Everyone has heard the term “bankruptcy,” and many believe that it is a simple matter of going before a judge and ridding themselves of all of their debt.  This is not the case, and both traditional and newer laws may impact one’s decision to file.

Definition of Bankruptcy

At bankruptcy needed?its core, bankruptcy is a legal filing, in which an individual declares that s/he does not have the money to pay existing debt.  The filing is put before a federal judge, who then determines how the debt will be discharged (“wiped out”).  For individuals, there are two types of bankruptcy – Chapter 7 and Chapter 13.  Which chapter to select depends on some very specific factors.

Bankruptcy law has it beginnings at the federal level, and the types of filings and criteria are generally established by Congress.  Each state has added to those federal laws, however, and now, all states have their own “rules of play” as well.

Chapter 7 Bankruptcy

The majority of people who cannot pay their debts file for Chapter 7, often known as the “wipe the slate clean” bankruptcy.  Generally, there cannot be steady wages that provide any disposable income to the person, and the goal is to be rid of all “unsecured’ debt, such as credit card accounts, personal loans and medical bills.  The debtor must prove, however, that s/he does not have the assets or the regular income to pay off even a portion of the amount owed.  Social Security, insurance proceeds, and certain other types of income cannot be considered income.

The Chapter 7 filer must list all assets, including jewelry, artwork, stocks/bonds, and even pedigreed pets. (Note:  Generally, clothing, furniture, basic personal items and an older or un-paid for car will not be considered assets).  State law determines how much equity you may have in a newer car and home, in order to keep them. It is important not to “fudge” or hide assets, because “bankruptcy fraud” carries serious consequences.

If you have valuable assets, the judge can appoint a trustee to dispose of them for distribution to your creditors.  If not, and you qualify for Chapter 7, your bankruptcy will be “discharged” by the judge, and you are free of the debt you have listed in your filing. 

Chapter 13 Bankruptcy

If individuals have steady income, and an analysis of their income shows that they have some amount to pay on debt, they must file for Chapter 13.  In this filing, the person keeps all of his/her assets and agrees to a repayment plan to creditors, usually amounting to less than the original debt amount and spread over 3-5 years.  The debt is “discharged” once the final payment is made.  Payments are usually made to a court-appointed trustee who in turn distributes the correct amounts to each creditor.

Important Changes to Federal Bankruptcy Law:  In 2005, Congress passed a law intended to make bankruptcy filing more difficult.  Important parts of that law are the following:

1.     Individuals must wait 8 years between two chapter 7 bankruptcies. 
2.    Chapter 7 requires a “means test”, a formula for determining debt vs. income.  If there is a specific amount of disposable income, the debtor will have to file for Chapter 13.
3.    Anyone filing for bankruptcy must receive a credit counseling certificate as a condition of the debt discharge. The certificate can be obtained through the internet or a phone consultation with an approved credit counseling agency.

In this economy, filing for bankruptcy is common and does not carry the “stigma” it once did.  Your credit score will suffer, but there are specific things that you can do to repair that credit faster than you think. Clients who filed bankruptcy have often a better credit score one or two years later than they had before filing.