Sense & Centsibility Blog

Bankruptcy 101: The Good, the Bad, and the Ugly

Man with empty pocketsThere is a lot of confusion and apprehension about filing bankruptcy. Some people believe they will lose everything they own. Others think they can keep everything and still get rid of debt. The truth is, it all depends on your unique situation and the bankruptcy laws that apply to you. While I will write about the basics of bankruptcy in this post, my best advice is to seek free consultations with at least 2 bankruptcy attorneys to find out if, and how, bankruptcy may help you.

The facts

Bankruptcy is a federal court process used to eliminate or repay consumer debts under the protection of the bankruptcy court. The purpose of bankruptcy is to give you a “fresh start.” Bankruptcy is also designed to treat all creditors fairly and the same. This means you must include all debts in a bankruptcy; you do not have the luxury to pick and choose. A trustee manages your bankruptcy case from start to finish. You will be required to meet with the trustee once during the bankruptcy process.

Types of personal bankruptcy:

Personal bankruptcies address personal consumer debts (for example, credit cards, personal loans, and medical bills) or business debts that have been guaranteed personally.

Chapter 7 is called a liquidation bankruptcy. Your non-exempt assets (things you own that are NOT protected under the bankruptcy laws) may be sold to repay creditors. Typically, most people who file Chapter 7 bankruptcy do not own more assets than they can protect. If that is your situation, all of your unsecured debts can be eliminated without losing anything you own. You can receive a Chapter 7 discharge once every 8 years.

Chapter 13 is commonly called a repayment or reorganization bankruptcy. A plan is filed with the bankruptcy court which proposes how you will repay your debts to creditors. Some debts may be paid in full, some partially paid, and others dismissed with no payment. Chapter 13 repayment plans run from 3 to 5 years long. You can typically keep all your assets in a Chapter 13 bankruptcy. Whether you are eligible to file a Chapter 7 or Chapter 13 bankruptcy will be determined by the “means” test. If your household income exceeds the median income for your geographic region, you may be required to file a Chapter 13 bankruptcy. A means test will be done by your bankruptcy attorney.

You should know that some debts cannot be discharged in bankruptcy. They include child and spousal support; student loans (in most cases); criminal restitution; debts that could have been listed in a previous bankruptcy; luxury goods or services, or cash advances obtained shortly before filing; recent income tax debts; fines, penalties, and restitution imposed for violating the law; and debts for personal injury or death caused by intoxicated driving.  

The benefits of filing bankruptcy...THE GOOD

1. The automatic stay: As soon as you file bankruptcy, you will receive immediate protection from almost all types of collection activity. The automatic stay can stop foreclosures, repossessions, garnishments, license suspensions, and creditor harassment. Depending on the situation, the stay may only be temporary. Ask your bankruptcy attorney how the automatic stay affects you.

2. Protects assets through exemptions: Each state determines which assets and how much value will be exempt in the bankruptcy process. Assets are items or property that you own. Exempt assets are protected so you may keep them when filing bankruptcy. There are also federal exemptions to protect assets, so you must choose one set of exemptions over the other. You cannot mix and match exemptions. A bankruptcy attorney typically analyzes your situation to determine which exemptions offer better protection. Examples of exemptions include equity in homes and vehicles, furniture and household goods, retirement funds, and more.

3. Total debt amount discharged: A Chapter 7 bankruptcy results in all unsecured debts that were included in the bankruptcy being discharged, meaning you have no legal obligation to repay the debts. Therefore, it is extremely important to compile a complete list of debts for your bankruptcy. If you discharge home or car loans, you will likely lose those assets.

4. Prevents mortgage foreclosure or repossession: A Chapter 13 plan can include back payments if you are behind on mortgage or car loans, tax debts, or student loans. These debts can be consolidated into 1 monthly payment that fits your budget. This may allow you to keep your assets, and pay your debts more affordably than trying to do it on your own. However, you must have enough income to pay the ongoing mortgage or car payments plus the Chapter 13 payment.  

The consequences of filing bankruptcy...THE BAD

1. Bankruptcies can stay on your credit report for 10 years. This will make it harder and more expensive to get credit such as mortgages, car loans, or credit cards in the future.

2. Renters may have difficulty finding new housing. Many landlords review credit reports when people apply for rental housing. Ways to avoid this problem include getting a letter of recommendation from a current landlord, renting from or moving in with friends or family, or saving the 1st and last months’ rent + a damage deposit. And sometimes, just being honest about your situation will do the trick!

3. Filing bankruptcy may make it harder to find a job. Some employers review credit information of job applicants. Employers need written permission from you to do so, but bad credit or bankruptcy may mean losing out on some job opportunities.

4. Insurance premiums may jump. Many insurers, especially auto and homeowners, factor in your credit score when determining rates. The worse your score, the higher the premiums. If you have a good history with your insurer, you may feel less impact than those with little or bad histories.

5. Bankruptcy is considered a public record. So people may find out that you filed bankruptcy. Also, some newspapers publish bankruptcy filings. This can damage your personal or business reputation in your community.

6. Discharging medical debts may make it more difficult to receive future medical care. In Minnesota, any medical provider is required to provide services in an emergency. That may also be the law in the state where you live. However, if a medical visit is not an emergency, service may be refused, or you may need to pay co-pays up front.

7. Impact on utility and phone services. After filing bankruptcy, utility services such as electric, gas, water, landline and cell phones may require payment in advance or a deposit to cover several months of service if you discharged bills you owed the providers. If you are late on a utility payment after bankruptcy, a company may be quick to cut off service or charge late fees.   

And finally...THE UGLY

Filing bankruptcy may take an emotional toll that will affect your self-esteem (“I must be a failure!”) and financial future for years to come. Think about if your personal morals and ethics are compatible with bankruptcy. If not, there may be other debt repayment options that suit you better - with far fewer consequences. If you want to discuss options for dealing with your debts, contact LSS Financial Counseling at 1-888-577-2227 or start online counseling now. We serve everyone and appointments are free and confidential. Now is the time to take charge and get your debts under control!

Author Barbara Miller is a Certified Financial Counselor with LSS and specializes in Bankruptcy Counseling and Education.