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Basics of Bankruptcy

In 2016, over 770,000 Americans filed for non-business bankruptcy, one of the lowest numbers since 2006 and half the number of filings in 2010, according to the Administrative Office of the U.S. Courts. All bankruptcies are handled in federal court and involve a process spanning months or years to pay off qualified debts and regain financial footing.

Why & When People File

Bankruptcy may bring to mind reckless and irresponsible spending and use of credit cards. But the reality is other financial hardships account for most bankruptcies, including unexpected job loss, divorce, and medical bills not covered by health insurance.

The demographics on who files bankruptcy show nearly an even split between men and women. In 2010, 64 percent were married, 17 percent were single, 15 percent were divorced, and 3 percent were widowed. With an increase in student loan debt and lower-paying jobs out of college, a growing percentage of filers hold a college degree.

Types of Bankruptcy

For non-business bankruptcy, there are three filing options: Chapter 7, Chapter 13, and Chapter 11. Each option handles repayment of debts differently and each has a different timeline for processing and repayment.

Chapter 7 bankruptcy, also called “straight bankruptcy,” is by far the most common and often preferred because of the opportunity to discharge—in other words not pay back—debts, including credit card debt, medical bills, personal loans, and mortgage debt. For this relief, however, a debtor must be prepared to lose property. Under Chapter 7, a debtor’s property (not only land, but also assets such as vehicles) is temporarily put under the supervision of a court-appointed trustee. Property deemed “exempt” is kept by the debtor, and “nonexempt” property is sold to pay creditors. Exemption laws vary by state, but it’s a general rule that debtors can use exemption laws to retain their property. A typical Chapter 7 case lasts four to six months from date of filing to official discharge—when debt is wiped out.

To qualify for Chapter 7, a debtor must receive credit counseling and pass a means test. To pass the means test, a debtor must be below the median income for the state or their disposable income must not exceed certain thresholds.

Chapter 13 is a reorganization of a debtor’s finances and applies to those with regular income. Filers pay back anywhere from 1 to 100 percent of debt to creditors over a three- to five-year period. A bankruptcy attorney helps create a payment plan to use disposable income (money left over after subtracting allowed expenses from gross income) to make a consolidated monthly payment to creditors. Less disposable income means a lower percentage of debts are paid back.

Individuals can also file for Chapter 11, which involves a similar repayment plan to Chapter 13 but with fewer types of debt discharged. With Chapter 13, a debtor is not required to turn over disposable income to a trustee, but they forfeit all of their disposable income over five years to pay their debts.

What Bankruptcy Means Financially

It’s a myth that you can’t afford to file for bankruptcy because you will lose everything you own! In bankruptcy, you don’t automatically lose all of your property. A court compares your assets (home, vehicles, investments, etc.) against applicable exemptions in your state to decide if any of it can be sold to pay off creditors. Remember, the majority of those who file Chapter 7 use exemption laws to retain all or most of their property.

Bankruptcy does affect your credit score, but the effects aren’t permanent and with healthier spending and borrowing habits, you can bring that score back up. The sooner you get help with debt, whether that’s through bankruptcy or a debt consolidation plan, the sooner you can raise your credit score. At the end, debtors filing Chapter 7 or 13 usually end up with a score in the mid-500s, on a scale of 300 to 850. A bankruptcy will stay on your credit report for seven to ten years, affecting future credit and loan offers.

Getting Help Before, During, and After

Before starting the long journey of bankruptcy, consider speaking with a debt counselor and using trusted debt consolidation options like debt management plans, debt consolidation loans, and debt settlement plans. Your local credit union is a great place to find these kinds of resources. Implementing a personal budget and sticking to it is a free first step to managing your finances and avoiding bankruptcy.

If filing bankruptcy is your only or best option, seek out legal help to ensure you come out the other side with the best chance for a brighter financial future.

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