Monday, June 6, 2011

What Does Filing Bankruptcy Do?

Many people trying to get debt relief have no idea what bankruptcy is, let alone how it works and what is does. This post will serve as an introduction for anyone looking to get an understanding of what bankruptcy can do for you (I'll also add some of what it can't do for you).

Bankruptcy Discharges Debt
People file bankruptcy when they become insolvent, that is, unable to repay their debts. Any society that uses credit in its economic structure also has some law to handle cases where debtors cannot repay their debt. In modern society, that law is the bankruptcy code.

Bankruptcy law offers relief from debt that you cannot repay in the form of a "discharge". When debts are discharged in bankruptcy, you are no longer liable to repay them, so you're "off the hook".

What Debts Can Be Discharged?
With some exceptions, most unsecured debts can be discharged in bankruptcy. This includes your credit card debt, debt from medical bills/hospital bills, personal loans, payday or "cash advance" loans and unsecured bank loans.

Secured loans like your car note and your mortgage can be discharged, but the lien against the collateral is not removed, so the creditor can repossess the property. Generally, the only way to get out of those loans is to let go of the collateral "securing" it; i.e. the house and/or the car.

Certain "special" types of unsecured debts are also usually non-dischargeable. These debts, called "priority unsecured debts", include debt from unpaid family support (alimony and child support), debt from unpaid taxes (although tax debt older than three years can sometimes be discharged), student loan debt (there are exceptions to this rule too, in cases where the debtor can prove that he or she will NEVER be able to repay it) and debts owed to government entities.

How Does it Work?
I'll try to keep this part short and sweet, but it can be a little complicated in a real case. Typical personal debtors and small business owners will have two different options under bankruptcy law. The first, and most common is a chapter 7 "liquidation".

Chapter 7
In a chapter 7 bankruptcy case, you submit to the court ALL information regarding both your debts and your assets. The trustee assigned to your case will evaluate your assets to see if there is anything that can be sold (liquidated) to pay off some of your debt. In the great majority of chapter 7 cases, the trustee will not sell anything for one of two reasons: It's too difficult to sell (or not worth the trouble) or it's protected by bankruptcy exemptions.

Exempt assets typically include your primary residence, your car, retirement assets, certain household items and tools and a variety of other things. These exemptions vary by state.

Any valuable non-exempt property may be sold if the trustee believes it's valuable and can be sold easily.

Chapter 13 "Restructuring"
Chapter 13 bankruptcy is a type that's best for people who have a steady income and/or a lot of assets that may be at risk of liquidation in a chapter 7.

In a chapter 13 bankruptcy, you create, propose and enter into a three or five year payment plan with the bankruptcy court and the trustee. This payment plan is created by calculating your net disposable monthly income, which is basically the money you have left over each month after taxes and your bills.

Once you have your net disposable income, your plan must meet the following guidelines.
  1. It must account for repayment of all priority debts (listed above)
  2. It must include at least as much payment to non-priority unsecured debts as a chapter 7 would
Much of your debt can still be discharged under a chapter 13 plan, but it's not done until you complete all of your plan payments.

The payments are made to the bankruptcy trustee, who will then disburse the money amongst your creditors as per the confirmed chapter 13 payment plan. At the end of your plan, whatever debt is still left is discharged and you're free and clear.

To Recap in a Nutshell
  1. Bankruptcy can get rid of most, but not all debts.
  2. Most people who file for bankruptcy will not have to worry about losing any property.
  3. Chapter 7 involves a "quick discharge" of debt. It's usually done in about three to five months from start to finish.
  4. Chapter 13 involves creating a plan to repay some of your debt over three or five years with payments that you can afford. Upon completion of the plan, outstanding debts are discharged.
Get More Information
This is just the "highlights" of what filing for bankruptcy does. If you want to learn more, I suggest the following resources:
  1. A Guide to Bankruptcy on BankruptcyLawFirms.com
  2. Bankruptcy Information from Nolo.com
  3. Bankruptcy Books from Nolo.com

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