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Every year, hundreds of thousands of Americans declare personal bankruptcy. Let’s face it—with large corporations, multimillionaires, and many average people declaring bankruptcy every day, it just doesn’t carry the stigma that it used to.
Creditors have been alarmed in recent years by the dramatic increase in the number of personal bankruptcies. They insist that one of the main reasons consumers are filing for bankruptcy in unprecedented numbers is because the bankruptcy laws are lax. In other words, some bankers think that consumers take on too much debt knowing that they don’t really have to pay it back.
In addition, their study did not find widespread “abuses” of the system: They did not find large numbers of people running up large credit card bills while on vacation in Europe and then returning home to file for bankruptcy. Those cases do exist, but the Sullivan study concludes that, in the large majority of the cases they studied, bankrupts were “very sick financially, weighed down with debts far beyond their capacity to repay. A small group, perhaps 5 percent of all bankrupt debtors, might be abusing the system.”
A banker’s nightmare, bankruptcy can help the debtor “wipe the slate clean” and start again, or it can be a choice that haunts consumers for years to come. How do you decide whether to declare personal bankruptcy, and how do you file for it if you do? What are the differences between Chapter 7 and Chapter 13? What will you lose, and what can you keep after bankruptcy? What will bankruptcy cost you, both financially and in terms of your future ability to obtain credit and reach personal financial independence again?
There are three main types of personal bankruptcy: Chapter 7 and Chapter 13 are the most common of the two. Chapter 12 is a special type of bankruptcy for family farmers. Chapter 11, which may sound familiar because it is often used by corporations, is generally not used by consumers since it is complicated and better protection is usually offered under Chapter 13.
Chapter 7 bankruptcy is commonly called “straight” bankruptcy or “liquidation.” Under Chapter 7, certain types of property (such as tools of the trade, part of the equity in your home, or a certain amount of cash and clothing) are exempt, or protected, from bankruptcy. That’s the property you get to keep. The rest of your property may be taken by the court and converted to cash, which is then divided up among your creditors. Your bankruptcy is then discharged (completed) and most creditors can no longer try to obtain payment from you, even if the total amount you owed them was not paid off.
Chapter 13 bankruptcy is often called the “wage-earner’s plan.” Under Chapter 13, you work out a repayment plan, subject to court approval, that allows you to pay back some or all of your debts within three years—without giving up property. A Chapter 13 plan can be stretched out to five years if a judge can be persuaded to allow it.
In general, bankruptcy is a legal procedure that:
- Gives consumers who can’t possibly pay back all their debts the opportunity to wipe them out and start over.
- Helps people who are having a difficult time paying their bills the chance to work out a reasonable repayment schedule and pay off part or all of their debts under the supervision of the court.
- Prevents creditors from stripping an individual or family of all their assets when they can’t pay their bills.
- May offer some breathing room for someone who is facing wage garnishment, a repossession, utility disconnection, foreclosure or eviction, and needs time to work out a reasonable schedule for repayment.
Bankruptcy is a serious financial step, and we do not recommend you file for bankruptcy until other options have at least been examined. We frequently hear from people who declared bankruptcy and now feel like financial failures: They can’t get credit, their applications to rent apartments or homes are consistently declined, they find it difficult to travel or write checks because they don’t, have a major credit card, etc.
Some of these people complain that they were never really told about all the consequences of filing. Most were simply told that bankruptcy is an easy way to “start over again.” One woman told me that her bankruptcy lawyer told her that she would be considered a better credit risk after filing, since she would no longer owe anyone any money.
Before deciding to file, you should also try to find a decent lawyer who can explain the pros and cons of both types of bankruptcy. Beware of someone who only tries to sell you on how wonderfully easy bankruptcy is and what a perfect solution it offers to all your problems.