Declaring bankruptcy consists of going to a federal bankruptcy court and asking it to relieve you of some or all of your debt burdens. The process is a two-sided coin. On one side of the coin is the potential to be relieved of some debts, which could help you get a fresh start and help stop calls from debt collectors. On the other side of the coin is the potential negative impact that bankruptcy may have on your ability to borrow money over the next few years. The filing may also be on your credit record for years afterward, depending on the category of your bankruptcy filing.
Here's a high-level overview of how filing for bankruptcy works and the potential impact it could have on your finances.
How Does Filing for Bankruptcy Work?
There are two primary types of personal bankruptcy. Here is some information on how they work:
Chapter 7: This is the most common type of bankruptcy. If the court accepts your petition, you will likely be relieved of most or all of your debts (note the exceptions mentioned below). A "means test," which varies by state and includes a review of your finances, determines your eligibility for a Chapter 7 filing. However, the result is generally the forced liquidation and sale of a lot of your assets, and the record of the bankruptcy can stay on your credit for up to 10 years.
Chapter 13: This type of bankruptcy is often used by people who have incomes that are too high for eligibility for Chapter 7 relief, and who agree to only a partial debt write-off. They will likely have to continue to chip away at some of their debts. A chapter 13 bankruptcy can remain on your credit report for seven years.
Possible Exceptions to Bankruptcy Relief
Not all debts can be erased by a bankruptcy filing. For example, bankruptcy generally won't eliminate child support and alimony obligations, student debt, taxes and some debts you assumed in the six months before your bankruptcy filling. Also, filing for bankruptcy won't necessarily get anyone who co-signed a loan for you off the hook. That person may still be obligated to pay that debt.
You generally don't have to have a lawyer to represent you in a bankruptcy proceeding. However, it might be a good idea to have one, particularly if your debts are substantial. A judge is not allowed to give you advice, so an attorney may be able to help guide you.
How Can Bankruptcy Impact Your Finances?
If you're deciding whether to file for bankruptcy, you may want to consider how it could impact your finances and what might remain of your assets after declaring bankruptcy. Bankruptcy cases are handled by federal courts, but state law can play a role in determining what you can shield from creditors (known as "exempt property") in a bankruptcy filing. You may be able to keep pensions, retirement savings, a vehicle you use to get to work and tools you use for work.
Whether you can keep your home might depend upon how much equity you have in it. The greater the equity, the more likely you might have to raise cash to pay off creditors (including your mortgage company). If you have a rainy day or emergency fund, those funds will likely need to be used to pay down debts.
For most people, bankruptcy is a last resort after exhausting possible alternatives, such as negotiating a settlement directly with individual creditors or obtaining a debt consolidation loan. As you look into your options and determine the best next step for your unique financial situation, consider keeping this information on the potential impact of bankruptcy in mind.