If you're in financial distress and wondering about bankruptcy, this article will guide you through everything you need to know about the process.
The number of bankruptcy filers decreases each year. There were half as many filers in 2018 as there were in 2010. According to the United States court's administrative office, 772,646 people filed for bankruptcy in 2019 and due to recent economic circumstances surrounding the onset of COVID-19, we'll likely see an uptick in filings. While bankruptcy receives some negative connotation, it can be a positively freeing option for individuals and businesses suffering financially. How does bankruptcy work? Keep reading for a guide walking you through the process from beginning to end.
The first step in determining whether filing for bankruptcy is an option for you requires that we take a look at the requirements for the most common "Chapters" or types of bankruptcy.
Chapter 7 Bankruptcy
Chapter 7 is the most common bankruptcy Chapter in the United States. It's often called a "straight bankruptcy" or "liquidation bankruptcy" as it discharges most, if not all, of your unsecured debts.
The catch is that not everyone qualifies for a Chapter 7 bankruptcy, here are some signs qualifying questions to ask yourself:
- Would it take at least 5 years to pay off your debt, even if you resorted to extreme measures?
- Do your debts account for more than half your annual income?
- Does your debt significantly affect important aspects of your life, like your relationships or your ability to sleep?
- Do you have very little (if any) disposable income (i.e. left over for non-essential purchases)?
- Is your monthly income below your state's median level?
If you answered yes to most of these questions you may qualify for a Chapter 7 bankruptcy.
Please consult an attorney for a more complete discussion of your options and the ramifications of filing.
Chapter 13 Bankruptcy
In a Chapter 13 bankruptcy your debts will get reorganized so you can pay them off either partially or in full, over the next 3 to 5 years. If you don't comply with your payment plan, however, your creditors could potentially go after your assets to satisfy your unpaid debts.
To be eligible for Chapter 13 bankruptcy, you can't have more than $394,735 in unsecured debt, including personal loans or credit cards. Likewise, you can't have more than $1,184,200 in secured debts, including car loans and mortgages. These figures are precise because they reflect the consumer price index, so the numbers adjust periodically to reflect any changes. Chapter 13 suspends foreclosure proceedings and payments on any other debts owed. This buys some time for the individual while the court considers the plan.
Generally speaking every bankruptcy begins as a Chapter 7, and then the Means Test is applied to determine if it should be switched to a Chapter 13.
The Means Test
The Means Test is used to determine whether or not your monthly income is below your state's median level. It was designed to limit Chapter 7 to only those who can't pay their debts. There are 2 steps to the means test.
- Income - If your income is less than the median income for your state, then you qualify. If it's more, you'll have to show that you don't have enough disposable income left over to pay debts.
- Expenses - Using the last 6 months of your income and expenses as reference, deduct specific expenses (like rent, utility bills, etc.) from your monthly income to arrive at your disposable income.
If you have enough disposable income to repay creditors, you'll likely have to file a Chapter 13 bankruptcy, in which you'll pay back a portion of your debts.
Determine Your Property Exemptions
Each state's exemption laws dictate what types of property (or how much equity in a specific type of property) you're allowed to keep if you file for Chapter 7 bankruptcy. Most individuals find they can keep household furnishings, a modest car, retirement accounts, and even some equity in a home. Talk with your lawyer to clearly outline what you can protect before you file.
If you have a lot of assets you want to keep, then you might have to file for Chapter 13 to pay back a portion of those debts.
How Does Bankruptcy Work?
There's a lot of paperwork involved in filing for bankruptcy, so it's important that you find a lawyer who's an excellent communicator, and guides you throughout the process. Ask your attorney the right questions to ensure they're a good fit for you and your case.
Missing any deadlines could get your case dismissed.
In the forms you file, you'll tell the court about all of your debts, income, expenses, property, and prior transactions. You must name all your creditors, and determine what to do about any secured debts.
Take a Credit Counseling Course
Before you file, you'll have to take a credit counseling course. The course will help you determine if you are in financial distress and help you decide whether bankruptcy is the best course of action for you. The law states that you must receive credit counseling by taking one of the offered courses within the 180-day period before you file.
It takes about 60 to 90 minutes to complete, and if you're filing with a spouse or partner, you must take the course together.
File Your Forms
Once you've completed the first course, you'll file your petition, which officially starts your case. Your lawyer will guide you on which forms must be completed, and they'll typically submit everything for you.
You'll have to pay a filing fee at this time. If you can't pay it all at once, talk to your lawyer about available payment options.
Submit Additional Documents to the Bankruptcy Trustee
After the initial paperwork, you'll then have to submit additional documents to the trustee on your case. Typically, the trustee must receive these at least 2 weeks before your court date.
In the documentation, you'll have to prove the accuracy of the financial information you provided in your initial bankruptcy forms. Expect to file 3 to 6 months of bank statements, credit card statements, paycheck stubs, profit and loss statements, tax returns, and any other requested documents.
Take a Debtor Education Course
Once all of your paperwork is filed, including any requests from the trustee, you must complete a second course - the debtor education course. You can't receive a discharge without taking it, so it's best to complete it as soon as your lawyer gives you the go-ahead. It must be completed after you file for bankruptcy, and within 60 days of your first meeting date with your trustee and any creditors.
The course takes 2 hours to complete, and it provides the filer(s) with financial management tools, like how to rebuild credit after bankruptcy and tips for making a budget and sticking to it.
If you fail to mail your certificate to the court on time, the court will deny your bankruptcy discharge. You can file again, but you'll have to go through all the motions, including the filing fee, from the very beginning.
341(a) Meeting of the Creditors
Every bankruptcy filer must attend a meeting of the creditors the "341 meeting". The bankruptcy trustee conducts the meeting, where they'll verify your identity, have you swear an oath of truth under the law, and ask about your finances and petition. Their job is to review your submitted paperwork for accuracy and to make sure your creditors get paid as much as possible.
Creditors can appear to ask questions if they so desire, but this doesn't happen often. Typically, this meeting lasts 10 minutes or less.
Once you've completed all the necessary requirements, the court will then grant you a bankruptcy discharge. The discharge won't state which of your debts get wiped out, but rather, which of the debts that survive.
Debts like student loans and domestic support obligations are examples of those that you'll still owe. Additionally, if any creditors dispute your bankruptcy case, you could end up having to go back to court to further explain why you can't make payments on your debt.
If you're wondering, "Should I declare bankruptcy," don't forget to consider the aftermath. Bankruptcy stays on your record for 7 years if you declare Chapter 13, and 10 years if you declare Chapter 7.
There are effective alternatives to bankruptcy that you can discuss with your attorney, including debt settlement programs. Additionally, there are ways to improve your credit once you file. Ask your lawyer about what you can do once you receive your discharge to get your credit back in shape as quickly as possible.
Understand When to File for Bankruptcy
How does bankruptcy work? If you're drowning in debt with no foreseeable way to pay it back in less than 5 years, then you probably have good reason to file bankruptcy.
Even though the process takes around 4 months or more to complete, many people feel rejuvenated after their discharge, ready for a fresh start and less, if any, financial burden.
Are you ready to get started and want to learn how we can help? Contact us at your convenience, and a member of our team will get back to you promptly.