Bankruptcy is a legal process in which individuals and companies who have accumulated more debt than they are able to repay can regain their financial footing. Depending on the type of debt and the form of bankruptcy filed, they can have some or all of the debt erased. Some debts are not eligible for elimination, including:
- Child support or alimony
- Federal income taxes
- Federal student loans
- Wages owed
- Debts due to fraud, malicious acts or DUI
- Debts not discharged in a previous bankruptcy
Types of Bankruptcy
There are several types of bankruptcy, the most common of which are Chapters 7, 13 and 11.
Chapter 7 bankruptcy
This is the most popular form, because it discharges all eligible debts. The trade-off is that you must give up many of your assets, which the court uses to pay creditors. Specifics vary by state, but the law does exempt some items from seizure; usually things like clothing, your home, household goods and, possibly, your car. The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 made it harder to file Chapter 7. You must now pass a “means" test, which compares your average monthly income for the six months before you file with the median income for similar households in your state. You may file Chapter 7 if either your income is lower than the median, or if your disposable income, calculated by subtracting allowed expenses from total income, is below a defined amount. Other circumstances that may disqualify you from filing Chapter 7 include having:
- filed Chapter 7 within the past eight years
- exited Chapter 13 within the past six years
- had any bankruptcy dismissed within the past 180 days
Chapter 13 bankruptcy
This form of bankruptcy requires filing a repayment plan detailing how you intend to repay your creditors over the next three or five years, depending on income. The plan must give priority to those debts that cannot be discharged, and unsecured debts are included as your disposable income allows. When the plan is complete, any remaining debt is discharged. The Bankruptcy Code imposes upper limits on debt levels for Chapter 13 filers. As of April 1, 2010, these limits are:
- Secured debt: $1,081,400
- Unsecured debt: $260,475
Businesses may not file Chapter 13, although business owners may include business-related debts in their filings, if they are personally liable for them.
Chapter 11 bankruptcy
This form is similar to Chapter 13, but does not have any limits on debt level. It is used mostly by businesses, but individuals with too much debt to qualify for Chapter 13 may file Chapter 11.
Additional Bankruptcy Requirements
When you file bankruptcy, you must include documentation disclosing your entire financial situation. This includes listing all your assets, debts, income and expenses, as well as proof of income for the previous 60 days. You must also get credit counseling before filing and then get additional counseling in financial management before your debts will be erased. Chapter 13 filers can get the second counseling session near the end of their repayment plan, if there is remaining debt. All counseling must be from a US Trustee-approved agency.
Bankruptcy is a Viable Option
Many people view bankruptcy as shameful and degrading. However, you can easily be overwhelmed with debt through circumstances beyond your control, like unexpected large medical bills or job loss. While bankruptcy does negatively affect your credit score and your ability to qualify for financing during the 10 years it stays on your credit report, it is also a lifesaver for anyone who truly needs it.