Can filing for bankruptcy help you get out of the money pit?
© alphaspirit/stock.adobe.com
We all have to deal with some level of financial burden at some point in our lives. Most burdens are manageable; some are only just tolerable. But in the rare event that the weight of financial hardship goes from heavy to crushing, then sometimes, the dreaded prospect of bankruptcy may be your only ticket out of rock-bottom territory.
If youâre gazing long and hard into that financial abyss, there are a number of things you need to think about before you dive in.
Key Points
- Understand the advantages and disadvantages of each bankruptcy filing type.
- Itâs important to know which debts are and are not dischargeable in court.
- The social stigma of bankruptcy can be just as difficult (or devastating) as the financial implications.
Bankruptcy is a status in which a court, by way of a judicial process, deems a person unable to pay their debts.
There are two kinds of personal bankruptcy for which you can file: Chapter 7 and chapter 13 bankruptcy.
Whatâs the difference between chapter 7 and chapter 13 bankruptcy filings?
To put it simply, chapter 7 can wipe out all your eligible debts. You will need to sell as much property as you can in order to pay your creditors, especially your nonexempt assets (e.g., vacation properties, expensive cars, jewelry, and collectibles). Whether you can keep your car, home, and other assets depends on state laws and exemptions. Many states will let you keep exempt property that you need to run your household, such as furniture, clothing, retirement accounts, and possibly your home and car if you donât have much equity in them.
With chapter 13, you can keep most of your assets, but youâll have to create a payment plan to pay back what you owe over time. Not all debts are dischargeable, and this may vary on an individual basis.
Which âchapterâ might be a better option for me?
It depends on whether youâre rock-bottom broke or still have some financial means.
Chapter 7: In general, chapter 7 is easier to file, faster to complete, and lighter on the wallet. But youâll have to liquidate a number of your assets. The fewer you own, the better.
- The fine print: In order to file chapter 7, your income level has to meet qualification levels according to the means test, which is a form youâll have to submit to the court. If your income or financial means is too high, you wonât be eligible to file for chapter 7. The good news, however, is that you can still file for chapter 13.
Chapter 13: Chapter 13 is a better solution if you have enough regular income to pay back most or all of your debts through a repayment plan. This option is best for those who likely have the financial means to make good on their payments, but need much more time to settle their debts.
- The fine print: The upside is that you get to keep most of your property, although you may have to pay to keep your ânonexemptâ assets, like luxury and other nonessential items. That arrangement will be included in your chapter 13 repayment plan. And if you donât keep up with payments on your assets held as collateral (such as a car loan or mortgage), the lender can potentially petition the court to repossess or foreclose on them.
Are there any debts that bankruptcy wonât discharge?
The simple answer is yes. There are debts the court wonât discharge through bankruptcy. However, it also depends on the state in which you live and other legal matters that are best discussed with a bankruptcy attorney.
Here are some debts that generally arenât discharged in a bankruptcy:
- Most student loans
- Most tax debts
- Child support
- Spousal support
- Debts due to intentional wrongdoing or fraud
- Wages owed to your workers
- Personal injury damages caused when driving while impaired
- Government fines or penalties
Can I lose my home if I file for bankruptcy?
It depends. If youâre filing for chapter 7 and youâre current with your mortgage, you might be able to keep your home. If youâre not current in your payments, you could lose it.
If youâre filing for chapter 13, youâll likely include your mortgage debt in your repayment plan. Whether youâre able to keep your home depends on how your debts are restructured.
What are the pros and cons of filing for bankruptcy?
As bleak as bankruptcy can be, thereâs certainly light at the end of the tunnel. The pros and cons of bankruptcy slightly differ depending on which chapter you file.
Note: This is not a complete list. But it does answer a few of the common questions potential bankruptcy filers typically ask:
Pros of chapter 7 bankruptcy
- Speedy and less costly process. Filing for chapter 7 can typically take three to six months, and it costs far less than a chapter 13 filing.
- Clean financial slate. Most of your debts will be discharged, giving you something of a fresh start.
- No more creditor harassment. Chapter 7 bankruptcy puts an end to collection activities, lawsuits, and wage garnishments.
Cons of chapter 7 bankruptcy
- Ten years of bad credit. As you probably know, bankruptcy will stain your credit report and keep your credit score low for up to 10 years. This will make it difficult for you to obtain any form of creditâor credit at a competitive rate of interest. Watch out for predatory lending.
- Loss of assets. A number of your assets, possibly including your home or even your car, may be liquidated to pay your creditors. The details will vary from state to state, so check your local bankruptcy laws.
- Limited qualification. If your financial means or income is too high, you may not qualify for chapter 7.
Pros of chapter 13 bankruptcy
- Asset retention. You can keep your valuable assets, like your home or carâan essential advantage if you have regular income but are short on time in making your regular payments.
- Breathing room. Your chapter 13 repayment plan can give you three to five years to repay your debts in terms that are reasonable based on your current income, expenses, and financial capacity.
- Cosigner protection. If you have cosigners for any of your loans, a chapter 13 filing may give them a break. Chapter 13 makes it harder for creditors to pursue your cosignersâan advantage thatâs absent if you file chapter 7.
Cons of chapter 13 bankruptcy
- Seven to 10 years of bad credit. Your credit report may suffer for seven to 10 years, making it difficult for you to obtain any form of credit, or credit with average rates of interest.
- Repayment obligation. Although youâll gain time to repay your creditors, making three to five years of repayments can be a challenge. Furthermore, once you file for chapter 13, you canât turn around and file for chapter 7 for another six years.
- Expense. Filing for chapter 13 bankruptcy can be far more expensive than a chapter 7 filing, especially when you factor in your attorney and court fees.
The bottom line
As Longfellow said: âInto each life some rain must fall.â
Most of us have suffered a financial setback or two. Bankruptcy, although an unpleasant or even seemingly unbearable choice, is sometimes the best way forward. Knowing the ins and outs of chapter 7 and chapter 13 bankruptcy can help you make the best decision regarding how and when to proceed.
And when you do get back on your feet, be sure to show some gratitude. Pay it forward by helping those in need, just as society helped you when you needed some relief.
This article was most recently revised and updated by Karl MontevirgenThis article was most recently revised and updated by Nancy Ashburn
