When you are over your head in debt, bankruptcy may seem like the perfect cure-all. It promises to wipe the slate clean. More than 1 million people file for personal bankruptcy every year, seeking relief from debt collectors and the weight of their bills.
But filing for bankruptcy is not a decision to be taken lightly.
To file for bankruptcy, you, the debtor, file a petition with a federal bankruptcy court. The court appoints a trustee, or the person who will oversee your case with your creditors. The court puts into effect an "automatic stay," which prevents creditors from seizing your bank accounts, repossessing your car or taking your house or car.
Individuals are eligible to file for two types of bankruptcy: Chapter 7, called "straight" bankruptcy, and Chapter 13, also known as "wage-earner" bankruptcy.
Here's how each type works.
Chapter 7: Liquidation
1. You, as an individual or business, ask a court to wipe out the debts owed.
2. After filing out forms detailing your property, income, and monthly living expenses, you must attend a hearing with your trustee. At this meeting, non-exempt property that will be sold to pay off your creditors will be determined.
3. Your non-exempt property is sold and the proceeds are used to pay off creditors. What property is exempt varies by state, but typically includes partial or total equity in your home, life insurance, retirement plan assets and most furniture and household goods.
Chapter 7 bankruptcy takes about six months and costs $175, which may be waived for people on public assistance or below poverty level.
You cannot file for Chapter 7 bankruptcy if you filed in the previous six years, if someone co-signed a loan for you or if you rang up more luxury debt -- such as a vacation -- after filing. In addition, if it is determined that you can repay your debt in the next three to five years, the court may dismiss your case or recommend filing for Chapter 13.
Note also that Chapter 7 can't help if you owe child support and alimony, debts related to injury or death for a DWI case, student loans, fines and penalties for violating the law (such as traffic tickets) or income tax (and all other tax debts). These are known as non-dischargeable debts, and you must devise a plan for repayment on your own.
Chapter 13
• You must have a steady income to qualify.
• You establish a repayment plan to repay your debts over three to five years.
• Your income level must be high enough to pay for everyday expenses plus your monthly payment.
• The cost to file is about $160.
• Payments are made to your trustee, who pays your creditors.
• You qualify if your secured debts (such as home and car loans) are under $750,000.
• You qualify if your unsecured debts (credit cards, department store cards, medical bills, student loans) are under $250,000.
• You lose no property.
Should You File?
Bankruptcy's aftereffects are long and damaging. Filing remains on your credit report for up to 10 years, even if you don't go through with the process. Bankruptcy remains tied to your record whenever you apply for a job with a salary above a certain amount, or insurance or loan above a certain amount, even after the 10-year period has passed. Most important, bankruptcy does not change your financial management habits.
There are alternatives to bankruptcy. You can negotiate with creditors personally or seek help from debt-management counselors.
Where to Find Help
There are many non-profit organizations you can turn to for free, confidential guidance and information. Before filing for bankruptcy, make sure you seek help. Try these counseling services:
- Consumer Credit Counseling Service
- American Consumer Credit Counseling
- Association of Independent Consumer Credit Counseling Agencies
- National Association of Consumer Bankruptcy Attorneys
