Filing for bankruptcy is a difficult and scary decision to make. It is important to understand what bankruptcy means for your credit and even your belongings. Paying off the debt you owe is the best method of handling credit issues. To start you should create a realistic budget for yourself. There are a couple of approaches you can take to creating a budget. One is to determine which debt carries the highest interest rate and pay those first. The second is to pay the debts with the lowest balances then apply the money towards the other debts. Either of these are popular approaches. You can read more about budgeting here.
If you have nothing to lose, doing nothing is possibly the best option. This sounds might strange and is technically unethical. However, if you have no money and no property there is very little a creditor can do to you to collect money from you. When you have nothing to lose you can consider yourself Judgment Proof.
Simply put, bankruptcy is when you owe more than you can afford to pay. To determine where you are financially, start with an inventory all of your assets. Separate these assets into two categories; liquid and non liquid. Liquid accounts include; retirement funds, stocks, bonds, college savings accounts, and other non-bank account funds. Non liquid accounts include; real estate, vehicles, high value assets such as art and jewelry and some furniture. Add up a rough estimate for each item and calculate a total dollar figure if you were to sell.
Collect and add up your bills and credit statements. Again, separate these into categories. If you are creating a budget, you might have already performed this step. Have a category for your monthly expenses; food, gas, electricity etc. Include the debt for your mortgage and car payment(s) in a separate category. You’ll want to keep these separate because depending on the equity of these items filing bankruptcy might require you liquidate these assets. Finally, add the expenses for other bills such a credit cards, loans, medical bills etc., these are the items that show up on your credit report.
If the value of your liquid and non liquid assets is less than the amount of debt you owe, declaring bankruptcy is a viable option to help you. However, bankruptcy is not the only answer. You must understand that bankruptcy is not a simple and easy solution to get out of debt. One of the requirements of bankruptcy is taking a credit/financial counseling course. If you have a way of getting out of debt through proper budgeting and financial management you should strongly consider against filing.
Is Filing for Bankruptcy Right for You?
Sometimes debt and personal issues have made it so the best budget in the world cannot help you. At this point you have to decide if filing bankruptcy is right for you. There are important questions to ask yourself to determine if bankruptcy is right for you.
First, you must determine if filing for bankruptcy will help you. There are some debts that cannot be discharged by filing bankruptcy. Make sure the debt burdening you does not fall into the non-dischargable category.
Second, you must determine if you qualify for the chapter of bankruptcy you want to file. If you are trying to wipe out debt, you must qualify for Chapter 7 vs. Chapter 13 bankruptcy. If you do not qualify for Chapter 7 then you will have to continue paying some of your creditors through Chapter 13.
Purpose of the Bankruptcy Automatic Stay
As mentioned previously, bankruptcy will grant you an automatic stay which prevents creditors from contacting you any further. The automatic stay also prevents any lawsuits for debt collection against you from moving further along.
If you are you facing foreclosure or repossession the stay will apply to these secured debts as well while you work out payment options. Chapter 7 and Chapter 13 bankruptcy handle secured debt differently. Be sure to understand the difference between the two filings especially when it comes to real property and personal property.
The Purpose of Chapter 7 Bankruptcy
The purpose of Chapter 7 is to discharge certain debt and give a debtor (you) a fresh start. The courts will want you to keep the purpose of a Chapter 7 in mind, and not to abuse it. In fact, there is definitive language on the definition of abuse of Chapter 7. To prevent people from abusing Chapter 7 the courts will require you to perform a means test. If you do not pass the means tests you cannot file for Chapter 7.
The amount of property you own is an important consideration when filing for bankruptcy. When you file for Chapter 7 there is a certain amount of property you can keep. However, understand part of a Chapter 7 filing is liquidating assets and paying off certain debt. After debt is paid through liquidation, there is no guarantee that debt gets discharged by filing bankruptcy. Read more about Chapter 7 bankruptcy here.
The Purpose of a Chapter 13 Bankruptcy
The purpose of Chapter 13 is to help you repay your creditors. You definitely want to list creditors to make sure the Chapter 13 bankruptcy includes them. Creditors must file a claim so they are included in the Chapter 13 payment plan. If you do not list a creditor the debt will remain once the bankruptcy discharge is complete. Read more about Chapter 13 bankruptcy here.
Types of Debt, Priority Debts, Secured and Unsecured
There are three types of debts a bankruptcy addresses in the hearing; priority, secured and unsecured. It’s possible to lose some property if debts are secured by it. Unsecured debts are those that are not attached to any items.
If your primary reason for filing is inability to pay a debt classified as priority you will have to rethink your strategy. Priority debts include;
- Child support
- Spousal support
- Income tax bills
- Money owed for causing personal injury or death of another person due to drugs or alcohol
- Criminal fines
- Overpayment of government benefits
- Some credit card debt*
- Student loans*
- Liens on property*
*Under normal circumstances credit card debt is dischargeable, but there are some cases when it becomes non-dischargeable. If the courts suspect fraud with regard to the credit card charges, the debt becomes non-dischargeable.
*Although student loans are not a priority debt, they are very rarely dischargeable. This is especially true if the debts are federal student loans.
*Although liens on a property are not technically a priority debt, they are not discharged with bankruptcy. The liens are only discharged if you include property when filing for bankruptcy.
Priority Debts in Chapter 13 Bankruptcy
Chapter 13 pays all priority debts in full and sometimes with interest. Your Chapter 13 payment plan will always include these debts.
Priority Debts in Chapter 7 Bankruptcy
If the bankruptcy trustee recovers any money in your Chapter 7 filing, the trustee will pay priority debts first. If there is not enough money to pay priority debts, non priority debts do not get paid at all.
Chapter 7 vs. Chapter 13
Before filing for bankruptcy understand the difference between Chapter 7 and Chapter 13. Both filings negatively affect your credit. However, a Chapter 13 bankruptcy shows you made a responsible effort to repay your creditors. If you are trying to purchasing a house, then most of the loan guarantors will look at more negatively Chapter 7 than Chapter 13. The time period you have to wait after having a Chapter 13 bankruptcy discharged is lower than that of Chapter 7. There are benefits to each filing, but remember you must qualify for Chapter 7. If you are considering cleaning up your credit to purchase a house, read the article here about how significant derogatory events affect your chances of purchasing a house.