Most people think of bankruptcy as a process in which you go to court and get your debts erased. It’s not that simple.
In fact, there are two types of bankruptcy: the familiar liquidation bankruptcy, where your debts are wiped out (Chapter 7 bankruptcy) and “reorganization” bankruptcy, where you partially or fully repay your debts. The reorganization bankruptcy for individuals is called Chapter 13 bankruptcy. (There are two other kinds of reorganization bankruptcy: Chapter 11, for businesses and for individuals with debts over $1 million, and Chapter 12, for family farmers.)
Filing for bankruptcy puts into effect something called the “automatic stay,” which immediately stops your creditors from trying to collect. Creditors cannot garnish your wages, empty your bank account or go after your car or house.
Until your bankruptcy case ends, your financial problems are in the hands of the bankruptcy court. The court exercises its control through a court-appointed person called a “bankruptcy trustee.” The trustee’s primary duty is to see that your creditors are paid as much as possible.
The Five Myths About Bankruptcy
Chapter 7 Bankruptcy – An Overview
Chapter 7 bankruptcy is sometimes called “straight” bankruptcy. It cancels all or most of your debts. In exchange, you might have to surrender some property. It takes up to six months and costs approximately $175 in filing fees.
To file for Chapter 7 bankruptcy you fill out several forms describing your property; income; monthly living expenses; debts; exempt property – the property you keep out of bankruptcy; any property you sold or gave away; and money you spent during the previous two years. The trustee reviews your papers at a short hearing, called the “creditors’ meeting,” which you must attend. Creditors may attend, too, but rarely do. After this meeting, the trustee collects your nonexempt property to sell to pay your creditors. If the property isn’t worth very much or would be cumbersome to sell, the trustee can abandon the property – meaning you get to keep it.
Chapter 7 Bankruptcy – When It Might not Help
Filing for Chapter 7 bankruptcy is only one way to solve debt problems. In several situations, Chapter 7 bankruptcy may not be the right choice.
You previously received a bankruptcy discharge
You cannot file for Chapter 7 bankruptcy if you obtained a discharge of your debts under Chapter 7 or Chapter 13 in a case begun within the past six years.
A previous bankruptcy case was dismissed
You cannot file for Chapter 7 bankruptcy if a previous Chapter 7 or Chapter 13 case was dismissed within the past 180 days because you violated a court order or requested the dismissal after a creditor asked for relief from the automatic stay.
A friend or relative cosigned a loan
Anyone who cosigned a loan or otherwise took on a joint obligation with you can be held wholly responsible for the debt if you file for Chapter 7 bankruptcy.
Repayment through Chapter 13
A bankruptcy judge who decides you have enough assets or income to repay your debts can dismiss your Chapter 7 bankruptcy case or convert it to a Chapter 13 bankruptcy.
You defrauded your creditors
Bankruptcy is geared toward the honest debtor who got in too deep and needs the help of the bankruptcy court to get a fresh start. If you have engaged in any questionable activities, such as unloading assets to your friends or relatives to hide them from creditors, incurring debts for non-necessities when you were clearly broke or lying about your income or debts on a credit application, your case may be thrown out.
You recently incurred debts for luxuries
If you’ve recently run up large debts for a vacation, hobby or entertainment, filing for bankruptcy probably won’t help you. Most luxury debts incurred just before filing are not dischargeable if the creditor objects.
You expect debts for necessities
If you expect to incur more debts for necessities, such as additional medical costs you anticipate because of an existing illness, consider delaying filing for bankruptcy. Debts you incur after you file will not be discharged.
Chapter 7 Bankruptcy – Will It Discharge Enough of Your Debts?
Certain debts cannot be discharged in Chapter 7 bankruptcy. These are called non-dischargeable debts, and it doesn’t make sense to file for Chapter 7 if your primary goal is to get rid of them. In general, they are:
- Back child support and alimony
- Student loans that first became due fewer than seven years ago
- Court-ordered restitution
- Income taxes less than three years past due
- Court judgments for injuries or death to someone arising from your intoxicated driving
Furthermore, the bankruptcy judge can rule any of the following debts nondischargeable if the creditor objects in the bankruptcy court:
- Debts incurred on the basis of fraud, such as lying on a credit application
- Debts from willful or malicious injury to another or another’s property
- Debts from larceny (theft), breach of trust or embezzlement
- Debts you are obligated to pay under a divorce settlement
Chapter 7 Bankruptcy – How Much Property Will You Have to Give Up?
Whether or not you file for Chapter 7 bankruptcy may depend on what property will be taken to pay your creditors – your nonexempt property. In most states, you can keep the following items (this list varies greatly from state to state):
- A motor vehicle, to a certain value
- Reasonably needed clothing
- Reasonably needed household furnishings, goods and appliances
- Jewelry, to a certain value, and personal effects
- Life insurance (cash or loan value, or proceeds), to a certain value
- Pensions and retirement plans
- Part of the equity in your home
- Tools of your trade or profession, to a certain value
- Portion of unpaid but earned wages
- Public benefits (welfare, Social Security, unemployment compensation) accumulated in a bank account
If you’ve pledged property as collateral for a loan, the loan is called secured. The most common examples are house and motor vehicle loans. In most cases, you’ll either have to surrender the collateral to the creditor or make arrangements to pay for it during or after bankruptcy.
Maybe Chapter 13 Bankruptcy Is a Better Choice
Chapter 13 bankruptcy is different from Chapter 7. Instead of asking the court to wipe out your debts, you propose a three to five year repayment plan under which you pay all, or a portion of, your debts. To file for Chapter 13 bankruptcy you fill out the same forms as you would for a Chapter 7 case plus your proposed repayment plan. If the court accepts your plan, you make payments to the bankruptcy trustee who distributes a share to your creditors.
There are many reasons why people choose Chapter 13 bankruptcy – and in particular, choose Chapter 13 over Chapter 7. Generally, you are probably a good candidate for Chapter 13 bankruptcy if you are in any of the following situations:
- You are behind on your mortgage or car loan and want to make up the missed payments and reinstate the original agreement (You cannot do this in Chapter 7 bankruptcy. You can in Chapter 13 bankruptcy.)
- You owe federal income taxes (Unless you meet several conditions, you cannot discharge federal income taxes in Chapter 7 bankruptcy. You can use Chapter 13 bankruptcy to pay the IRS over time.)
- You have property you’d lose if you filed Chapter 7 bankruptcy
- You received a Chapter 7 discharge within the previous six years
- You have a co-debtor on a personal debt
- You have a sincere desire to repay your debts, but you need the protection of the bankruptcy court to do so
Chapter 13 Bankruptcy – Are You Eligible?
Chapter 13 bankruptcy has a number of eligibility requirements.
Your debts must not be too high
You will not qualify for Chapter 13 bankruptcy if your secured debts exceed $750,000. A debt is secured if you stand to lose specific property if you don’t make your payments to the creditor. Home loans and car loans are common examples of secured debts. But a debt might also be secured if a creditor – such as the IRS – has filed a lien on your property.
In addition, your unsecured debts cannot exceed $250,000. An unsecured debt is any debt for which you haven’t pledged collateral. Most debts are unsecured, including credit cards, medical bills, student loans and department store charges.
You must have stable and regular income
This doesn’t mean you must earn the same amount every month. But the income must be steady – likely to continue – and periodic – weekly, monthly, quarterly, semi-annually or seasonally.
You must have disposable income
Your income must be high enough so that after you pay for your basic needs, you will have money left over to make periodic payments to the trustee. To determine if your disposable income is high enough, you must create a monthly budget. If the trustee or a creditor thinks your budget includes expenses other than necessities, it may be challenged.
Talk to a Bankruptcy Attorney
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