There is no arguing that it’s expensive to live in today’s world. The average credit card debt for Americans is $5,673 per U.S. adult with a credit card, according to creditcards.com. Average student loan debt for the graduating class of 2018 was $29,200, and wages have been stagnant or growing very slowly, depending on whom you ask, with some experts putting the growth at less than one percent per year. With all the financial responsibilities Americans are taking on, it may be surprising to learn that the number of bankruptcy filings in the United States are actually on the decline. But what is bankruptcy, exactly?
Filing for bankruptcy comes with serious financial consequences, but for some, it may be the best way out of a dire situation.
What Is declaring bankruptcy?
Bankruptcy is a legal procedure where a person can present their finances to a court and request to have some or all of their debt canceled, said Bradley R. Bailyn, Esq., a bankruptcy attorney at Bailyn Law. In 2018, 755,182 people filed for bankruptcy.
Types of bankruptcy
Although there are multiple types of bankruptcies, not all of those apply to individuals. As far as one person filing for bankruptcy goes, there are two types a person could pick from:
Chapter 7: Commonly referred to as liquidation bankruptcy, an individual that enters Chapter 7 Bankruptcy liquidates most of their assets (with limited exceptions) to pay off creditors, said David Reischer, Esq., a bankruptcy attorney and CEO of LegalAdvice.com.
“A benefit of Chapter 7 is that it allows an individual to quickly discharge their debt and get a fresh start,” Reischer added. “A negative of Chapter 7 is that non-exempt property must be sold to satisfy any debt obligations to creditors.”
Chapter 13: Sometimes referred to as reorganization bankruptcy, this form of bankruptcy allows individuals with regular income to keep most or all of their property, as long as they pay off their debt obligations through a repayment plan, said Reischer.
Although it’s a positive to be allowed to retain most or all of your property while catching up on payment obligations, a downside of this form of bankruptcy is that it can be difficult for individuals to meet those reorganization obligations, Reischer added.
Additional forms of bankruptcy include:
Chapter 7 for businesses: Similar to an individual filing of Chapter 7, except there is no property exempt from liquidation, said Bailyn, and the debt is not canceled because the company can just be dissolved afterwards.
Chapter 11 for businesses: This is an option to remain in business while getting help from the court and your creditors to renegotiate the terms of your financial agreements so that your payments match up with your income, said Bailyn.
Chapter 12 for individuals: Similar to Chapter 13, except that Chapter 12 applies only to certain farmers and fishermen. “If you’re under that circumstance, it allows you to manage a higher level of debt than would be possible under a normal Chapter 13, and allows some additional leniencies, because farms and fishing operations have to take on so much debt,” said Bailyn.
When and how do I declare bankruptcy?
The decision to file for bankruptcy is complex and very personal, but there are some common reasons to keep in mind. “You want to do it when you will get the maximum advantage since you can only file every few years,” said Bailyn. “People typically file when a life-changing event has occurred.” For example, some reasons Bailyn has seen people file for bankruptcy include:
- They can no longer make the minimum payments on their credit cards and a lawsuit has been filed, a judgment entered, and their salary is about to be garnished.
- The house is about to be taken in foreclosure.
- They just got a big, unexpected, one-time medical bill.
Individuals have even used bankruptcy to discharge debt tied to large federal income tax bills, according to Amy Northard, CPA and founder of The Accountants for Creatives. The qualifications, however, can be stringent.
“Your eligibility for discharging debts for federal income taxes depends on several factors: When was the tax return was due? The income tax debt may be eligible to be discharged if a tax return was due at least three years before you filed your bankruptcy. When did you actually file the tax return? You must have filed the return at least two years prior to filing for bankruptcy,” she said.
It should probably come as no surprise that debt incurred while committing tax fraud can’t be wiped via bankruptcy.
“Did you commit fraud? If you filed a fraudulent tax return or willfully attempted to evade paying taxes, you are not eligible,” Northard added.
Once you’ve decided to file, the process is fairly simple. Either you hire a lawyer, access reduced or free legal services, use a registered bankruptcy petition preparer, or you do it yourself. “If you do it yourself, you download the paperwork and you fill it out, maybe with the help of a book about filing for bankruptcy,” said Bailyn.
Once the papers are filed—either with specialized bankruptcy software by you or your lawyer to the clerk of the court that serves your home location— for a Chapter 7 case, the filer would meet with a trustee overseeing their case, and potentially some of their creditors. This is known as the 341 meeting, said Bailyn, and if things go well, the meeting should last five minutes and involve a trustee looking through your documents to ensure everything is true and correct, and then the debt is discharged.
“In a Chapter 13, once the papers are filed you need to show the court for three months that you’re able to handle the payments, and if so, the judge will hopefully confirm the plan, and then you need to make your payments for the next three to five years and your debt is discharged or canceled at the end.”
Although bankruptcy can provide relief in a dire situation, it’s important to understand the consequences, which can include major impacts to your finances. Filing for bankruptcy could stay on your credit report for up to 10 years, but many people have substantially repaired their credit after two years, and their credit score may be the same as it was before they got into such bad debt, said Bailyn.
In the end, Bailyn said bankruptcy can sometimes be the best option because, while it sends you into a temporary low, it’s also a good way to start over with a fresh slate. “If you sit in debt for 10 or 20 years, your credit will never get better,” he added. It may also appear in online people searches, depending on multiple factors.
The only way from rock bottom is up
Bankruptcy might seem like an extreme step to take—and it’s one to consider thoroughly before doing so—but bankruptcy could be the best thing for people in serious debt. Additionally, “debt counseling programs rarely, if ever, work and often make your situation far worse than it was,” said Bailyn.
Plus, “as soon as you file the papers, you get an automatic court order freezing all enforcement actions against you for debt—meaning no foreclosure, no garnishment, no lawsuit continuation, no collections activity. It gives you breathing room.”
Breathing room, and a chance to start over.