Bankruptcy is a legal process during which consumers or business organizations can eliminate or repay some or all of their debts under the protection of the federal bankruptcy court. For the most part, bankruptcies can be divided into two types — liquidation and reorganization.
Chapter 7 bankruptcy comes under the liquidation category. It is called liquidation because the bankruptcy trustee may take and sell (“liquidate”) some of your property to pay back some of your debt. However, you may keep property that is protected (also called “exempt”) under state law. There are several types of reorganization bankruptcies, but Chapter 13 is the most common type for consumers. In Chapter 13 bankruptcy, you keep all of your property, but must make monthly payments over three to five years to repay all or some of your debt. If you are looking to avoid filing for Bankruptcy, debt counseling is an excellent alternative to Chapter 13 bankruptcy.
Both Chapter 7 and Chapter 13 bankruptcy have many rules — and exceptions to those rules — regarding which debts are covered, who can file, and what property you can and cannot keep. There are bankruptcy resources and professional advising available to guide and help people better understand the complex process of filling a bankruptcy.
Chapter 7 bankruptcy can be filed by individuals (called a “consumer” Chapter 7 bankruptcy) or businesses (called a “business” Chapter 7 bankruptcy). A Chapter 7 bankruptcy typically lasts three to six months.
Property liquidation. In Chapter 7 bankruptcy, some of your property may be sold to pay down your debt. In return, most or all of your unsecured debts (that is, debts for which collateral has not been pledged) will be erased. You get to keep any property that is classified as exempt under the state or federal laws available to you (such as your clothes, car, and household furnishings). Many debtors who file for Chapter 7 bankruptcy are pleased to learn that all of their property is exempt.
Secured debt. If you owe money on a secured debt (for example, a car loan for which the car is pledged as a guarantee of payment), you have a choice of allowing the creditor to repossess the property; continuing your payments on the property under the contract (if the lender agrees); or paying the creditor a lump sum amount equal to the current replacement value of the property. Some types of secured debts can be eliminated in Chapter 7 bankruptcy.
Eligibility for Chapter 7. Not everyone can file for Chapter 7 bankruptcy. If your income is more than the median income, however, you must pass “the means test” — another requirement of the new law — in order to file for Chapter 7 bankruptcy. For example, if your disposable income is sufficient to fund a Chapter 13 repayment plan — after subtracting certain allowed expenses and monthly payments for certain debts — you will not be allowed to file for Chapter 7 bankruptcy. In addition, the court will dismiss your case if you have filed a previous bankruptcy within a certain period of time, or if the court believes you are cheating your creditors. There are three situations when you don’t have to pass the means test in order to qualify for Chapter 7 bankruptcy.
Your Debts are Primarily Non-Consumer Debts
If more than 50% of your debts are non-consumer debts you are excused from the means test requirement. Non-consumer debts generally refer to business debts – those debts that you incurred for your business or with profit motives in mind. However, some courts consider personal income tax debts to be non-consumer debts too.
If you are a disabled veteran and your debts were incurred primarily while you were on active duty or engaged in homeland defense activities, you don’t have to pass the means test. To qualify for this exclusion, you must have a disability rating of at least 30%.
Military Reservists and the National Guard
The final exception to the means test requirement is for members of the military reserve or National Guard for the period they are on active duty and for 540 days thereafter, as long as they were on active duty or performing homeland defense activities for at least 90 days. Once the exclusion period ends, if the time has not passed for objections to the means test qualification in your bankruptcy case, you will have to take and pass the means test.
Bankruptcy doesn’t work on some kinds of debts. Though bankruptcy can eliminate many kinds of debts, such as credit card debt, medical bills, and unsecured loans, there are many types of debts, including child support, spousal support obligations, most tax debts and student loans that are difficult to be discharged in bankruptcy. However, a bankruptcy will temporarily stop collection calls from creditors of defaulted student loans.
Chapter 13 bankruptcy is also known as “wage earner” bankruptcy because, in order to file for Chapter 13, you must have a reliable source of income that you can use to repay some portion of your debt.
Repayment. When you file for Chapter 13 bankruptcy, you must propose a repayment plan that details how you are going to pay back your debts over the next three to five years. The minimum amount you’ll have to repay depends on how much you earn, how much you owe, and how much your unsecured creditors would have received if you’d filed for Chapter 7 bankruptcy.
Debt limits. Your debts must be within limits set by the federal government: Currently, you may not have more than $1,010, 650 in secured debt and $336,900 in unsecured debt.
Secured debts. If you have secured debts, Chapter 13 gives you an option to make up missed payments to avoid repossession or foreclosure. You can include these past due amounts in your repayment plan and make them up over time.
Whether you file a chapter 7 or 13 bankruptcy, it is important to take steps to rebuild your credit. To ensure that you credit improves quickly, make sure to take proactive steps to reestablish credit worthiness.
Participating in a credit or debt counseling agency’s debt management program is a similar to filing for Chapter 13 bankruptcy. The agency will help you come up with a plan to pay back your creditors over time, somewhat like a Chapter 13 plan. But working with a credit or debt counseling agency has one advantage: No bankruptcy will appear on your credit record, so your credit history will not be impacted as negatively as with Chapter 7.
A debt management program also has some disadvantages when compared to Chapter 13 bankruptcy. First, if you miss a payment, Chapter 13 protects you from creditors who would start collection actions. A debt management program has no such protection: Any one creditor can pull the plug on your plan. Also, a debt management program usually requires you to repay your debts in full. In Chapter 13 bankruptcy, you often pay only a small fraction of your unsecured debts. Finally, beware of debt management and debt settlement scams – there are many companies that do not care about helping consumers, but just want to collect fees for their services. Tread carefully before you sign up for a plan and do your research.
In addition to Chapter 13 bankruptcy, there are two other types of reorganization bankruptcy: Chapter 11 and Chapter 12.
Chapter 11 bankruptcy. Chapter 11 is typically used by financially struggling businesses to reorganize their affairs. It is also available to individuals, but because Chapter 11 bankruptcy is expensive and time-consuming, it is generally used only by those whose debts exceed the Chapter 13 bankruptcy limits (rare) or who own substantial nonexempt assets (such as several pieces of real estate). If you are considering Chapter 11 Bankruptcy, you’ll need to talk to a lawyer.
Chapter 12 bankruptcy. Chapter 12 is almost identical to Chapter 13 bankruptcy. But to be eligible for Chapter 12 bankruptcy, at least 80% of your debts must arise from the operation of a family farm. Chapter 12 bankruptcy has higher debt ceilings to accommodate the large debts that may come with operating a farm, and it offers the debtor more power to eliminate certain types of liens. Very few people use Chapter 12 bankruptcy; if you want to join their ranks, you should consult with a lawyer. (To talk to a bankruptcy attorney in your area, visit Lawyer Directory