A person (or corporation) who is no longer able to satisfy their financial responsibilities may be required to file for bankruptcy, which is a legal procedure at the federal level. The debt is either discharged or reorganized during bankruptcy, and various types of liens placed against the debtor’s property may also be lifted. It is typically seen as a last resort option and has a long-lasting bad impact on the debtor’s credit. That does not imply that it is always the best choice.
First, some background data.
All debts are not discharged in bankruptcy. Criminal restitution and child/spousal support are not dischargeable in bankruptcy. Furthermore, obligations incurred after filing for bankruptcy protection or those that the filer forgets to disclose on the bankruptcy documents are not considered. Technically, student loan debt can be canceled in bankruptcy, but this rarely happens. Debts acquired dishonestly, debts brought on by criminal activity (such as driving while intoxicated), and debts brought on by other willful detrimental activities are additional debts that are normally not protected by bankruptcy protection. The legal obligation for cosigners to pay cosigned debts persists even after bankruptcy.
In addition, any creditor may make a case to have a debt excluded from bankruptcy, and occasionally they succeed. Big cash advances made recently (within 70 days of filing) and recent large debts (within 90 days of filing) to any one creditor typically are not dismissed.
Chapter 7 and Chapter 13 bankruptcy are the most prevalent types of bankruptcy for people.
Chapter 7 Insolvency
Chapter 7 involves liquidation. After some assets are sold to reduce balances, debts are removed. Clothing, furniture, and a vehicle (up to a specific value) owned by the person are just a few examples of property that is exempt from the process and not up for seizure and auction. The primary residence is frequently also exempt. However, the debt connected to the assets the filer is permitted to keep is not discharged by the bankruptcy. In other words, the debtor might be permitted to continue making mortgage and auto loan payments even if he or she is allowed to maintain their respective vehicles.
Credit card debt, medical expenses, unsecured loans, and past due service provider invoices are routinely discharged in Chapter 7 bankruptcy. If the debtor complies with specified requirements, some tax debts may be discharged.
Bankruptcy under Chapter 13
A reorganization process is chapter 13. For the designated repayment time (often three to five years), the filer is still responsible for paying the debts, but under the court’s supervision. (Some outstanding unsecured loan balances may be discharged at the conclusion of the repayment period.) Since the reorganization depends on the filer’s income, no property is seized or auctioned. The debtor must demonstrate that they have enough income to make all mandatory debt payments, as well as any additional payments necessary to catch up on past-due bills.
A Chapter 13 bankruptcy can halt a foreclosure and compel the mortgage holder to agree to a payment schedule that has been approved by the court. Additionally, in rare circumstances, Chapter 13 can be used to lower the total amount of debt. For instance, the filer can request that the loan sum be reduced to the vehicle’s replacement value if he owes more on it than it is worth. The debt is “crammed down” in this way.
Effects of Insolvency
debt reduction Debt is significantly decreased or completely removed. Debtors receive a fresh start financially and/or a workable short-term debt repayment strategy.
Credit. One of the most serious adverse events that can be recorded on a consumer’s credit report card is bankruptcy. It endures for seven to ten years (Chapters 13 and 7). A bankruptcy will often automatically disqualify an applicant from consideration by creditors and companies. Bankruptcy does not materially worsen the situation for debtors who are dealing with several collection accounts, charge-offs, and other adverse credit occurrences. The damage to the consumer’s credit score lessens over time, and the process of restoring a sound credit score can start right once after bankruptcy is discharged.
Loanee status. Debtors who fail to fully repay a government-backed loan (such as an FHA or VA mortgage) due to bankruptcy may not be legally compelled to do so, but they won’t be eligible for another government-backed loan until they do so.
Credit connections. Even though the debtor is not compelled to pay the bills after bankruptcy discharge, some creditors may refuse to do business with a bankruptcy filer unless all prior debts are paid in full.
moratorium on discharges. A person is not qualified for another discharge for several years after receiving one due to bankruptcy.
- If two Chapter 7 files are made, the second one must be made within eight years of the first to qualify for a release.
- Two Chapter 13 filings – If the second filing is made within two years of the first filing, it is not eligible for a discharge.
When the new filing is made under a different chapter, the waiting periods are slightly different. There are many exceptions, and they range from four to six years.
When is declaring bankruptcy a wise move?
In order to avoid long-term damage to the consumer’s credit, bankruptcy should be approached with caution. It’s not free, either. Ironically, the person filing for bankruptcy will need to find the money to get through the procedure, usually by employing a bankruptcy lawyer.
Some things to think about
A lack of cash flow or bankruptcy. If your monthly expenses consistently exceed your income and you have used up all of your payment plan alternatives, it can make sense to consider bankruptcy. A few indicators that bankruptcy may be a sensible financial choice include:
- Unable to catch up on bills
- Uses payday loans or cash advances to pay for necessities of life
- Uses a credit card for everyday purchases but is unable to pay it off.
- Received a foreclosure or repossession notification
If all of the assets’ market values are greater than the entire debt, it is said to be insolvent.
Property. A person who has little to no assets or income that creditors can seize or garnish may not gain much from bankruptcy because there is little for creditors to go after. Unsecured debt is debt that is not related to taxes, child or spousal support, or student loans. Each jurisdiction establishes its own restrictions on what is exempt for someone who possesses assets and property. A bankruptcy lawyer can assist with maximizing exemptions and preventing property from being seized. For instance, spouses filing jointly in several states are eligible to claim two exemptions. However, someone who doesn’t want to take the chance of losing their property may need to look into alternatives to bankruptcy.
Relief sought after. Bankruptcy might not be a solution if all or a significant amount of your debt is likely to be deemed non-dischargeable (child support, some student loans, recently unpaid taxes, recent bills that the court would ignore, legal judgements against you, etc.).
Other choices have been used up. Customers who are drowning in debt should first consult a licensed, government-approved debt counselor. On a three to five year plan, the debt can frequently be reorganized outside of bankruptcy. Furthermore, the bankruptcy court mandates financial counseling.
A readiness to adapt. Debtors who seek bankruptcy protection have a special chance to get their financial lives back on track. The consumer must promise to handle money and debt more responsibly going forward if the bankruptcy was caused by unsecured debt, such as credit card debt. Otherwise, bankruptcy just turns into a never-ending cycle.