- Bankruptcy is a legal process that allows you to wipe out certain debts or at least make them easier to handle.
- Chapter 7 and Chapter 13 bankruptcy are the two main choices for struggling consumers.
- Filing for bankruptcy can provide significant relief, but it can also limit your financial opportunities in the future.
- Carefully consider all of your options before pursuing a bankruptcy filing.
Bankruptcy is a legal process that lets you make a fresh start with your finances, either through restructuring your outstanding debts or by having them canceled altogether.
“Filing for bankruptcy is a serious matter, and the decision to do so can impact your life for years to come,” says Leslie Tayne, founder and head attorney at Tayne Law Group, a debt-relief firm based in New York. “So before you go this route, you should try to deal with your debt in other ways.”
And while bankruptcy can relieve some of the financial burdens you’re experiencing, it doesn’t relieve you of all your debts, and you’ll have to live with the consequences for years.
So what does it mean to file for bankruptcy? Here’s what you need to know.
Inside this article
How does bankruptcy work? Chapter 7 vs. Chapter 13
Bankruptcy provides struggling consumers with an opportunity to eliminate some of their debts, or at least reorganize them in a way that makes them more affordable. There are two types of bankruptcy that most individuals can file: Chapter 7 and Chapter 13. Here’s a quick summary of each:
Also known as liquidation bankruptcy, Chapter 7 bankruptcy involves selling some of your assets to pay down certain debts, after which the remainder are discharged. While it may be the more appealing of the two options, not everyone qualifies.
More specifically, your income must be below the median in your state, or you must pass a means test, which takes your income, expenses and family size into consideration to determine your ability to pay your obligations.
A trustee assigned by the court will be tasked with selling some of your personal property to pay off debts. Some assets are exempt from liquidation, such as a car and home worth up to a certain amount, but the rules vary by state.
For that reason, Chapter 13 bankruptcy may make more sense for some people. “You’ll likely want to file for Chapter 13 bankruptcy if you have a significant amount of property,” says Tayne.
Chapter 7 bankruptcy provides fast relief, with many filings discharged within four to six months, but the public record will remain on your credit reports for 10 years. That can have a negative impact on your finances, since it can lower your credit score and make it harder for you to, say, rent an apartment or qualify for lower car insurance rates.
Also referred to as reorganization bankruptcy, Chapter 13 involves restructuring your debt in a way that makes it more affordable.[2, 3] Your total monthly payments will be set at 15% or less of your disposable income—that is, what remains after necessary living expenses—and you’ll be put on a repayment plan that lasts for three to five years, depending on your income.
After the repayment period ends, any remaining debt will be canceled.
Chapter 13 bankruptcy requires more from you and can take several years, during which time you may have a hard time obtaining new credit. However, the public record will remain on your credit reports for only seven years, making it easier for you to recover in the long run.
Which debts can I include in bankruptcy?
You can have most unsecured debts, such as credit cards, personal loans and medical bills, forgiven through bankruptcy.[1, 3]
While student loans can technically be discharged, this can be incredibly difficult to achieve in practice. Additionally, you may be able to get certain secured loans discharged, such as the mortgage on your home, but the lender may still foreclose on or repossess the property.
The following cannot be discharged through bankruptcy:
Child support and alimony
Certain tax debt (there are some exceptions for tax debt that dates back several years)
Court fees and penalties
Debts you didn’t list in your bankruptcy filing
Debts for willful and malicious injury to another person or property (Chapter 13 allows you to include debts for property damage)
Debts for death or personal injury caused by your operation of a motor vehicle while intoxicated or impaired
How to file for bankruptcy
The process of filing for bankruptcy can seem daunting, but breaking it down can potentially help make it go more smoothly. Here are some steps you’ll take:
Attend a credit counseling session
Before filing for bankruptcy, you’ll need to have undergone credit counseling from a government-approved organization within 180 days of your application. This session can cost up to $50, but you may be able to get the fee waived if you can’t afford it. A credit counselor can help you take stock of your situation and provide you with guidance, including alternatives to bankruptcy.
Hire an attorney
If bankruptcy appears to be the only option, the next step is to consult with a bankruptcy attorney, who can help you navigate the system and determine which option to pursue, Chapter 7 or 13.
Submit your filing
When you’re ready to file, your attorney will help with the process. If you’re filing Chapter 7, the fee is $338, but you can petition to pay in installments or have the fee waived. For Chapter 13, the court filing fee is $313. You may be able to pay the fee in installments, but there’s no waiver option. Attorney fees can vary from a few hundred to a few thousand dollars, depending on the firm and the type of bankruptcy you file—Chapter 13 is more expensive because it lasts longer.
Receive a stay from the court
When you file, the court will place a temporary stay on your debts, which stops your creditors from collecting payments, garnishing your wages, repossessing property, turning off utilities and foreclosing on your house.
Attend a meeting of creditors
You’ll be required to attend a meeting of creditors, where you’ll answer questions about your debts and financial situation under oath to ensure you’re not abusing the system. After the meeting, creditors may object to certain debts or portions of a debt being discharged.
Follow the plan and complete an education course
Once everything has been settled by your court-appointed trustee, you’ll proceed with the liquidation or reorganization plan, depending on which option you chose.[1,3] Before your discharge is complete, you’ll need to attend a debtor education course, which typically costs between $50 and $100, but the fee is waivable for those who can’t afford it.
Pros and cons of filing for bankruptcy
Going bankrupt can provide some short-term relief and a fresh start, but it also has some long-term repercussions. Here’s what to think about before you start the process.
You’re granted an automatic stay when you file, getting creditors off your back and halting repossession or foreclosure.
You’ll have a court-appointed trustee to handle all of the communication between you and your creditors.
You can settle your debts for less than what you owe and keep some of your assets.
Once debts are discharged, your creditors are legally prohibited from trying to collect.
You may lose valuable assets, including your home or your vehicle.
Not all debts can be discharged.
The process can take up to five years for Chapter 13.
Bankruptcy can lower your credit score and make it difficult to obtain credit, rent an apartment, qualify for inexpensive car insurance and more.
You may need to wait up to four years to buy a home.
If you’re thinking about filing for bankruptcy, you’ll need to talk to a credit counselor first. In this session, you’ll likely learn about various options available to help you avoid bankruptcy. Here are some to consider:
If you still have good credit and a moderate amount of debt, you may be able to use a personal loan, balance transfer credit card or home equity loan or line of credit to consolidate your debts at a lower interest rate and then pay them down.
Debt management plan
If your biggest issue is credit card debt, a credit counseling agency can put you on a debt management plan, which typically lasts from three to five years. The agency will negotiate lower interest rates and monthly payments with your credit card companies. You’ll make one monthly payment to the agency, which will distribute it to your creditors. Your credit card accounts will be closed, and there are modest upfront and ongoing fees, but this option can prevent further damage to your credit.
If you’re behind on your debts but don’t want to file for bankruptcy, you may be able to negotiate with your creditors to pay less than what you owe in a lump-sum payment. You can negotiate on your own or enlist the help of a debt attorney or debt settlement company for a fee.
Carefully review your situation and research your options to find the best path forward. If you decide to proceed with bankruptcy, it’s also crucial to take steps to address your financial situation so you don’t get in trouble again.
“Review your credit report regularly, so you can address any errors you see and monitor your progress over time,” says Tayne, “and reflect on the financial habits that may have contributed to your needing to file bankruptcy and commit to changing those habits.”