You've lost your job and have fallen behind on your mortgage. The hospital and the credit card agencies are threatening to sue you, and if they win judgments against you, you could be forced to sell your home to pay the bills. Your credit rating has plunged, threatening your ability to get any financing or loans in the future. You never thought you'd be in this situation, but you're considering bankruptcy. Can it help solve your problems? And if so, which kind of bankruptcy do you need?
Bankruptcy is a legitimate legal process that allows people or businesses in financial trouble to erase or repay most debts and start over. It can help prevent creditors from harassing you, garnishing your wages or foreclosing on your home. But there can be a lot of shame and stress connected with filing for bankruptcy something attorneys urge you to let go of.
"It's one of the hardest things people can do," says Ed Boltz, a Raleigh, NC-based bankruptcy attorney and president of the National Association of Consumer Bankruptcy Attorneys (NACBA). "But if you file sooner rather than later, it's better for your credit in the long run." He adds that people who wait until they are facing lawsuits to file for bankruptcy often have an especially difficult time getting their finances back on track.
What bankruptcy can NOT eliminate is student loan debt (unless you're permanently disabled and unable to work), child support and alimony, come tax liability, incourt-ordered restitution and debts from car accidents caused by drinking or otherwise breaking the law.
The two most common bankruptcy plans for individuals are known as Chapter 7 and Chapter 13. Both can halt debt collection and give you a new financial start.
Chapter 7: Best option if you're low-income without a lot of assets
Chapter 7 involves liquidating your assets to eliminate debt. This kind of bankruptcy eliminates unsecured debts, such as medical bills, credit cards, store cards, utility bills, payday loans and other debt that are not backed by property (collateral). It's called "liquidation" because all or some of your property may be sold (liquidated) to pay off some of your debt.
Chapter 7 is usually an option if you don't own a house or have a lot of possessions, except for basics like clothing and furniture. Typical applicants don't have enough money to pay down their debt after covering rent and basic monthly expenses.
You don't have to be penniless to qualify for this type of bankruptcy, but you do have to meet certain criteria. Usually, your income must be equal to or less than the median income for a family of your size in your state.
If your income is higher than that, you may still be able to qualify by passing a "means test." You can pass this test if you have a lot of expenses, such as high mortgage, car loan payments and taxes that eat up your income. The Census Bureau has a state-by-state online means test.
However, the means test can become complicated, so it's best to check with an attorney. Also, you can't file for chapter 7 again if you have already done so in the last seven years.
With Chapter 7, you can wipe out most of your unsecured debt, such as medical bills or credit card balances. Depending on state laws, you may get to keep essential property such as personal possessions, clothes, household furnishings and your car. Social Security payments and the tools of your trade may also be exempt.
This bankruptcy process can be completed in four to six months and is relatively cheap, costing about $335 in filing and administrative fees (not including attorney fees), and usually requires only one trip to the courthouse.
While the bankruptcy is in process, an "automatic stay" immediately stops any lawsuits and most actions by creditors, collection agencies or government agencies. It stops your creditors from harassing you, taking any actions to collect money, evicting you or garnishing your wages. This could give you some space to get a fresh financial start.
That said, bankruptcy isn't easy. Your credit score will immediately drop by up to 150 points or even more, and the bankruptcy will stay on your credit report for up to 10 years. Bankruptcies also become public record. You're not obligated to volunteer this information to potential employers or creditors, but they can easily find out on their own. Once your debts have been wiped out and you're done with the bankruptcy, you can work on raising your credit score again.
Chapter 13 bankruptcy: Best option if you have regular income and need to stop a foreclosure
Chapter 13 bankruptcy may be able to halt foreclosure on a home or other secured property. It creates a payment plan so you can pay off your debts over the next 3 to 5 years. Since you need a steady income to do this, it's sometimes called a "wage earner's plan." This is an option for people who have significant investment (equity) in their home. They have a regular income and can pay basic living expenses but can't keep up with payment on all their debts.
To qualify for Chapter 13, you have to show that your unsecured debts (credit cards and medical bills, for example) total less than $394,725 and your secured debts (such as mortgages) are less than $1,184,200. You must also be able to prove to the court that you can afford to meet your repayment obligations.
Chapter 13 is more complicated and may take longer to file and be approved, but it has some advantages. First and foremost: You have a chance to stop foreclosure and keep most of your property. You can make one monthly payment that will get distributed among your debtors. And Chapter 13 can cover some debts that aren't addressed by Chapter 7.
As with Chapter 7, filing for Chapter 13 will create an "automatic stay" that immediately stops your creditors from harassing you, taking any actions to collect what you owe, evicting you, garnishing your wages or foreclosing on your home. You won't be contacted by your creditors over that 3- to 5-year repayment period.
You don't necessarily need to pay an attorney to file for bankruptcy, but it's generally a good idea. "If your case is not complicated and you don't have a home or a lot of assets, you may be able to handle it without an attorney," says Cara O'Neil, an attorney and legal editor for Nolo Press, a publisher of legal guides for consumers.
"The problem is that there is potential for making an error, especially if you have assets you want to protect, such as your home," she says. "Once your case is filed, it stands. So if you don't completely understand the process and you make an error, you may end up forfeiting property you could have saved."
If all goes well, you will slowly pay off your debt and can begin rebuilding your credit when you're finished.
The bankruptcy process
If you do consult with a lawyer, which is advisable, it's best to find one who is well-versed in the complex laws of bankruptcy. "If you're going to see a lawyer, see a bankruptcy attorney. You're not going to pay any more [than if you saw a non-specialist]," Boltz says. Many or most lawyers specializing in bankruptcy offer a first consult free, he adds.
You can find bankruptcy lawyers listed through your state's bar association, or on websites such as NACBA. Check out credentials, and don't be fooled by people who prepare forms and who say they are just as good as a lawyer. "All they are legally allowed to do is type," Boltz says. "They can't give you advice."
Your bankruptcy attorney will advise what you need to file for bankruptcy. This will include bank statements, tax returns, paycheck stubs, insurance documents and a list of debts. If you own property you will need documentation. The attorney will check debts from credit reports. You will also have to complete a credit counseling course from a government-approved organization within 180 days before you file. Check the list of approved debtor education providers online or at the bankruptcy clerk's office in your district.
If your attorney finds you are eligible for bankruptcy, you'll fill out a petition and a number of other forms. These will be filed with the bankruptcy court in your area.
Filing fees are set by the courts, and are generally under $400. Costs for legal help vary. For Chapter 7, lawyers' fees are generally under $2,000. For Chapter 13, they are between $3,500- $5,000. Some of the expenses may be tax deductible, so check with a tax expert.
If you can't afford a lawyer, you may qualify for free legal services. "Many attorneys do pro bono bankruptcies, and many legal aid organizations have bankruptcy programs," says James Haller, president of the National Association of Consumer Bankruptcy Attorneys (NACBA). "However they're limited as to the number of clients they can handle and can only accept the most needy."
Shortly after you file, a creditors meeting is scheduled at the courthouse. Your bankruptcy trustee will conduct the meeting, asking you questions about debts and the papers you filed for bankruptcy. This is usually the only courthouse meeting for a Chapter 7 bankruptcy. If you're doing a Chapter 13 bankruptcy, a repayment plan is set up and a creditors' meeting scheduled. Over the next few years, you'll report to the trustee, usually twice a year. You will have to complete a court mandated and approved budget management education course before your debts can be discharged.
Bankruptcy is never the final answer to financial troubles. It's just the first step toward getting your finances back in order. But if used wisely, it can be a helpful toolone that you'll never have to use again.
Filing for Bankruptcy: What to Know. Federal Trade Commission. https://www.consumer.ftc.gov/articles/0224-filing-bankruptcy-what-know
Bankruptcy. United States Courts. http://www.uscourts.gov/services-forms/bankruptcy
How Does a Bankruptcy Affect My Credit Score? Consumer Financial Protection Bureau. https://www.consumerfinance.gov/askcfpb/1233/how-does-bankruptcy-affect-my-credit-score.html