personal bankruptcy

What Actually Happens if You File for Personal Bankruptcy?

Paying monthly credit cards, medical bills, school loan, car loans, and insurance can be hard, and then there’s keeping up with the basics like food and mortgage or rent.

It’s often difficult to pay off debt and stay afloat, and if you don’t have sufficient funds in savings, you could be one big car repair away from not being able to. Add to that a major medical issue or even losing a job, and it becomes impossible to pay for these things.

People file for personal bankruptcy when their debts far exceed their available income.

Reasons Why This Might Happen Include:

  • Being unemployed
  • Incurring huge medical debt
  • Incurring debt in the form of loans or credit cards
  • After a divorce

Nonetheless, it’s often the last resort for people who are in over their head.

So if you think this might be a course you’re willing to take, then you might want to know what really happens when you file for personal bankruptcy? It’s probably a good idea to know beforehand what to expect so that if it’s something you’re considering, you can make an informed decision.

A lot of people don’t really know what personal bankruptcy is, or understand what happens after they file. For instance, many are under the assumption that bankruptcy clears all debt obligations; it just makes them go away. But that’s far from true.

You still have to pay your debts, it just how you pay that is different. The two most common types of personal bankruptcy are Chapters 7 and 13. So let’s review each.

Chapter 7 Personal Bankruptcy

Chapter 7 Qualifications

If you file Chapter 7, you’ll likely have to liquidate certain assets, like a car or a second home, to pay off some of your debt. But you don’t have to sell other essential assets.

Here are the eligibility requirements for Chapter 7:

  1. The filer’s current monthly income must be equal to or below the state’s median.
  2. If the filer’s income exceeds their state’s median family income, the filer must pass the second part of the means test, which is to look at how much disposable income the filer has left after paying monthly expenses, such as rent and food, and then determine whether there is enough money to pay some of their creditors or not.
  3. The filer must also not have had a rejected Chapter 7 file in the past 180 days.
  4. The filer must not have filed a Chapter 7 or 13 within a certain number of years.
  5. The filer must have gone through credit counseling 180 days prior to filing.
  6. The filer has not attempted to defraud creditors, such as:
  • Transferring assets to family members
  • Destroying property
  • Purchasing luxury items
  • Lying on a credit application

Chapter 7 Petition

A chapter 7 case begins with filing a petition with the bankruptcy court.

You then must also file with the court:

  1. Schedules of assets and liabilities;
  2. A schedule of current income and expenditures;
  3. A statement of financial affairs;
  4. A schedule of executory contracts and unexpired leases;
  5. A copy of your most recent tax return;
  6. A certificate of credit counseling and a debt repayment plan
  7. Notice of payment from employers from the past 60 days
  8. A list of all creditors
  9. Notice of all income
  10. A list of all property
  11. A detailed list of monthly living expenses

What Happens Next

1. Automatic Stay

Following filing a petition, an “automatic stay” will stop all collections of debt.

A bankruptcy trustee is assigned and notice will be sent out for a meeting of creditors.

2. Meeting of Creditors

During the meeting of creditors, the trustee will ask the debtor various questions about the bankruptcy to confirm the validity of all documents. Any creditor may ask the debtor questions about his or her income and the nature of the bankruptcy, but typically only car creditors and the IRS appear to discuss payments.

3. Selling Property

The trustee will then sell any non-exempt property. What is exempt and non-exempt depends on the state you live in. Usually, exempt property is the property you need, such as your primary home and also any retirement accounts. Everything else may be sold to pay off creditors.

4. Financial Management Course

Before you receive a discharge, you will have to take a financial management course in financial management This class is usually taught by a credit counselor and takes about an hour and a half.

4. Debt is Discharged

If none of your debtors object, a discharge is ordered. The general discharge order notifies all your creditors that you did what you were required to do under the bankruptcy laws and in turn, is relieved of the obligation to pay any more on the debts that are dischargeable. Essentially, your debt is wiped clean. The discharge effectively wipes out all your debts, with the exception of certain taxes and child or spousal support obligations.

Chapter 13 Personal Bankruptcy

With Chapter 13, instead of selling off all your assets, you instead create a plan to pay off your debts, usually within three to five years. However, just like Chapter 7, you have to qualify.

You have to qualify, though, and that means your secured debts, like your house or car, can’t be worth more than $1,149,525 and your unsecured debts cannot be more than $383,175.

Chapter 13 Qualifications

Here are the eligibility requirements for Chapter 13:

  1. The filer must not be a business
  2. The filer must also not have had a rejected Chapter 7 file in the past 180 days.
  3. The filer must not have filed a Chapter 7 or 13 within a certain number of years.
  4. The filer must have gone through credit counseling 180 days prior to filing.
  5. The filer has not attempted to defraud creditors.
  6. Income taxes have been filed
  7. The filer must not have incurred more than $336,900 in unsecured debt (such as credit card debt and medical bills) and has less than $1,010,650 in secured debt (home and/or car).
  8. The filer must have a proposed plan to pay off their debt within a certain time frame.
  9. The filer must have enough income to pay off the debt

Chapter 13 Petition

The process of filing for a Chapter 13 personal bankruptcy is similar to a Chapter 7.

What Happens Next

1. Automatic Stay

Similar to a Chapter 7, an automatic stay is issued, which includes any foreclosure proceedings.

2. Meeting of Creditors

This is followed by a Meeting of Creditors, but this time they discuss and ask questions about the proposed payment plan. Any issues about the payment plan are resolved at this time.

3. Claim Filing

Any creditors who wish to participate in distributions must file a claim.

4. Repayment Plan Hearing

You, your appointed trustee, and any creditors who wish to attend come to court for a hearing on your chapter 13 repayment plan.

After Bankruptcy, What Is Affected?

Some Debt is Not Forgiven

Debts such as child support, alimony, student loans and taxes won’t go away. However, student loans can be forgiven if you can prove “undue hardship”.

Your Credit Score Will Drop

If you previously had a good credit score, the drop might shock you. However, if it was already low, then the drop won’t seem as severe. It can take years for your credit score to recover. With Chapter 13, because you’re paying back your debt, the recovery is about 7 years. But with Chapter 7, it’s 10 years.

Can You Avoid Personal Bankruptcy?

In some situations, certainly. Here are a few things to try before resorting to filing for bankruptcy:

  1. Try negotiating with creditors. Some creditors are willing to work with you to work out a payment plan. They’d rather get their money back, even if it takes longer with reduced payments, then not get anything at all.
  2. Consult a credit counselor to create a debt reduction strategy This alone may help get you back on track. There are credit counselors who can help you negotiate lower interest rates and minimum payments, for instance.
  3. Create a budget you can stick to that includes not incurring additional debt.
  4. Sell off assets to pay creditors.
  5. Find another source of income can help too. It’s worth looking into alternatives before taking the plunge.

What’s the Next Step?

If after reading this you’re still unsure if you should file for Chapter 7 or 13 personal bankruptcy, or which one is best for your situation, you’re not alone. Most people still chose to consult an attorney. The process is long and has an overwhelming amount of requirements and steps.

Many people who file for personal bankruptcy often don’t even know where to start. Luckily you don’t have to figure this out on your own.

Contact an experienced bankruptcy attorney in your area and get a better understanding of how personal bankruptcy works. Or check out our blog for useful tips on personal finance.