What You Need to Know About Bankruptcy

If you are in debt and are thinking about bankruptcy, there are some important things that you need to know. Some of those things may make you feel better, and some probably won't, but if you go into a bankruptcy knowing what to expect you're more likely to be satisfied with the process and its outcome.

You Don't Need to Be Embarrassed About Bankruptcy

Although some people may make assumptions about you if they find out that you have filed for bankruptcy, such that you're irresponsible with your money, you would probably be surprised if you learned the names of all of your friends, neighbors and co-workers who have gone through bankruptcy.

  • Many people file bankruptcy for reasons outside of their control, such as the loss of a job or unexpected medical expenses.
  • Many file for bankruptcy protection after a divorce.
  • Most people who file bankruptcy have suffered an unexpected financial setback, and simply want to get back on their feet.

Businesses may act like it's somehow wrong or immoral for individuals to file for bankruptcy, but many of those businesses have, themselves, gone through bankruptcy at some point in the past. You don't have to feel guilty about seeking a fresh start as, believe me, none of those businesses have felt guilty when they have used bankruptcy to modify or eliminate their own debts.

You Get Immediate Protection from Creditors

Once you file for bankruptcy protection, an automatic stay goes into effect that prohibits creditors from continuing to engage in action to collect your debts. Creditors who violate the stay may open themselves up to serious consequences.

A bankruptcy can thus help you prevent or delay an eviction or foreclosure, or a repossession. It may allow you to get your utilities turned back on after a shutoff for nonpayment. It may allow you to stop the garnishment of your wages. Debt collectors must stop contacting you about your debts.

Sometimes a creditor will file a motion with the bankruptcy court asking for relief from the stay, so that they can enforce a debt or take other action such as completing an eviction, but you'll be protected from any such action unless and until the court approves the creditor's motion.

Do keep in mind that the automatic stay applies to debt that you incur before bankruptcy, but not to debts that arise after you file. Once you file for bankruptcy, you can't stop paying your new bills, such as your rent or utility bills without consequence.

There is More Than One Kind of Bankruptcy

For consumer debtors, the most common forms of bankruptcy are Chapter 7 bankruptcy and Chapter 13 bankruptcy.

  • Chapter 7 bankruptcy results in the discharge of some or all of your debts, although you may need to surrender some assets to creditors.
  • Chapter 13 bankruptcy involves a repayment plan, normally thirty-six to sixty months in duration, during which most of your discretionary income is used to repay your creditors.

You must pass a means test to qualify for Chapter 7 bankruptcy, in essence an evaluation of your income and assets to determine if you are able to repay some of your debts over time. If you do not qualify for Chapter 7 bankruptcy under the means test, you will have to file under a different chapter.

Businesses are not eligible to file for Chapter 13 bankruptcy, but may file to reorganize through a Chapter 11 bankruptcy. Chapter 11 will allow a business to stay open while it goes through the bankruptcy process. Although consumers are allowed to file Chapter 11 bankruptcy, it is far more complex and expensive than a Chapter 13 bankruptcy and thus will almost never be an appropriate option for your personal debts.

There are a couple of other forms of bankruptcy, available to municipalities, family farms and fisherman, but they are rarely used.

Bankruptcy May Not Eliminate All of Your Debt

Most people who file bankruptcy are able to get significant relief from their debts, but most will find that they have debt that is not dischargeable in bankruptcy. They may find that they want to keep some of their debt, in order to keep an asset such as a home or car that is secured by that debt.

If you owe money on student loans, for child support, or to your ex- as the result of a divorce judgment, that debt will not normally be dischargeable in bankruptcy. The legal requirement for getting student loan debt discharged is very difficult to meet.

If you want to discharge secured debt, such as a car loan secured by a lien on your car or a mortgage on your house, you must normally surrender the secured asset.

You should discuss with your bankruptcy lawyer the possibility of keeping your assets.

  • Your bankruptcy lawyer will explain reaffirmation, a formal action that keeps a loan in place after bankruptcy, and alternatives to reaffirmation that may still allow you to keep the property as long as you continue to make payments.
  • Your bankruptcy lawyer will also let you know if you can keep an asset without a formal reaffirmation. Even without reaffirmation many lenders will allow people to keep their secured assets after bankruptcy, such as a home or vehicle, as long as they keep making timely payments on their loans.

If you make purchases with loans, lines of credit, or credit cards shortly before filing bankruptcy, you may have to repay that money. Debts incurred shortly before bankruptcy will be viewed skeptically by the bankruptcy trustee and court, and may be set aside as fraudulent.

Bankruptcy Will Not Permanently Ruin Your Credit

You may be concerned that your credit will take a big hit as a result of a bankruptcy filing, and that you will never recover. While it is true that bankruptcy will harm your credit, and that the short-term effect of a bankruptcy will be to make credit far less available and far more expensive, those results are temporary.

Even before a bankruptcy drops off of your credit report, you will have the opportunity to rebuild your credit. You can start with secured loans or credit cards. After six months to a year, you will probably qualify for a regular credit card. But remember, if overuse of credit cards played a role in your bankruptcy, you will want to avoid repeating past mistakes.

You can get a small loan on a used car. As you repay those debts – with your payments being made on time, or even being made early – and build a record as a responsible borrower and help rebuild your credit score.

Long before the bankruptcy drops off of your credit report, you can demonstrate to creditors that you are a responsible borrower who is deserving of their trust.

Bankruptcy Shouldn't be Scary

It's easy to say that bankruptcy isn't scary, but if you're thinking about bankruptcy you probably have a lot of anxiety about the process and what will happen.

In most consumer bankruptcy cases, as long as you are honest and act in good faith, the process is likely to be simple. Court hearings are usually simple and short. Truly, you will almost certainly find the bankruptcy process to be a lot more simple and a lot less intimidating than you fear.

Copyright © 2017 Aaron Larson, All rights reserved. No portion of this article may be reproduced without the express written permission of the copyright holder. If you use a quotation, excerpt or paraphrase of this article, except as otherwise authorized in writing by the author of the article you must cite this article as a source for your work and include a link back to the original article from any online materials that incorporate or are derived from the content of this article.

This article was last reviewed or amended on May 7, 2018.