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Bankruptcy can feel like a daunting process. You should gather as much information as possible about bankruptcy, the types of bankruptcy available to you, and what happens after you file for bankruptcy before deciding if bankruptcy is the right option. This article will explicate the issues you may face after you file for bankruptcy and will attempt to answer these questions:
The focus of this article will be the impact of a Chapter 7 or Chapter 13 bankruptcy. Although individuals may also file for Chapter 11 or Chapter 12 bankruptcy, only a very small fraction of consumers qualify under either of those chapters. Chapter 11 bankruptcy is generally used by businesses seeking to restructure or reorganize their debt. Chapter 12 bankruptcy is only available to family farmers and fishermen. Since individual consumers overwhelmingly file for bankruptcy under either Chapter 7 or Chapter 13, these two chapters will be the focus of this article.
The decision to file for bankruptcy should never be taken lightly. Before choosing to file for bankruptcy, it is useful to consider the other options for debt relief. Bankruptcy is usually the recourse of last resort for a debtor when all other options are either unavailable or worse than filing for bankruptcy. When faced with a potential lawsuit, foreclosure, or wage garnishment, many debtors will explore government protection through bankruptcy proceedings. There are three options to consider prior to filing for bankruptcy:
You can enlist the aid of a credit counseling organization, or you can simply default on your debts. Contacting your creditors to work out a plan for repayment of debts may be a win-win solution for both parties. If your creditor(s) believe that your only other options are to either default or declare bankruptcy, it will be in their best interests to work with you on creating a repayment plan. If you default on the debt, your creditor will get nothing; if you file for bankruptcy, there is no guarantee the creditor will be repaid as much compared to working with you privately.
Credit counseling agencies will advocate for you in negotiating a repayment plan with your creditors. Every state has non-profit credit/debt counseling agencies who will work with you to alleviate your debt. Enlisting the services of these agencies creates a bulwark between you and your creditors, which may prove to be effective in negotiating a realistic repayment plan.
While this option may seem bleak, if you don’t have many non-exempt assets and your income isn’t substantial, defaulting on your debts may be favorable to filing for bankruptcy. If you default on a debt, creditors may either send a debt collector to attempt to collect on the debt or sue you in court to force repayment. However, debt collectors who contact you in an attempt to collect on an unpaid debt are required to abide by the strict mandates set forth in the Fair Debt Collection Practices Act. This federal statute bars debt collectors from using abusive, unfair, or deceptive practices to collect from you. They must also follow all applicable state laws governing debt collection. Creditors can attempt to force repayment of your defaulted debts by suing you in civil court, but are unlikely to do so. The resource cost (of time and attorney’s fees) for a creditor to sue you for repayment may be greater than any return they can expect the court to grant them.
Once you make the decision to file for bankruptcy, you’ll need to understand which chapter of the Bankruptcy Code is applicable to your situation. Chapter 7 and Chapter 13 have different eligibility requirements. There are pros and cons to both chapters and it isn’t possible to declare one chapter as being objectively better. If you make less than the medium income in your state, you automatically qualify to file for Chapter 7. A list of the median incomes based on family size in all states is maintained by the U.S. Department of Justice. Qualification is determined by taking the debtor's average income over the previous six months and comparing it to state income figures for families of the same size.
If you make more than the median income in your state, you may still qualify to file for Chapter 7. Applicants are required to take the means test, which takes your income and compares it to your expenses. Those who fail the means test will need to file for bankruptcy under Chapter 13, as it may mean the court believes you canb repay your creditors given a certain time frame and good game plan.
In a Chapter 7 bankruptcy, the court appoints a trustee who will create a bankruptcy estate comprised of your non-exempt assets. The trustee then liquidates – or “sells off” – these assets to repay your creditors. Creditors are repaid in accordance with bankruptcy laws. Compared to a Chapter 7 bankruptcy, you keep your assets in a Chapter 13 bankruptcy. In a Chapter 13 bankruptcy, the court appoints a trustee who will administer the case. Instead of your assets being seized, the court requires a Chapter 13 debtor to file a repayment plan. The plan will provide for fixed payments periodically to the trustee who will then distribute to creditors in accordance with the terms of the plan. While a Chapter 7 bankruptcy lasts somewhere between four and six months, Chapter 13 bankruptcy usually proceeds for around three to five years.
In the preceding sections, we touched on some of the fall-out from filing for bankruptcy. Since bankruptcy will significantly hurt your credit score, you may find it difficult in the first couple of years after the discharge to get approved for loans and mortgages. Depending on the type of bankruptcy you file under, you may lose many of your assets or be required to make periodic payments over several years. Since not all debts are dischargeable, even after bankruptcy, there may be debts you are still responsible for, such as child support or student loans. In addition, some secured debts are also not dischargeable via bankruptcy. For instance, if a lender has a lien on your house and you default on your loan, that lender can still foreclose on your home even after bankruptcy.
You should also understand that filing for bankruptcy is a matter of public record. This means that everything you file with the court, such as the personal financial information listed in your bankruptcy schedules, is accessible by anyone in the public. Everything mentioned above is a tangible, concrete consequence of bankruptcy. Before filing for bankruptcy, you may also want to assess the personal and emotional toll that this process may have on you and your family. Since bankruptcy is a major undertaking, it would be very beneficial to gather as much information as possible so you can be mentally prepared heading into a bankruptcy filing.
There is no way to sugar-coat this: filing for bankruptcy will severely hurt your credit score. However, not filing for bankruptcy and piling up more debt is detrimental. And defaulting on debt may prove more harmful to your credit score for a longer period of time. Sometimes bankruptcy can be a useful means of getting out from under the burden of debt. Your credit score will take a significant hit but you'll get to start anew. You can then begin making prudent, fiscally-responsible choices regarding your finances.
There is no exact number your credit score will drop if you file for Chapter 7 or Chapter 13 bankruptcy. Model estimates based on reputable industry sources report that your credit score may take a hit of anywhere between 160 to 220 points, depending on the type of bankruptcy you file. A Chapter 7 bankruptcy will remain on your public record for up to 10 years. In comparison, Chapter 13 will remain on your public record for up to 7 years. Under both Chapter 7 and Chapter 13, discharged debts will remain on your credit report for up to 7 years after they are discharged. However, since Chapter 7 debts are discharged within months after filing, they may remain on your credit report for less time than debts discharged under Chapter 13. Many of your debts under Chapter 13 remain active until discharge at the end of the three to five-year repayment plan. Thus, they could remain on your credit record long after the bankruptcy itself.
There are two very important actions you can take after bankruptcy to see faster long-term improvement of your credit score.
First, it is critical that you regularly check your credit report to make sure everything is being reported correctly. After your debts have been discharged, the discharged accounts should show a balance of $0 and no longer listed as delinquent. If there are inaccuracies in the report, contact the credit reporting agency immediately to have it fixed.
Second, reapply for credit soon after the bankruptcy is discharged. Sooner or later, the bankruptcy will fall off your credit report. If during that interim period you choose not to apply for any new credit, by the time the bankruptcy is wiped from your credit report, you’ll have a long period of time where it looks like you had no credit at all. This makes improving your credit score an even longer process. Instead, by reapplying for credit soon after the bankruptcy ends, you can immediately start rebuilding a credit history and improving your credit score. Be mindful of the irresponsible choices that put you into debt. One of the smartest choices you can make going forward is to always pay off your credit card balance in full by the due date.
Your assets will be affected differently depending on the type of bankruptcy you file. In general, your assets shouldn’t be in any jeopardy in a Chapter 13 bankruptcy proceeding. Chapter 13 bankruptcy consists of a repayment plan over the course of three to five years to satisfy the court that your creditors have been compensated (even if not fully).
Conversely, Chapter 7 bankruptcy is liquidation, meaning your non-exempt assets are seized by the court and sold off to repay your creditors. Generally, the courts will consider all items deemed essential to modern life as exempt from bankruptcy proceedings. However, property exemptions under Chapter 7 bankruptcy are governed by both state and federal law.
Some states choose to follow the federal guidelines, whereas others will require debtors in their state to follow state law. Some states will allow you to choose between the federal or state exemption law. You should understand the applicable exemption laws in your state prior to filing for bankruptcy.
The moment you file for bankruptcy, the court issues an “automatic stay” on most (or all) of your debts. This means that creditors and debt collectors are not allowed to contact you regarding or attempt to collect on an outstanding debt. The automatic stay also bars a creditor from commencing or continuing a lawsuit against you to collect on a debt. Although most debts, repossessions, foreclosure proceedings, wage garnishments, and such are halted during the bankruptcy process, there are financial obligations you are not shielded from with the automatic stay. These include items like child support, alimony, and certain tax audit proceedings with the IRS.
The purpose of Chapter 7 or Chapter 13 bankruptcy is to wipe out your debts and create a clean slate so that you can have a “fresh start.” At the end of a Chapter 7 or Chapter 13 bankruptcy proceeding is the discharge, which absolves most people of most of their debt. Debts that are discharged no longer have to be paid and creditors cannot attempt to collect on them.
While many debts are dischargeable through bankruptcy, there are specific debts and obligations which you will still be responsible for. These include, but are not limited to, child support and alimony payments, student loans, criminal restitution, debts for personal injury/death resulting from a DUI/DWI, and certain taxes. In general, while your unsecure debt will be discharged via bankruptcy, many types of secure debt may not (or should not) be.
Unsecure debt includes items such as credit card bills and medical bills. This type of debt is called unsecure debt because there is no “security” or property tied to the debt. A secure debt on the other hand will often have a lien attached to it. For instance, the mortgage on your home or the loan you received to buy your car are examples of secure debt. If you default on your mortgage, the creditor may foreclose on your home; if you stop paying off your car loan, your vehicle may get repossessed.
Although secure debts can be discharged in a Chapter 7 filing, most people will choose to reaffirm those debts. Reaffirmation of secure debts occurs during the bankruptcy proceedings and is a promise by the debtor to the creditor to continue paying off those debts after the bankruptcy has concluded. The reason debtors will choose to reaffirm certain debts is to retain possession of key items, such as a car or home.
The Bankruptcy Code lists 19 categories of non-dischargeable debt. All other debt is potentially dischargeable. One of the most common types of debt discharged by bankruptcy is credit card debt. Once you file for bankruptcy, the court can discharge all qualifying pre-petition debt. However, any debts you incur during the bankruptcy proceedings – meaning all debt you take on after you file the paperwork – will remain your responsibility to fulfill and will not be discharged at the end of the bankruptcy. There is no simple, straight-forward answer as to exactly how your debts will be affected by bankruptcy and which debts will and will not be discharged. Retaining the services of a bankruptcy lawyer may be useful in navigating the complexities of bankruptcy law.
This article is intended to be helpful and informative. But even common legal matters can become complex and stressful. A qualified bankruptcy lawyer can address your particular legal needs, explain the law, and represent you in court. Take the first step now and contact a local bankruptcy attorney to discuss your specific legal situation.