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Bankruptcy - The Last Resort

Bankruptcy. Just saying the word can bring a lump to your throat and put a knot in your stomach. What is bankruptcy, and how do you know if it's for you?

Are your debts overwhelming? Are you worried about how you're going to pay all your bills this month? Are you considering filing personal bankruptcy? Before you decide to take this irreversible step, make sure you understand what bankruptcy is and how considering bankruptcy may affect you.

U.S. Bankruptcy Law Basics

The purpose of bankruptcy is two-fold:

  • To provide relief when you cannot pay your debts

  • To return as much money as possible to your creditors

There are several steps involved with declaring bankruptcy. First, you may want an attorney because legal paperwork must be filed in U.S. Bankruptcy Court. The applicable laws include Title 11 of the U.S. Code and an amendment to it, S.256 — the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (Bankruptcy Reform Act). It is not mandatory that you have an attorney but having the assistance of an expert may be helpful.

Second, you need to be aware of the filing fees, which in 2006 were $299 for Chapter 7 and $274 for Chapter 13, in addition to attorney fees (variable). If your income is less than 150% of poverty guidelines, you can apply for a fee waiver in Chapter 7 filings. See the U.S. Courts information about bankruptcy fee waivers.

Third, you must determine the type of bankruptcy you can file. There are two types of personal bankruptcy most often filed by a consumer: Chapter 7, which erases most of your debts, and Chapter 13, which creates a debt repayment plan. See the descriptions of Chapter 7 and Chapter 13 below. For a general introduction to bankruptcy law, see the U.S. Courts publication Bankruptcy Basics, available as a downloadable pdf file. See also the American Bankruptcy Institute's Overview of Bankruptcy and Frequently Asked Questions.

President George W. Bush in April 2005 signed into law the Bankruptcy Abuse Prevention and Consumer Protection Act, which makes it more difficult to file the Chapter 7 form of bankruptcy. See the White House website for President Bush's remarks about this law.

The 2005 Bankruptcy Abuse Prevention and Consumer Protection Act

The Bankruptcy Abuse Prevention and Consumer Protection Act, an amendment to U.S. bankruptcy laws, went into effect in October 2005. Also known as the Bankruptcy Reform Act, it makes the following changes to bankruptcy laws:

  • Credit counseling is required before filing for bankruptcy; before the bankruptcy process is completed, bankruptcy petitioners must also complete a debtor education class.

  • Those who wish to file Chapter 7 bankruptcy must pass a means test, thus steering more debtors to Chapter 13.

  • Bankruptcy filers must produce more documentation, such as tax returns and proof of income, than previously required.

  • Stricter and shorter time limits are implemented. If a bankruptcy petitioner fails to supply the required documentation within 45 days, the case is automatically dismissed. If you filed for bankruptcy in the past year and it was dismissed, under your current filing creditors are only stayed (barred from attempting to collect) for 30 days after your petition is filed.

  • The time period between discharges is lengthened: For Chapter 7, it is 8 years before you can file for bankruptcy again; for Chapter 13, it is 2 to 4 years.

  • Under Chapter 13 filings, certain debts are no longer dischargeable, including luxury goods, educational loans, and debts to pension plans.

For more information about the 2005 Bankruptcy Reform Act, see the U.S. Courts Bankruptcy Resources webpage and the American Institute of Certified Public Accountants article Bankruptcy Abuse Prevention and Consumer Protection Act of 2005.

Filing a Chapter 7 Bankruptcy

If you have insufficient income to pay your debts and have no prospect of creating additional income, Chapter 7 may help you. A Chapter 7 bankruptcy gives you a clean slate. This means that many of your unsecured debts are discharged, and you don't have to repay them.

But the Bankruptcy Reform Act has made it more difficult to file a Chapter 7 bankruptcy. First, you must attend a credit counseling session from a government-approved credit counseling agency within 6 months before filing your bankruptcy petition. See the U.S. Trustee Program List of Approved Credit Counseling Agencies. Also, before your bankruptcy proceedings are discharged, you must complete a debtor education course. See the U.S. Trustee Program List of Approved Providers of Personal Financial Management Instructional Courses.

Those who wish to file Chapter 7 must pass a means test to prove they lack the financial resources to pay back their debts. A debtor's income for the past six months is compared with median income for the state where the debtor resides. If the debtor's income is greater than the state median, and the disposable income is sufficient to pay at least $10,000 over the next five years, filing Chapter 7 is not an option. Instead, the debtor can petition for Chapter 13 reorganization of debt. For more information about calculating income for the means test, see the U.S. Trustee Program Means Testing webpage, and Form B22a – Chapter 7 Statement of Current Monthly Income and Means-Test Calculation.

If you file Chapter 7, you maintain responsibility for your secured debt (such as a home mortgage or car loan) if it is considered exempt. The laws determining what property is exempt vary according to your state of residence, so check with your bankruptcy attorney. A court-appointed trustee generally sells non-exempt property, such as real estate or personal property of value, and the proceeds are used to pay your creditors. For more information about Chapter 7 bankruptcy, see the U.S. Courts Bankruptcy Basics article Chapter 7 – Liquidation Under the Bankruptcy Code.

You should keep in mind that not all unsecured debt is dischargeable. For example, Chapter 7 does not eliminate:

  • Government student loans

  • Taxes

  • Fraudulently created debts

  • Alimony

  • Child support

You will continue to be responsible for these debts, even after you file a Chapter 7 bankruptcy.

Filing a Chapter 13 Bankruptcy

A Chapter 13 bankruptcy, also called the wage-earner plan, gives you some breathing room with your unsecured debt. When you file Chapter 13, the courts appoint a trustee who is responsible for summarizing all of your debts into a payment plan you can afford. The trustee allocates your monthly income to your creditors. This type of bankruptcy relief is available to you if you have:

  • A regular source of income

  • Less than $307,675 in unsecured debt (e.g., credit card debt) and less than $922,975 in secured debt (e.g., home and auto loans)

In Chapter 13 your debts are not discharged and you keep your property. Generally, the repayment schedule lasts from three to five years. After completing the court-ordered repayment plan, most remaining debt is discharged. One of the changes brought about by the 2005 bankruptcy reform legislation is that certain debts can no longer be discharged:

  • Educational loans

  • Child support or alimony

  • Debts for luxury goods of $500 or more that were incurred within 3 months before filing for bankruptcy

  • Cash advances of $750 or more obtained within 70 days of filing

  • Drunk driving damages; personal injury lawsuit damages; fines related to criminal prosecution

  • Income tax debt arising from fraudulently filed tax returns or from tax returns that were not filed or filed late

  • Trust fund tax debt

On the positive side, the 2005 bankruptcy reform allows loans from retirement plans or IRAs to be part of a Chapter 13 reorganization, which means you can replenish your retirement savings.

There are new limits on the frequency of filing Chapter 13. You must wait two years between Chapter 13 filings, or four years if you have previously filed for Chapter 7 bankruptcy. For more information about Chapter 13 bankruptcy, see the U.S. Courts Bankruptcy Basics article Chapter 13 – Individual Debt Adjustment.

Consider The Impact of Bankruptcy

Financial relief can be a positive effect of bankruptcy; however, you should weigh this relief carefully against the following:

  • Bankruptcy can stay on your credit report for up to 10 years

  • You may have difficulty re-establishing credit

  • You may have difficulty renting or buying a home for several years

  • Your debts can only be discharged once every six years under Chapter 7

  • It may be more difficult for you to get some types of jobs (particularly those dealing with money).

Keep in mind that credit assistance programs work similarly to Chapter 13 bankruptcy but without the stigma usually associated when considering bankruptcy.

The Final Decision

Making the decision to declare personal bankruptcy is not one to be taken lightly and should be considered as a last resort. You may have other options that will work for your situation — make sure you explore them all. To learn about bankruptcy alternatives, search for related articles in the CareOne Credit Knowledge Center.

Take control of your finances with our debt help tools. Use our calculators and budget planner to help you manage your money.

For more information on personal finance, or debt consolidation, search the CareOne Credit Knowledge Center Articles.

To learn about our debt management service, see the CareOne Credit Quick Answer Guide.


 

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