Different types of bankruptcies are often the last resort option after an individual has gone through difficult financial circumstances. Typically, the assumption is that bankruptcy results from financial irresponsibility and abuse of extended credit. However, that is not always the case.
People file for bankruptcy for a variety of reasons, including loss of regular income, divorce, and medical bills. In fact, CNBC reports that two-thirds of bankruptcy filings cited medical issues as a large part of the reason.
It's also important to make note of student loans if this is part of your debt. In some cases, forgiven student loans happen with bankruptcy, though you should prepare for a challenging process.
If one of the above reasons has you thinking about filing for bankruptcy, there are some key factors you need to consider first before starting any bankruptcy proceedings.
Declaring bankruptcy is not a decision to take lightly as it comes with long-term consequences. These consequences can be very limiting and impactful to you as the filer.
As a result, it's important that you understand the process of how bankruptcy works. It's also important to consider all your alternative options as well. Our article breaks down the key things you need to know about the different types of bankruptcies.
What is bankruptcy?
There's a lot to know when it comes to bankruptcy laws. A person is bankrupt when they cannot pay their debts. Bankruptcy is a process that the federal courts of the United States handle.
During this process, bankruptcy judges make the final decisions on cases, including whether an individual is eligible to file for bankruptcy or not.
Bankruptcy is for situations where a borrower is in excessive debt that they can't overcome, typically. For instance, if you are facing foreclosure on your home or are unable to pay other debts that you owe.
How do you declare bankruptcy?
The individual who is in debt or owes money has to declare bankruptcy. In order to begin bankruptcy proceedings, you have to file a bankruptcy petition.
Once the application is received, you'll then have to appear before a court and explain the circumstances that led to your current financial situation.
The 3 most common types of bankruptcies
There are different types of bankruptcies that a debtor can file. These types of bankruptcies largely depend on personal circumstances.
Broadly speaking, the 3 most common types of bankruptcies are Chapter 7, Chapter 11, and Chapter 13 bankruptcy.
Chapter 7 bankruptcy
Under chapter 7 bankruptcy, consumers with low incomes can apply to erase some of their debts. And it can also work for small business bankruptcy.
Liquidation bankruptcy is the name, and it means that you will have to sell many of your assets in order to pay the debt.
A trustee is chosen to manage this process, and only assets that are not exempt are put up for sale. Examples of exempt assets could include the equity in your home, a pension, or a vehicle up to a certain amount.
Once the trustee has sold all the eligible assets and used the proceeds to pay off outstanding debt, the remaining debt is forgiven.
Specific conditions for Chapter 7 bankruptcy
Chapter 7 bankruptcy does contain some minimum conditions including:
- You have not previously filed for Chapter 7 bankruptcy in the last 8 years.
- You must be able to pass a means test which essentially determines if your monthly income is low enough to qualify for Chapter 7 bankruptcy.
Once you meet these conditions, a formal process of classifying the debt begins. In this process, debt is categorized as secured or unsecured. Then your debt is prioritized for repayment.
Unsecured debts (debt not backed by any assets) are given a higher priority in bankruptcy proceedings. These include tax obligations, child support, and personal injury claims made against the debtor.
After the unsecured debt has been paid off, the secured debt (debt backed by assets e.g. mortgages) is next in line.
Chapter 13 bankruptcy
Also called the wage earners bankruptcy, this type is less severe.
As the name implies, this bankruptcy is reserved for those with an income who can pay all or part of their financial obligations without having their assets repossessed.
This particular type of bankruptcy helps borrowers who have access to funds but are under pressure from their creditors to pay back their debts as soon as possible.
With Chapter 13 bankruptcy, you have 3 to 5 years to pay back your outstanding obligations. You also have to use all your disposable income to meet your monthly payments. In line with this, you'll need to submit what is known as a reorganization or repayment plan.
Similar to Chapter 7 bankruptcy, a trustee is appointed to manage the finances, and this trustee is responsible for collecting payments from you, the debtor, and paying the creditors their money.
With this type of bankruptcy it may be appealing to you if you are concerned about losing your home to foreclosure and want to keep your assets in place.
Chapter 11 bankruptcy
Business bankruptcies often use Chapter 11, but individuals may also use it. It basically reorganizes your debts but doesn't close the business entirely.
Which can sometimes be preferable because it allows a business to keep operating by restructuring the debt. It may include liquidation of some assets, a payment plan, and other things that help to settle the debt.
Some businesses have used chapter 11 to stay afloat and succeed despite the complexity.
What's the difference between chapter 11 and chapter 7 bankruptcy?
It's important to know the difference between chapter 11 and chapter 7 bankruptcy.
Basically, with chapter 7 you have to sell off quite a few things to pay your debts. While with chapter 11, you retain more rights and don't usually have to liquidate everything. You can even keep your business running and potentially be successful in the future.
While you don't have to completely start from zero with chapter 7, it's definitely more intense than the restructuring that occurs with chapter 11.
The big difference between chapter 7 and chapter 13 bankruptcy
There's a considerable difference between chapter 7 and chapter 13 bankruptcy. Essentially, chapter 13 allows you to pay back the debts you owe over time without selling off your assets. On the other hand, Chapter 7 liquidates most of what you own, and in a much quicker manner.
Other types of bankruptcies
There are other types besides the 3 most common types of bankruptcies that you hear about more often. Here are the other forms of bankruptcy.
Chapter 12 bankruptcy
Family fishermen and family farmers with a regular annual income may use chapter 12. It helps these types of businesses to continue operations while simultaneously filing bankruptcy.
In this case, you do not have to liquidate all assets and can instead work out a system to pay off debt.
Chapter 9 bankruptcy
Only municipalities can use Chapter 9. It's a sort of adjustment of debts similar to chapter 11. You do not have to liquidate all assets.
It allows the insolvent municipalities to find a way to pay off their debt in a reasonable way. But bankruptcy cases for chapter 9 are fairly unusual.
Chapter 15 bankruptcy
Chapter 15 is one of the types of bankruptcies that is very unique and specific. It's for insolvency cases involving a foreign country and the United States.
Upsolve describes this as, "a set of rules and procedures that determine how the United States court system will handle foreign bankruptcy proceedings that involve assets in the U.S. "
How to file for bankruptcy
Here is an overview of how to file for various types of bankruptcies:
How to file for Chapter 7 bankruptcy
To file for Chapter 7 bankruptcy, you will need to go through the following steps outlined below. The entire process will take you about 4 months to complete.
To get started, it is essential to find and work with an experienced bankruptcy attorney. The steps are as follows:
Step 1: File a petition with a local bankruptcy court
Do this along with all of your financial statements. Which includes all your income, list of debts, lists of assets, recent tax returns, etc.
Step 2: Complete the required bankruptcy counseling
There is a fee for this. Other costs include a filing fee for the petition, plus court fees, and attorney fees.
When evaluating the cost of filing for bankruptcy, it may be tempting to file the required paperwork on your own. However, the importance of working with a qualified attorney cannot be overstated.
Working with a qualified professional is worthwhile. Especially because of the paperwork required to go through the process coupled with the potential that it could get rejected by the bankruptcy court if paperwork is filed incorrectly.
How to file for Chapter 13 bankruptcy
To file for Chapter 13 bankruptcy, you need to follow the steps outlined below. Before you start, you need to ensure that your unsecured debt e.g. credit cards, personal loans, etc, and your secured debt does not exceed the set amount.
Reviews of these thresholds happen periodically to keep up with inflation.
Step 1: Find a bankruptcy lawyer
You can often get a free evaluation from most lawyers to see if they are a good match to work with.
Step 2: File your petition and pay the required filing fee
The fee goes to the bankruptcy court. In addition, expect a required administrative fee.
Step 3: Provide all accompanying paperwork
The paperwork includes:
- A list of the outstanding creditors and the amounts you owe each of them.
- Evidence and paperwork detailing your income.
- A list of your assets such as property and vehicles (If there are any contracts in your name, these will need to be provided as well).
- A list of your monthly living expenses.
- Your most recent tax returns and a statement showing your unpaid taxes.
Consequences of filing for bankruptcy
Choosing to file for any of the types of bankruptcies is not an easy decision to make, and it is one to take seriously. Specifically making sure you have a good understanding of the potential consequences.
Some of the major consequences of filing for bankruptcy include:
Limited ability to borrow money in the future
Once you’ve gone through bankruptcy proceedings, it will be extremely difficult to gain access to any lines of credit as a permanent public record will exist in your name.
If you’re not used to a lifestyle of paying for items in cash, this may prove to be a challenge for your lifestyle going forward as credit is very commonly used in society.
Your credit report will display your bankruptcy record for up to 10 years
It's stipulated in the Fair Credit Reporting Act, which allows credit agencies to report bankruptcy. Not only will this impact your ability to take out loans in the future, but it could also have a limiting impact on your career as creditors run background checks during the employment process.
As you proceed with the bankruptcy process, it is imperative to get a copy of your credit reports from each of the 3 agencies both before and after the process.
Qualifying for a loan or credit card after filing for different types of bankruptcies
While bankruptcy may not be the easiest process to navigate, going through it does not have to spell the end of your relationship with credit. There are steps that you can take to build your credit back to a healthy level.
Check your credit
As mentioned above, the best place to begin is to check your credit reports to ensure they accurately reflect your financial circumstances. The reports must reflect the bankruptcy as well as show a record of the released debt.
Leverage a secured card
The next step, if you’re looking to get a credit card, is to apply for a secured card. A secured card is an excellent way to rebuild your credit.
Financial institutions can issue this form of credit because the funds in your bank account back it. The funds serve as the credit line for the card, and should you ever default, the funds work as collateral.
An alternative way to get a card is to work with a friend or family and be added as an authorized user to that person’s account.
The primary cardholder will have the sole responsibility of paying off the card. However, the authorized user benefits from the boost to their credit score if the account is paid on time.
It is advisable to check with the credit card company to confirm if the account will be added to your credit history as an authorized user.
Make payments on time and ensure that your credit history reports it. It's the best way to ensure you gain the benefits from this arrangement.
Leverage a credit-builder account
Another alternative to improve your credit score to the point where you can apply for a credit card is to leverage a credit-builder account. A credit-builder account, also known as a credit builder loan, is a small loan you take out in your name.
However, instead of the funds disbursing directly to you, the credit-builder account issuer holds onto it in the form of a secured loan by placing your money into a certificate of deposit.
Alternatives to the different types of bankruptcies
Deciding whether to file for bankruptcy or not can be a tough decision. If you’re wondering what to do, it may help to know that there are alternative options out there. Some options include:
Debt management plans
You may be able to negotiate a debt management plan where you, as the debtor, are able to pay back the full principal over an agreed-upon period of time.
This creates a monthly payment plan that is tailor-made to cover your specific needs, and it can help to provide some structure to your payment process. One thing to note however is that the lender is under no obligation to agree to it.
Free consumer counseling resources can guide you in the right direction.
Done correctly, debt consolidation combines all your outstanding debts into one lump sum with a lower interest rate and a more sustainable monthly payment.
Debt consolidation is typically in the form of a loan, and the interest rates are typically much lower than those charged by individual card companies.
A debt settlement is an alternative to debt consolidation. It seeks to allow a debtor to make a lump sum payment that is usually less than what the debtor currently owes.
The amount is typically 50 – 75% of the original value of the debt. Lenders will report this as “settled for less than agreed” to the credit bureaus. The record will remain a part of your credit report for seven years.
Even with bad credit, you can apply for a personal loan depending on the specifics of your situation. However, interest rates will be incredibly high, and so will the monthly payment. So you'll need to determine if this option is right for you.
Life after bankruptcy: Steps to take to recovery after various types of bankruptcies
If bankruptcy is something you've gone through, you probably want to know what to do next. Here's how to stay on track.
Once you have completed the bankruptcy process, you may want to rebuild your credit. While this is possible, it is also advisable to do so cautiously.
Some steps to ensure a healthy relationship with money include making sure you have firm boundaries when using credit to make purchases.
Additionally, you want to make sure you are paying off your card at the end of every month without question. Prioritize only making purchases on your credit card that you can pay off in full each month, and follow through on doing so.
Learn to budget
Budgeting should naturally become a key component in your tools to successfully navigate life after bankruptcy. While budgeting takes discipline, it is much easier with a range of tools to assist with the process.
For some, working with pen and paper may be optimal, while for others, using online tools may be better. Other strategies such as automating your bills and savings will help to ensure that you’re meeting your obligations consistently.
Build up your emergency savings
Emergencies undoubtedly arise, and having a robust emergency fund in place goes a long way. An emergency fund is money in a separate account that you don’t necessarily have instant access to.
The recommended amount to start with is $1,000, with a goal to get to 3 to 6 months of your core living expenses.
Understand the types of bankruptcies and know your options!
When it comes to filing for bankruptcy, it's important to take all of the above into consideration. And also to attempt to fully exhaust all your alternative options.