A lot of people think that going through the process of filing for bankruptcy is a good way to quickly and easily erase all of their debt. While bankruptcy can be a good financial strategy for people with certain kinds of debts, it is important to understand the process of bankruptcy before filing. There are two main types of bankruptcy that can be filed by private individuals. Chapter 7 and 13 are also the most common types of bankruptcy filings, although there are methods for businesses and farmers that are not used as often.
Chapter 7 Bankruptcy
Chapter 7 bankruptcy is meant to help Americans who have to completely wipe out or erase their debts. Originally, this type of bankruptcy was designed to help people who did not have any ability to repay the debts that they owed. For example, many people with high hospital bills do not have the ability to pay off the debt, especially if they are unable to find a job due to their illness. Of course, Chapter 7 can eliminate more than hospital bills. Credit card debts, store debts, past due balances on utility bills, and even secured debts such as car loans and mortgages can be eliminated with a Chapter 7 bankruptcy.
It should be noted, however, that this particular type of bankruptcy can be the hardest for a consumer to qualify for. While it can help a consumer eliminate the most debt, recent changes in bankruptcy laws have made it harder to actually get this type of bankruptcy. While the laws that determine who qualifies for it vary between states, it is generally true that people applying for Chapter 7 have to prove to a judge that their income is so low that they cannot pay back their debts within a reasonable period of time without undue hardship.
Chapter 7 can be a good way to completely erase unsecured debts. Unsecured debts typically include credit cards, consumer loans, payday loans, and medical debt. These are usually totally erased by a Chapter 7 filing without having to make further payments or sacrifice assets by a Chapter 7 filing. If a person wants to include secured debts, however, it is possible that the law will require them to sell the asset that the loan secures. For example, a person who wants to include their car loan debt might be required to sell their vehicle. Again, it should be noted that laws vary from state to state. In some states, it is possible to eliminate a portion or all of a secured debt and still hold on to the asset.
Chapter 13 Bankruptcy
Chapter 13 is meant for individuals who need to restructure and erase their debts. This type of bankruptcy is usually required of people who have enough income to make some type of payment on their debts. For example, a couple with a good income who can no longer make their credit card payments would use this type of bankruptcy to force their credit card company to change the payment terms of their card. A bankruptcy judge could then order the credit card company to lower the interest rate and/or reduce the amount that the filer has to pay each month.
When filed, a judge will review the paperwork and either approve or suggest modifications to the debt payment plan. Typically, these plans last about five years and will partially or completely pay off the debt. At the end of this term, the remaining debt will typically be discharged.
Under a Chapter 13 filing, a debtor might be required to sell more of his or her assets than he or she would under a Chapter 7 filing. In order to pay some unsecured debts, it might be necessary to sell jewelry, electronics, antiques, or other belongings.
Other Types of Bankruptcy
In addition to these two types of individual bankruptcy, there are several types of filings that are almost exclusively used for businesses, farmers, and other types of debtors. For example, a Chapter 9 filing can only be applied to municipalities like cities, counties, states, or towns and allows for their reorganization. Chapter 11 filings are the third most common type of bankruptcy filing. This chapter is almost always used to reorganize businesses but in some cases it may be used by individuals as well. These cases almost involve an individual who is filing for bankruptcy along with his or her privately owned business, however. Chapter 12 is used exclusively to adjust the debts of a family farmer or family fisherman. Finally, Chapter 15 bankruptcy applies to cross-border cases, in which the debtor has assets and debts both in the United States and elsewhere.
Drawbacks of Filing for Bankruptcy
It is important to note that some types of debt cannot be discharged in a bankruptcy. Student loans, tax debt, and child support are three examples of debt that can hardly ever be erased by filing, no matter what type of bankruptcy is being filed. Consumers who have these debts will have to work out a deal with their creditors in order to pay them back. Options such as debt refinancing or consolidation might be good options in these cases.
The most common consequence of bankruptcy is a dramatic drop in a person’s credit score. If a person has near-perfect credit, this drop can be 300 points or more. A person with poor credit, however, will probably not notice this dramatic of a drop. Either way, a low credit score and the fact that the bankruptcy is noted on the credit report generally disqualifies most people from obtaining new lines of credit or loans. For this reason, it is generally suggested that a person who is considering bankruptcy make sure that he or she has a primary residence, vehicle, and any other items that he or she would need credit to purchase before filing for bankruptcy.
In addition to not being able to qualify for a new loan in the seven years that a bankruptcy stays on his or her credit report, consumers also need to consider how the bad information on their report will affect other aspects of their life. Many potential employers pull credit reports as part of the hiring process. Many companies will reject potential employees who have a bankruptcy on their record. There may also be other consequences, such as being unable to obtain auto insurance.