Foreclosures and excessive debts are a homeowner's worst nightmares come true. Many believe bankruptcy to be the perfect solution for these problems. But, that's where people get trapped. Bankruptcy stays on your credit record for quite a long time, making advancing in life incredibly difficult. In addition, the updated bankruptcy law, passed in 2005, includes severe restrictions that make it more complicated to file for bankruptcy.
According to data collected from the United States courts, bankruptcy filings declined in the 12-month period ending March 31, 2018, compared to the previous year. But there was still quite a large volume of petitions filed. A total of 756,722 people filed for personal bankruptcy. The total number of Chapter 7 cases filed were 480,933, versus 290,566 Chapter 13 filings.
This article is meant as a guide if you are thinking of filing for bankruptcy and need information regarding the process and its consequences to your financial health.
How to File for Bankruptcy
When faced with foreclosure or any such financial insolvency, the final option in this situation should be bankruptcy. Declaring yourself bankrupt is the only legal way to get rid of your financial setbacks. However, the process of filing for bankruptcy is easier said than done. (To nip foreclosure in the bud, read Saving Your Home from Foreclosure and Are You Living Too Close to the Edge?)
When you file for bankruptcy, you have to explain to the presiding bankruptcy trustee or judge how you got into this financial rut. In the meantime, the bankruptcy court will ask you to file the entire list of assets and outstanding debts with them.
Your assets are divided into two categories according to their nature. They are:
- Exempt Assets: These assets cannot be realized to pay the debts. Examples include some part of equity in your home and automobile, personal items, etc.
- Non-Exempt Assets: As the name suggests, these assets can be seized and sold to repay outstanding accounts. Home property other than the primary residence, recreational vehicles, boats, etc. fall under this category.
Likewise, your outstanding debts are classified into two types. They are:
- Secured Debts: These include loans in which the creditor has a security interest in the property provided as collateral. The property bought with credit may be your second home, a boat or a car.
- Non-Secured Debts: These debts are not secured by property. For example, credit card debt, medical bills, personal unsecured loans, etc.
The bankruptcy court considers secured debt as critically important because its non-payment will compel the creditor to lay claim on the property chosen as collateral.
Once all the essential information has been filed with the court, a bankruptcy trustee is designated to make sure that your secured debt is repaid in the given period. Consequently, the court issues a mandatory stay that prevents your creditors from laying their hands on you through property confiscation or foreclosure. The stay also prevents the creditors from pursuing a lawsuit against you. (For more on protecting your assets, read Bankruptcy Protection for Your Accounts.)
Which Chapter Is Right for You?
Chapter 7: This liquidation option enables you to keep the exempted assets, whereas unsecured debts from credit cards, etc. are discharged. Here, the non-exempt assets are realized to repay the secured debts. However, debts like student loans, child support, taxes, etc., will not be dismissed. This alternative is generally chosen by individuals with lower income and few assets, and more overall debt.
Chapter 13: Under this reorganization proceeding, you have to repay your debts over the specified period of three to five years through a logical repayment plan. The trustee collects the payments from you and transfers them to your creditors. Here again, you are permitted to keep your home, thereby preventing any looming foreclosure. This bankruptcy option is normally preferred by individuals who are interested in keeping their non-exempt property intact or who want to buy time against foreclosures or property seizures. (Don't lose your home: Use your home. To learn more, see Downsize Your Home To Downsize Expenses and Fix It And Flip It: The Value of Remodeling.)
Effects of the 2005 Law
The Bankruptcy Abuse Prevention and Consumer Protection Act was implemented in 2005 and made big changes to the country's bankruptcy laws. With the implementation of the updated 2005 bankruptcy laws, people are, to a greater extent, compelled to file for Chapter 13 instead of Chapter 7.
In order to be eligible for Chapter 7, your present monthly income would be calculated against the average income for a family of your size in your state. Here, your present monthly income implies your average income over the last six-month period. If your income is less than or equal to your state's average income, then you will be eligible to file under Chapter 7. However, if your income is higher, then you have to pass the Means Test to meet the criteria for Chapter 7.
In this test, your remaining disposable income is determined by deducting the specific expenses set by the Internal Revenue Services (IRS), and secured debt payments from your present monthly income. Now, if your monthly disposable income after deducting the above amounts is less than $100, you will be allowed to file for Chapter 7. If your disposable monthly income is between $100 and $166.66, then it is multiplied by 60 to determine whether you have enough money left to pay more than 25% of non-secured debt over a period of five years. If yes, then you must choose Chapter 13 over Chapter 7. If no, then you can have access to Chapter 7.
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However, the court has the authority to force you to file for Chapter 13 if it realizes that you will be misusing the system by filing for Chapter 7.
As stated by the 2005 law, the court abides by the living standards set by the IRS. This implies that the court decides what amount is reasonable to pay for daily expenses of food, rent, etc., and then how much should remain to pay for the debts.
The new law places stringent restrictions on exemptions in a way that you may not be permitted to keep all or a large part of the equity in your home. Consult your bankruptcy attorney to get more information about this issue.
Finally, the new law directs that you should meet with a credit counselor in the six months before applying for bankruptcy. You are also required to attend a money management program solely at your expense before your debts are paid off.
When the court issues a discharge, the debtor is then relieved of any liability to pay back his or her debts. That means creditors no longer have a legal claim against the debts, so they cannot pursue any collection activity, take any legal action or communicate with the debtor in any way. The court will send creditors a notice that the debts have been discharged. A copy is also sent to the petitioner's lawyer as well as the U.S. trustee. Any creditor who attempts to collect a debt after receiving a notice of discharge can be fined.
For a Chapter 7 bankruptcy, the discharge is usually issued anywhere between four and six months after the bankruptcy petition is filed. The discharge under a Chapter 13 bankruptcy is issued after the payment plan is complete, usually three to five years after the bankruptcy filing.
The Pros and Cons
One main point to consider is that you can avail to a bankruptcy loan after all your debts have been repaid and the bankruptcy has been dismissed. The main purpose of this loan is to restore your worsened financial health back to normal.
The negative point is that bankruptcy can stay on your credit report for more than 10 years, depending on which chapter you've filed. The cost of having a bankruptcy stamp on your credit score will affect your future prospects of getting a mortgage, loan or a credit card. (For more on this, read Consumer Credit Report: What's On It?)
But that shouldn't be a deterrent from trying to improve your credit score. After waiting for some time, you can try to get back into the credit game by applying for secured credit cards, using them only when needed and making your payments regularly and on time. This step can help you rebuild your credit and your overall financial health.
The Bottom Line
Declaring yourself bankrupt is not the key to ending your money problems. The odds may work out against you with bad credit in your name. Filing for bankruptcy has become complex as well as costly owing to the 2005 bankruptcy laws. As such, consultation with a trustworthy bankruptcy attorney before filing becomes necessary. Ultimately, making the right move in the right situation can provide you with a needed respite from anxiety and debt.