Bankruptcy -


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Bankruptcy is not necessarily the state of having no money. For our purposes, concerning debt management, bankruptcy is a legally declared inability to pay creditors. Creditors can report their debtors as bankrupt, but it is more common that "voluntary bankruptcy" occurs; this is when a debtor files for the status him or herself. By declaring bankruptcy, an individual or corporation can then take advantage of legal protections offered by the government.

Chapters 7 and 13

The two types of bankruptcy that are most relevant to this discussion are Chapter 7 and Chapter 13. These could be for individuals or corporations, and they're the most common forms of bankruptcy in the United States.

In the case of the former, the government will send a trustee to liquidate the property of the debtor and distribute the money to the creditors. There is usually a large amount of property, however, that is not seized. The prevailing wisdom that the government will leave most of your stuff alone (exempt) has led to abuses of Chapter 7 bankruptcy by people simply looking to avoid paying off their debts. This is not always the case, however; anyone filing for Chapter 7 should be fully prepared to lose valuable property up to and including his or her home.

Exemptions vary from state to state, but can include:
  • Equity in a home or a car
  • Tools of the trade (i.e., things you need in order to work)
  • Certain personal effects
Chapter 13 is a reorganization of debt that puts the debtor on a long-term plan to pay off their creditors. It's also called a "wage earner's plan," because it is proposed under the assumption that the debtor can earn enough over the course of 3 to 5 years to pay what he or she owes. All new debts must be paid within this period as well, so monthly mortgage payments and any other liens must be taken care of on top of the Chapter 13 plan.

Why File: Automatic Stay

One of the most appealing reasons to file for bankruptcy is the automatic stay that the court imposes. This keeps creditors from taking action against you concerning your debts to them. This is why bankruptcy is often referred to as "bankruptcy protection." In some cases, it could keep you out of jail! If you are concerned that a collection agent is going to take more from you than the government would, you might consider getting their (the government's) help.

Why Not to File

Filing for bankruptcy can do tremendous damage to your credit. This will affect your ability to open a bank account, get a credit card, buy a car, or buy a house. Bankruptcy will put you in financial strain for a long while. Paying off your debts traditionally is always going to be preferable.

Other Important Information

  • Under legislation passed in 2005, all individuals filing for bankruptcy must undergo credit counseling as a prerequisite for qualifying.
  • An individual who files for Chapter 7 may be denied and, in essence, forced to file for Chapter 13 if it is found that he or she would have enough disposable income in the next 3-5 years to handle it.
  • The government has cracked down as of late on bankruptcy abuse. Expect a thorough vetting of your assets and spending habits before you qualify.
Remember: bankruptcy is for people who are up against the wall. No matter how appealing the idea of having creditors off your back might seem, this is nothing to be entered into lightly. Explore your other options first, but, as a last resort, bankruptcy could save you from complete financial ruin.

Patrick Hanan  Posted by Patrick Hanan on June 15, 2010

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