5 Myths About Personal Bankruptcy

By Angie Mohr | May 05, 2011 AAA
5 Myths About Personal Bankruptcy

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.)

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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?)

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