Have you ever thought about the possibility of filing for bankruptcy? You know it happens all the time. Today, many people find themselves drowning in debt and unable to keep up with their obligations. They find themselves in a desperate situation and bankruptcy offers a pathway back to stability. While it’s better to take responsibility and pay down your debts, there are times when this simply isn’t an option and bankruptcy is the only way.
If you haven’t done it yourself, I am betting you probably know of someone or some business that has declared bankruptcy. In fact, it’s become so common that even a presidential candidate can have had multiple business bankruptcies and still garner respect and admiration as a responsible and savvy money manager (as incredible as that might seem). Today it’s become the way to “liquidate debt” or “reorganize debt” in order to manage financial problems. It even may turn a very negative situation into a positive one.
History of Bankruptcy
In order to understand bankruptcy today, we need to look at a bit of history. I know I always say it.. we examine the past to learn about the present and future, but damn it’s the truth!
Bankruptcy and its misfortunes have been around for centuries. In fact, “debtors prisons” were known throughout Europe as late as the early 20th century. It was the place where indigent people were sent when they just weren’t able to pay their bills. Historically, this was due to some sort of disastrous act such as wars, disease and just plain bad luck. Sometimes it was the death of the breadwinner which many times was simply caused by argument or some kind of prejudice. No matter the reason, the result was to send some people off to a “workhouse” or “poorhouse” so they could literally work off their debt and the cost of their incarceration.
When the Revolutionary War ended in 1789 and our federal government was created, we modeled our debtors laws on Great Britain’s. That lead to many honorable men serving some time in debtors prison due to debt accumulated and ignored from the war itself. But after the War of 1812, things were getting so out of hand that a feeling of sympathy and understanding developed about forgiving debts. In 1833, after many years of debating, the First Federal Bankruptcy Law was passed in the United States. However, it wasn’t until the 1970’s that there were major changes in these laws and a Supreme Court ruling in 1970 and another in 1983 gave us the type of bankruptcy laws that we use for the most part today (Williams v. Illinois 1970 and Bearden v. Georgia 1983). In 2005, a new law established a means test for Chapter 7 bankruptcy so that high income filers would be required to pay back some of their debts under Chapter 13, but more about that to come.
When to File for Bankruptcy
By definition bankruptcy helps people and entities to liquidate or reorganize their debts and still be able to maintain their lives and businesses. It gives them the ability to relive stress, pressure, and money issues and to stay out of jail. Today the 3 main reasons for bankruptcy are insurmountable personal medical debts, excess credit card debt, and lack of communication and acknowledging a debt by refusing to pay.
But how do you know if and when you should file for bankruptcy?
First, you want to be sure that declaring bankruptcy will help you. Not all debts are discharged so you’ll want to check on which of yours will and won’t be. Next, you’ll need to meet certain eligibility requirements, depending on what type of bankruptcy you’re filing for. If you’re facing a lawsuit, one benefit is that bankruptcy proceedings will provide an “automatic stay” against almost all collection actions from a creditor. This will also help you if your property is about to be foreclosed on or repossessed by a creditor. Finally, you should take stock of what property you own. Depending on how you file, your property may be sold off to pay off your creditors. If you are considering filing for bankruptcy, you may want to go for credit counseling and/or consult an attorney about the right path for you to take.
Types of Bankruptcy
There are 2 major types of bankruptcy procedures that I will highlight and explain.
Chapter 7 Bankruptcy
Chapter 7 allows individuals or businesses who file in their federal courts the ability to liquidate their unsecured debt completely and quickly with just a few exceptions and walk away from it to have a fresh start. In most cases you must give up all your unsecured assets to allow your debt to be discharged and your creditors get the proceeds of your possessions even if the assets don’t fully cover your debt.
Chapter 13 Bankruptcy
Chapter 13 is used by individuals and sole proprietors in a business to repay creditors with a reorganization plan. An agreeable payment plan is usually made in monthly payments and dispersed by the courts. Creditors agree to this while you continue to keep your property (or operate your business). Chapter 13 is used by more affluent individuals who want to maintain their property and assets while they have time to catch up and pay off their debt like car and mortgages.
Here are some of the differences at a glance:
|Chapter 7||Chapter 13|
|Type of Bankruptcy||Liquidation||Reorganization|
|Who Can File||Individuals & Businesses||Individuals & Sole Proprietors|
|Eligibility Criteria||Disposable income must be low enough to pass Chapter 7 Means Test||Cannot have more than $394,725 of unsecured debt or $1,184,200 of secured debt|
|Type of Debts||Certain debts can’t be liquidated, including student loans, child support and spousal support||Only certain kinds of assets can be reorganized, including credit card debt, mortgages, taxes, and invoice debt|
|Length of Time||Typically 4-6 months||Typically 3-5 years, but can last as long as 8 years|
|What Happens to Property||All nonexempt property can be sold to pay creditors||Debtors keep all property but must pay unsecured creditors an amount equal to nonexempt assets|
|Limitations||Can only file once every 8 years||No limit on number of filings, but less than 2 years between filings can affect discharges|
|Attorney Fees||About $1,000-$2,500||About $1,500-$4,500 (may be paid through the reorganization plan)|
What Will Happen When You File
If you find yourself in a position of facing bankruptcy today, there is some good news. First, once you file your petition, all bill collection and dunning and harassing phone calls will stop. Although you don’t need an attorney (it is highly recommended and favored by courtroom judges), it sends the signal to creditors that they have no recourse but to allow the system to start its procedures if they want to be paid.
The bankruptcy procedure doesn’t necessarily mean you will lose all of your assets, like your home and car. If you can show that you have equity in your home and you can pay the mortgage and car payments (while not be able to pay other creditors) you may still keep them in order to be able to continue to earn a living and function. Bankruptcy will wipe out most of you debts, but not all. If you owe back taxes, or any awards through divorce like child support or spousal support, you will still be required to pay or you may face imprisonment. Did I say imprisonment? Well it does still exist and not paying taxes and court fees leads us back to the concept of incarceration or “debtors prison”.
Even if you get your “fresh start” and are able to start paying your bills, bankruptcies will appear on your credit history and affect your credit score as a very negative event. It takes about 7 years for discharged debt to drop off your credit report. This is one of the major consequences of declaring bankruptcy rather than paying off your debt on your own.
As you can see, filing for bankruptcy should not be done lightly. It also indicates that something has gone seriously wrong with your finances. No matter what you ultimately decide about filing, you are obligated to reassess your future financial plans and decisions.
Have you ever considered filing for bankruptcy? Are you on top of your personal and/or business credit and bills? Have you learned any lessons about financial responsibility from family or friends filing bankruptcy?