Who Can File for Bankruptcy?

It's a simple question and actually has a simple answer. Generally, anyone can file for bankruptcy. Whether it would be advantageous for you to do so and if you are eligible for a certain chapter of bankruptcy requires that you evaluate your debts, your income and your equity.

Step One: Your Debts
First, you are going to want to find out what bankruptcy can do for you, and weigh that against the effect it will have on your credit. To do so you need to understand which of your debts can be discharged in bankruptcy.

Generally speaking, most unsecured debt can be eliminated. The exceptions to this rule are recent tax debts, family support debts and student loan debt. If you have a lot of credit card debt, medical bills, personal loans and other similar unsecured debts, then you can get those discharged.

Some secured debts may be discharged, but you would have to give up the collateral securing them. For example, if you wanted to get rid of debt from a car loan, you would have to give up the car. If you have other debts but you want to keep the car, then you will need to reaffirm the car loan debt in your bankruptcy.

Result: If your debt is mostly non-dischargeable, then bankruptcy can't do much for you. If not, then go on to step two.

Step Two: Your Eligibility
Whether you are eligible to file for bankruptcy, and for which type, is largely dependent on your income. If you have little or no income, then you would be best served by a chapter 7 bankruptcy. If you have a steady income then you may want (or need) to file for a chapter 13 bankruptcy instead.

Your Income and the Means Test
You may have heard about the means test provision in the new 2005 bankruptcy laws. This provision was introduced to ensure petitioners do not "abuse" the power that bankruptcy offers. This provision was largely driven by lobbying efforts on the part of the credit card industry in an effort to reduce the amount of people getting their debts discharged when they have the capacity to repay it.

If your income is above the median for your state, then a presumption of abuse arises, meaning you must pass the means test. If you cannot pass the test, then you cannot file for chapter 7, and must instead get into a chapter 13 payment plan.

What is the Means Test?
The means test is a set of calculations designed to determine if you have the capability to repay some of your debt in a chapter 13 bankruptcy. For more, see Nolo's article, The Bankruptcy Means Test: Are You Eligible for Chapter 7 Bankruptcy?

If your income allows you to file for chapter 7, then that will be the simplest and fastest way to get your debts discharged. If not, then you can still get rid of much of your debt in a chapter 13, but you must adhere to a three or five year payment plan.

Step Three: Your Assets & Equity
The final, and very important, consideration is how your equity and your property will be handled in a bankruptcy. In most bankruptcy cases, you would not lose any of your property, but if you file for chapter 7, the bankruptcy trustee handling your case will look to see if you have any non-exempt equity that can be used to repay some of your debt.

Generally, the only time your property would be subject to liquidation in a chapter 7 is if you have a substantial amount of non-exempt equity in it. For example, if you own a second home that is considerably more valuable than the amount of debt securing it the trustee would want to sell it, pay off the mortgage, give you the value of the exemption in your state, then distribute the rest to your creditors.

To learn more about your property in bankruptcy, see the post It's All About the Equity on this blog.

Should I File?
So you know you can file bankruptcy, but should you? The above three steps imply three fundamental questions that will help you understand if bankruptcy is a good option or not:

Will your debt be discharged? If most of your debt is dischargeable, then bankruptcy can help you.

Do you qualify? If you can pass the means test or if chapter 13 may be good for you, then bankruptcy can help you.

Is your property at risk? If your property is mostly exempt, then bankruptcy may be a good option. If you think chapter 13 would work, then you don't have to worry about your property. See this for more about the advantages of chapter 13 bankruptcy.

One Last Consideration
Finally, you need to understand how a bankruptcy will affect your credit. Typically, a bankruptcy filing will remain on your credit report for up to ten years. This does not mean your credit is ruined for ten years, but it will have an impact.

If your credit is already on its way down (which is usually the case for anyone struggling with debt) then filing bankruptcy, getting rid of your debt, and starting over may actually help you get your credit back up over the following couple years.

Most people who file for bankruptcy can get a credit card in a year or less, and can apply for a home loan in as little as two years. The long term implications of a bankruptcy are often better than remaining under a mountain of debt. Essentially, you get a clean slate and you can start building your credit score immediately.

Learn More
If you really want to learn the in's and out's of bankruptcy, check out Nolo's collection of Bankruptcy Books.

I've also written this introductory post on what filing bankruptcy actually does.