Bankruptcy has become steadily more common over the last ten years. Some consumers find inadequate health insurance has put them in the poorhouse, while layoffs and a sluggish economy have created almost an entire class of white collar and tech professionals with hefty debt loads and no income to pay it all down.
Generally, two bankruptcy options are available to consumers: Chapter 7 and Chapter 13. Because each state has its own bankruptcy laws, debtors who crave the relief of bankruptcy need to determine which type is best suited to their situation.
Chapter 7: Liquidation
Choosing the Chapter 7 option allows consumers to give up certain assets in exchange for creditors writing off their debts. Certain types of property are exempt from the proceedings. These exemptions are determined by state law. For example, most states limit the amount of home equity protected in Chapter 7 filings. If you have more equity in your home than your state allows, you might have to sell your home.
Often, you can keep items if you re-affirm the debt during the bankruptcy proceedings. For example, you may be able to keep your car for as long as you continue making the payments on time and sign a document stating that you intend to keep making those payments. Credit card accounts can be maintained in the same way.
Chapter 7 is frequently the option for people who little to lose: few or no assets (or at least not the kind of assets creditors feel they can profit from), little or no income, and more debt than they can handle.
Chapter 13: Repayment
A Chapter 13 bankruptcy allows a consumer to pay off debt over three to five years by submitting a repayment plan for the court’s approval. Part of creating a repayment plan is negotiating the interest rate and amount of debt that is repaid. A court-appointed trustee acts as contact point for your creditors. During the repayment period, you personally pay on any current bills and send your disposable income to the trustee, who distributes payment to your creditors.
Overall, Chapter 13 has less of a negative impact on your credit score than does a Chapter 7. With your financial future at stake, it’s a good idea to consult a bankruptcy lawyer to determine which option you should choose.
Advantages of Bankruptcy
The most immediate advantage of either kind of bankruptcy is that debt collectors must immediately cease contacting you. Foreclosure attempts and certain garnishments also come to a stop when you file. Interestingly, the fact that you filed bankruptcy could actually do less long-term damage to your credit rating than would a long list of unpaid accounts. Although bankruptcy will devastate your credit history, unsecured debt is generally wiped out—a trade-off that may make the most sense for your situation.
Because bankruptcy has become almost commonplace in the U.S., getting credit is now easy for many bankrupt consumers—even after Chapter 7 liquidations. Mortgage loans are available as soon as six months after bankruptcy and many debtors receive new credit cards even before the final judgment is rendered. It’s actually fairly easy to establish a good credit rating after bankruptcy as long as you follow this rule: Always make all payments on time. If you cannot follow that rule, you are probably better off sticking to cash-only transactions, which is fairly easy to do with debit cards, PayPal, and electronic fund transfers.
Disadvantages
Not all debts are cleared in a bankruptcy. Notable exceptions include student loans, alimony, child support, and taxes owed. If these types of obligations make up the bulk of your financial burden, bankruptcy offers little relief. Other drawbacks include these:
* The bankruptcy will be listed in credit reports for up to 10 years.
* You will be able to obtain new credit, but at much higher interest rates. How about a car loan at 21% or a credit card at 28%?
* You may not be able to get the kind of credit you need during the first few years following bankruptcy, such as a bank loan to start a new business or a mortgage loan at an affordable rate.
* Your insurance costs may increase as insurers are increasingly factoring credit scores into premium calculations.
* Although federal law prohibits current or potential employers from discriminating against employees or applicants solely because of bankruptcy, the knowledge of your bankruptcy might taint employers’ perceptions of you nonetheless.
* Almost inevitably, bankrupt consumers experience a sense of personal failure or humiliation after the immediate sense of relief fades.
* Most importantly, if you are a compulsive debtor, you may find yourself overwhelmed by debt once again and, if you have filed a Chapter 7, unable to take refuge in bankruptcy’s protections for another six years.
If you learn from your mistakes and will apply what you’ve learned, bankruptcy may be the wake-up call you need to correct an adulthood of bad spending and debting decisions. Just know the consequences of bankruptcy on your financial life.
