Bankruptcy 101

A lost job, failing business, divorce or staggering medical bill: A financial crisis can happen to just about anyone.You may not want to declare bankruptcy, but once you do, you may join the millions of people who find relief from the stress of crippling, insurmountable debt.

Of course, bankruptcy is a tough thing for anyone to go through. "People will talk about anything before they talk about bankruptcy," says Ed Boltz, a bankruptcy attorney in North Carolina and the former president of the National Association of Consumer Bankruptcy Attorneys (NACBA). "We keep boxes of Kleenex stocked up because people cry."

But bankruptcy shouldn't be a source of shame or embarrassment. If you are buried in debt, it may even be your best option. You may be on the road to bankruptcy if you've started paying groceries or the heating bill with credit cards. Using a credit card to pay off other credit cards is another red flag. While the process may be painful, it can give you a chance to get back on your feet and come up with a repayment plan without having to face aggressive debt collectors.

What kind of debt does bankruptcy wipe out?

Bankruptcy can eliminate "unsecured" debt -- such as credit card bills and medical bills -- that is not backed up by collateral (such as a house or car). While it's in process, bankruptcy's "automatic stay" halts any lawsuits and most legal actions and debt collection by creditors, government agencies or collection bureaus.

However, bankruptcy can't be used to pay off all debts. For instance, it rarely eliminates student loan debt and never cancels tax bills, car loans, child support or most mortgages.

In addition, bankruptcy should always be a last resort. Going into bankruptcy will take a major bite out of your credit score, and the event will stay on your record for 10 years. Still, you can rebuild your credit score by paying all of your bills on time. And bankruptcy does not prevent you from borrowing money; it just makes it costlier. "You can get a mortgage or finance a car, for example," Boltz says. But, he adds, you're going to pay a higher interest rate, and you may have to petition the court for permission to apply for the loan.

If you have any other option --perhaps consolidating debts or selling assets -- bankruptcy may not be for you. But if you have exhausted all your options and are in severe financial stress, don't hesitate too long to get help. People who delay filing for bankruptcy until they are hit with lawsuits often have a much harder time getting back on their feet, Boltz says.

Chapter 7 vs Chapter 13: Which is best for you?

Individuals who file for bankruptcy generally have two options: Chapter 7 or 13. Chapter 7 is generally the best choice for people without a lot of property or assets. It's available to anyone whose income is the same or less than the median income in a given state. People who make more than that can still be eligible if they can prove that their obligations overwhelm their income. This requires a "means test," which can be a fairly complicated procedure.

Chapter 13 bankruptcy can be a good choice for someone who has a lot of assets to go along with debt. If used properly, it can stop foreclosure of a house or other property. To qualify, unsecured debts such as medical bills and credit cards must be less than $394,725, while secured debts, such as car loans and mortgages, has to be less than $1,184,200. In addition, you have to document to the court that you can afford to make your monthly mortgage payments and other obligations.

You don't have to use an attorney to file for bankruptcy, but it's wise to do so. Most lawyers who specialize in bankruptcy will offer you a free consultation to start off with, Boltz says. You can locate bankruptcy attorneys on websites such as the National Association of Consumer Bankruptcy Attorneys or through your state bar association. Examine credentials carefully, and be wary of bankruptcy petition preparers who claim they are just as good as a lawyer. "All they are legally allowed to do is type," Boltz said. "They can't give you [legal] advice."

No matter how you handle your bankruptcy, it's important to be as honest and forthright as possible throughout the process. "Disclose everything," Boltz says. "It's better to tell me so I can help you keep it, rather than hide it."

Most people can successfully rebuild their lives after bankruptcy, primarily because the process relieves debilitating stress, says Cara O'Neill, a bankruptcy attorney and editor at Nolo Press. "Not only does it get rid of debt, but it frees up financial resources, too," she says. Once the weight of overwhelming debt is lifted, she says, most people make better decisions going forward.

For more advice, see MoneyGeek's special report on bankruptcy.

References

Are you eligible for a Chapter 7 bankruptcy? Nolo Press. http://www.nolo.com/legal-encyclopedia/chapter-7-bankruptcy-means-test-eligibility-29907.html

What Bankruptcy Can And Cannot Do. Nolo Press. http://www.nolo.com/legal-encyclopedia/chapter-7-bankruptcy-means-test-eligibility-29907.html

Bankruptcy Basics. Nolo Press.

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