 days. This is the deadline for creditors who wish to object to your debts being discharged.
In all, a Chapter 7 filing takes between four and six months. For a Chapter 13 filing, the process is different. It usually takes 95 days from the date of your filing to the date the repayment plan is approved. However, the bankruptcy won’t be discharged until the end of your three to five year repayment plan.
How Will Filing Bankruptcy Impact Your Credit Score?
A low credit score can negatively impact your ability to buy a house or a car. While bankruptcy is a necessary remedy for many, there is no denying that a bankruptcy filing will lower your credit score substantially at first.
Filers with a credit score above 700 can expect to see their credit score fall by about 200 points after the filing. With a lower score of 680, you can still expect a decrease of somewhere between 130 and 150 points.
On the other side of bankruptcy, that is, when the bankruptcy falls off your credit report, you can expect a bounce of between 50 and 150 points. Keep in mind that a Chapter 7 filing will remain on your credit report for 10 years, while a Chapter 13 filing will be there for between three and five years or as soon as you complete your repayment schedule.
Filing for bankruptcy protection can provide relief from outstanding debt and financial strain. Depending on how much debt you have and how complicated your financial situation is, you may want to consider hiring a bankruptcy attorney to help you through the filing and debt discharge process.
Addition Financial is here to help if you need help managing your debt and understanding your options. Click here to check out our financial courses and tools!
