It happens. Debts pile up and then something unexpected - an illness, a layoff, a divorce - punishes you for years of lax debt management. In early times, a debtor had a life of serfdom or prison to look forward to, but nowadays, we've learned to be slightly more forgiving. The good news is that filing for bankruptcy is not the end of your financial life. The bad news is that you're in for a rough ride. Here we take a look at what to expect when you file for bankruptcy, and how to survive. (For related reading, also see Should You File For Bankruptcy?)
TUTORIAL: Credit and Debt Management
Limitations of Bankruptcy
Bankruptcy will not solve all your problems. Lobbying by banks and credit card companies has made filing for bankruptcy more difficult and less effective. Bankruptcy will not clear away secured debts, meaning you may lose your car, your house, and anything else that has a lien on it – you may, but likely won't if you are making the payments. Bankruptcy will not free you from alimony, child support, student loans, taxes or other legally-protected obligations. What it will do, however, is clear your unsecured debt. Unsecured debt is, generally speaking, your bills – credit card bills, medical bills, phone bills, etc. – plus loans where nothing was put down as collateral. Running up your debts leading to the bankruptcy is fraud and these deceitful debts will be given legal status and require repayment.
Before you file for bankruptcy, you should exhaust all the options that have fewer consequences. Don't liquidate your retirement portfolio, but do consider drastic measures, because you may be forced to after the bankruptcy anyway. Take your time and gather all your documents. Also, avoid depositing money into banks that you have credit card or loan accounts at. They can seize your deposits if an account goes delinquent (as yours is about to). (The best cure for bankruptcy is prevention. To learn more, read Prevent Bankruptcy With These Tips.)
Anyone filing for bankruptcy is required to attend credit counseling, but it is a good idea to go before you're bankrupt. You may be lucky enough to find a way around bankruptcy, and you'll certainly get helpful debt-management tips. For example, you can pay a credit card to zero so it's not listed as a creditor in your filing and then keep it for after the filing to build up credit at a lower interest rate than you could possibly get after bankruptcy. Also, find a reputable lawyer to help you through the bankruptcy. Technically, you can go it alone, but the process is getting more complex. Be wary of bankruptcy specialists who charge high fees while churning through an equally large volume of cases. The lawyer will give you a checklist of even more documents to collect and begin your filing process.
Choosing Between Chapters
You don't actually choose what chapter to file bankruptcy under. Most people will be placed under Chapter 7 or Chapter 13. Chapter 7 is a "pure" bankruptcy that has become harder to get since 2005. In a Chapter 7 bankruptcy, non-exempt assets are sold to pay off a portion of unsecured debts and then most of the rest is forgiven. Retirement accounts, your house and car (as long as you can make payments), and other state-exempt possessions are left alone. It is due to fierce lobbying by the lending industry, mainly credit card companies, that Chapter 7 requirements have been tightened up. (Learn more about protected accounts in Bankruptcy Protection For Your Accounts.)
Chapter 13 is basically a court-ordered repayment plan. The plan is designed so that the debtor pays back as much as possible because the plan is somewhat biased in favor of lenders. The debt that cannot be paid off at the end of a three- or five-year period is forgiven. The bias in the Chapter 13 is another reason why you should try to make the drastic budget changes yourself rather than leaving it to the court. The advantage is that you don't lose possessions as long as you can meet the requirements of the repayment plan.
The Bottom Line
Once your bankruptcy has been filed, the calls from collection agencies will stop. This is when you'll be required to visit a credit counselor and attend a creditors' meeting. The bankruptcy will be finalized and you will begin your repayment plan under Chapter 13 or your fresh start under Chapter 7. The bankruptcy will remain on your record for seven to 10 years, making it difficult to get most forms of unsecured loans. It will also result in higher interest rates when you get a secured loan. If you're like the majority of people who file for bankruptcy, this will be a small price to pay to be finished with the crisis that brought the bankruptcy on. The good news is that the worst is over - now it's time for you to start building your personal finances anew.
For related reading, also take a look at Life After Bankruptcy.