For many people, filing for personal bankruptcy is an option that carries with it personal stigma and many unknowns. Persistent myths swirl around the process that are either half-truths or completely false. There is more than one type of personal bankruptcy filing, and each has its own rules and consequences, but the ultimate goal of each is to help a debtor out of a difficult financial situation. Here is a run-down of the top five myths about bankruptcy. (Going bankrupt can help pull you out of debt, but it's rarely the best option. Check out Declaring Bankruptcy Is No Easy Out.)

TUTORIAL: Introduction To Banking And Saving

1. You Will Lose Your House and Car
The two most-used types of bankruptcy filings are Chapter 7 and Chapter 13. Chapter 7 is also called a "liquidation" bankruptcy, as all assets of the debtor that are not exempt are sold and the proceeds distributed to the creditors. If you have significant assets, such as a vehicle or house, you will file Chapter 13 bankruptcy instead, which allows you to keep your assets and set up a payment plan with the creditors. This way, the creditors potentially end up with higher recovery and debtors can eliminate their debts over time while still being able to continue to live and work where they have been.

2. You Will Lose Your 401(k) or Retirement Assets
Certain assets are exempt from liquidation and distribution in a bankruptcy proceeding. 401(k) plans and IRAs are including in that group. This allows the debtor to have a more secure retirement even after filing for bankruptcy. However, if money is taken out of one of these plans prior to bankruptcy, those funds are not exempt and must be included in the filing. When deciding whether to access retirement funds to try to avoid bankruptcy, this fact must be considered if there is a chance that the filing will occur at a later time. (You can defend your retirement savings from the ravages of a bear market. We'll show you how. See Bear Spray For Your 401(k).)

3. Your Credit Will Be Ruined
Bankruptcy has a serious negative impact on your credit history - but only for 10 years. At that point, it falls off the report and is no longer easily visible to new creditors. In the meantime, however, creditors will be able to see the status of your bankruptcy proceeding. If you have been discharged and everything has been finalized, a creditor may be more willing to lend to you even during the 10-year period. Credit card companies may be the first in line to extend new credit to you after discharge.

4. You Won't Be Allowed to File for Personal Bankruptcy
Prior to 2005, there were limitations on who was able to file for bankruptcy. Changes to the law allow all debtors to do so now. Chapter 7 filing contains a means test with income and expense limitations. If your income is high enough to pay creditors under a Chapter 13 plan, you will be barred from filing for Chapter 7 relief. However, because bankruptcy proceedings can have a large impact on your future wealth and financial status, you should always consult a credit counselor and bankruptcy specialist before beginning the filing process.

5. You Can Only Ever File Once
There are limitations on how many times you will be granted bankruptcy relief, but you can file more than once. If you are seeking Chapter 7 relief, you must not have filed another Chapter 7 in the past eight years. Chapter 13 is only available to debtors who have not been discharged from a Chapter 13 in the past two years or a Chapter 7 in the past four years. Chapter 13 proceedings may be started in these circumstances but the debtor will not be granted a discharge until the time limitations have passed.

The Bottom Line
While bankruptcy law is complex, its ultimate goal is to help those who find themselves in financial crises. Knowing the truths from the myths will help you decide if bankruptcy is the right decision for you. (Find out how to determine whether this option will help or hurt your financial situation. Check out Should You File For Bankruptcy?)

Related Articles
  1. Economics

    What Happens in a Default?

    Borrowers are in default when they don’t honor a debt, whether their failure is intentional or not.
  2. Credit & Loans

    5 Signs a Reverse Mortgage Is a Bad Idea

    Here are the key situations when you should probably pass on this type of home loan.
  3. Credit & Loans

    5 Signs a Reverse Mortgage Is a Good Idea

    If these five criteria describe your situation, a reverse mortgage might be a good idea for you.
  4. Credit & Loans

    How Long Bankruptcy Will Affect You

    How long will the sad chapter of bankruptcy impact the rest of your life?
  5. Credit & Loans

    Guidelines for FHA Reverse Mortgages

    FHA guidelines protect borrowers from major mistakes, prevent lenders from taking advantage of borrowers and encourage lenders to offer reverse mortgages.
  6. Investing

    What’s Holding Back the U.S. Consumer

    Even as job growth has surged and gasoline prices have plunged, U.S. consumers are proving slow to respond and repair their overextended balance sheets.
  7. Credit & Loans

    What's a Nonperforming Loan?

    A nonperforming loan is any borrowed sum where the borrower has failed to pay scheduled payments for at least 90 days.
  8. Credit & Loans

    Can Corporate Credit Cards Affect Your Credit?

    Corporate cards have a hidden downside. If the company fails to pay its bills, you could be liable for the amount and end up with a damaged credit rating.
  9. Credit & Loans

    Your Credit Score: More Important Than You Know

    Credit scores affect key aspects of your personal and professional life. Knowing your score and managing your credit input can make a big difference.
  10. Credit & Loans

    What Qualifies as a Nonperforming Asset?

    A nonperforming asset is a loan made by a financial institution to a borrower who has failed to make any scheduled payments for at least 90 days.
RELATED TERMS
  1. Debt/Equity Ratio

    1. A debt ratio used to measure a company's financial leverage. ...
  2. Personal Property Securities Register ...

    A written, public, online record of legal claims to personal ...
  3. Roll Rate

    The percentage of credit card users who become increasingly delinquent ...
  4. Mini-Miranda Rights

    A statement a debt collector must use when contacting an individual ...
  5. Never Pay Strategy

    A colloquial term used to describe an individual who opens a ...
  6. Deficiency Balance

    The amount owed to a creditor if the sale proceeds from the collateral ...
RELATED FAQS
  1. Can my IRA be garnished for child support?

    Though some states protect IRA savings from garnishment of any kind, most states lift this exemption in cases where the account ... Read Full Answer >>
  2. Can creditors garnish my IRA?

    Depending on the state where you live, your IRA may be garnished by a number of creditors. Unlike 401(k) plans or other qualified ... Read Full Answer >>
  3. Is my IRA protected in a bankruptcy?

    All types of individual retirement accounts, or IRAs, recognized under the federal tax code enjoy substantial protection ... Read Full Answer >>
  4. How can I take a loan from my 401(k)?

    The majority of employers offer eligible employees the opportunity to save for retirement in a qualified plan through paycheck ... Read Full Answer >>
  5. How do I avoid a tax lien on my property?

    The best way to avoid a tax lien on your property is to make sure you pay all your state, municipal and federal taxes in ... Read Full Answer >>
  6. What is the best way to start to rebuild your credit after a bankruptcy?

    Bankruptcies can be devastating to your credit score. Even worse, a bankruptcy will be listed on your credit report for between ... Read Full Answer >>

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!