How Does Bankruptcy Work?

November 15, 2018

It happens. Good, hard working people find themselves overwhelmed with serious debt problems and considering filing for bankruptcy. For many, the idea of filing for bankruptcy carries a lot of negative connotations and they dismiss it as an option out of hand. However, it exists for a reason.

There are a lot of options out there to deal with debt, and I’m not suggesting that bankruptcy is the best solution for you. However, bankruptcy can be a powerful tool to help people get out from underneath serious debt issues. My goal here is to explore the basics and clarify a few important points about what bankruptcy can and cannot do, for those that may be considering this option.

There are two main options

There are two primary options for consumer (non-business or individual) bankruptcies – Chapter 7 or Chapter 13. They each offer different benefits and may treat debt and property issues differently as well, so knowing the difference is important.

  • Chapter 7: This option is primarily reserved for individuals with lower incomes and the eligibility requirements are harder for just anyone to meet. Chapter 7 bankruptcy will discharge most debts the filer has (see below for more on this), but any property that you are behind on payments for is likely to be lost (there are exemptions for items you’ll need to work and live). Basically what this means is that, for example, if you’re behind on your car payment, you’ll get out of the loan, but you’ll also lose your car. You may also be required to sell other items of value that you already own.
  • Chapter 13: Unlike Chapter 7, this option is designed to give you the ability to re-structure your debts into a court-approved repayment plan over a 3-5 year period.  This plan may include lower payoff amounts on some debts, with some balances forgiven, but it won’t just get rid of all your debts. A Chapter 13 filing can help stop mortgage foreclosures, allow you to keep property that isn’t protected with an exemption, and adjust amounts due on secured debt when the debt owed is more than the property is worth (a car loan of $15,000 on a vehicle worth $10,000, for instance).

What bankruptcy will do

While things vary based on the type of bankruptcy filed for, in general, you can expect bankruptcy to provide the following forms of relief:

  • Stop collection calls and activities
  • Stop a foreclosure, repossession, eviction, or wage garnishment
    • This may be temporary until the automatic stay expires, at which point your house or car may be lost if you can’t bring payments current under Chapter 7.
  • Wipe out credit card and other unsecured debt

What bankruptcy will NOT do

Unfortunately, filing for bankruptcy doesn’t take care of all debt issues. Knowing the limitations is important to make an informed decision. Some things bankruptcy will not address include:

  • Keeping property you can’t afford
    • Property that has a lien (like your house or car) is still at risk. Bankruptcy can eliminate the obligation to pay the debt, but it does not take a lien off the property.  So, if you cannot make the payments, that property can be foreclosed or repossessed once the automatic stay is lifted.
  • Eliminate child support and alimony obligations
  • Eliminate most student loans
  • Eliminate tax debts in the vast majority of cases
  • Other issues:
    • Debts you fail to list in your filing are not dischargeable
    • Debts related to liability from a driving while intoxicated are not dischargeable

Other things to know

Filing for bankruptcy will stay on your credit report for up to 10 years and may make it hard to obtain credit for that time. This does not have to be a deal breaker if the advantages are more compelling than the cons, but be aware that it will follow you for up to a decade.

Bankruptcy also isn’t free – your workplace EAP may help with this, but know that you even after your day in court, you probably will still have bills to pay.

Hopefully this helps clarify how bankruptcy can help if you are in serious debt trouble. You should explore all your options before filing for bankruptcy. This may include negotiating with creditors directly, tightening your budget to attack debt more aggressively, and credit counseling services to name a few.