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What is it and how does it work?

by xyonent
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Bankruptcy is a legal process that allows you to wipe out your debts or create a payment plan for your creditors so you can repay your debts.

Businesses, farmers, municipalities and individuals can file for bankruptcy.

While wiping out your debt may sound appealing, it does have its drawbacks — plus, some debts, like student loans, are notoriously difficult to wipe out, even in bankruptcy — but in some cases, it may be your best option.

Let’s take a closer look at bankruptcy and see what it means.

What do the numbers/types mean?

There are two types of personal bankruptcy: Chapter 7 and Chapter 13.

Chapter 7

Chapter 7 bankruptcy is a liquidation of debts and wipes out most unsecured debts. No repayments are owed to creditors for liquidated debts. Chapter 7 is considered to be a simple and easy-to-understand process.

The process takes 3-4 months to complete. Chapter 7 also gives you legal protections. For example, if someone sues you, that lawsuit is essentially wiped out along with your other debts. If your home is in foreclosure, the foreclosure is stopped, so you have time to come to an agreement with your lender.

To be eligible to file for Chapter 7, you must pass certain state means tests. One of the eligibility requirements is income. If your household income is $85,000 and the median income in your state is $65,000, you will not pass the means test and will not be eligible for Chapter 7 bankruptcy. In addition to the means test, you must not have filed for Chapter 7 in the past six years.

The court will decide which assets will be sold. You may be able to get exemptions for items such as your car, home, and retirement funds. Exemptions vary by state. Keep in mind that your home may be sold, depending on how much you owe and what it’s worth. Be prepared for luxury items like boats and vacation homes to be liquidated.

Some debts cannot be discharged, such as taxes, alimony, child support, and student loans.

Chapter 7 will remain on your credit report for 10 years. You can still apply for credit, but your interest rates will likely be terrible. However, everyone’s situation is different. Some people are able to recover to a fairly good credit score and obtain a car loan within a year. The cost of filing for Chapter 7 is $335.

Chapter 13

Chapter 13 is a reorganized bankruptcy. It is a mandatory repayment plan created by the court that lasts from 3 to 5 years. Most are 5 years. If you still have debts after 5 years, they will be discharged. Chapter 13 is for people who have an income but need some negotiating room with their creditors. In other words, they need to get their creditors to reduce their payments so that the debtor can catch up on their payments.

One advantage of Chapter 13 is that you can keep your home. Any ongoing foreclosures are stopped in Chapter 13. Unlike Chapter 7, your property is not sold. Credit card and medical bills may be discharged. To qualify, you must have regular income and have less than $394,725 in unsecured debt and less than $1,184,200 in secured debt. Tax debts (such as property taxes), child support, and student loans are not eligible. The filing fee for Chapter 13 is $310.

If you miss a payment during the plan term, you could lose all of your plan’s protections and benefits, which would put you back in the position you were in before you filed, even though you’d gone through all the hassle of filing bankruptcy.

Chapter 13 payments are not made directly to creditors. Instead, the debtor sends payments to the mediator, who then sends the payments to the creditors. There is no communication between the debtor and creditors during the payment plan.

Chapter 13 will remain on your credit report for five years.

In either bankruptcy case, if you decide to use a bankruptcy attorney, the cost can range from a few hundred to a few thousand dollars.

Does it really help?

Yes, you can if you have a plan to get your finances in order. If you’re stuck in too much debt and can’t see the light at the end of the tunnel, debt cancellation can help you get a fresh start.

But if you don’t have an income or a plan to increase your income or create a budget, filing bankruptcy may not help you in the end.

Also, keep in mind that bankruptcy doesn’t erase any past damage to your credit, so your credit score will remain low for years until the issues are resolved.

What about student loans?

Unfortunately, student loans are difficult to pay off, even if you file for bankruptcy. The only way to pay off student loans is if they are the source of your debt. Undue hardship Proving undue hardship to the borrower or dependents is difficult, and only a small percentage of people who file bankruptcy actually have their student loans forgiven.

Here’s why: Would an income-contingent repayment plan that reduces monthly payments to $0 really get you in trouble?

However, private loan borrowers who don’t have access to these types of programs have more options.

Check out our complete guide to student loans and bankruptcy.

Final thoughts

Filing bankruptcy does have its upsides if you have a plan to turn your situation around and not go back. Remember that bankruptcy is public record. Your employer and cosigners may be notified if you file. You should answer “yes” to any application that asks if you have ever filed for bankruptcy.

It’s truly an event that will stay with you in some way for the rest of your life.

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