Bankruptcy Basics

Bankruptcy Basics You Should Know

Bankruptcy is the legal process by which the debtor (an individual or company) restructures their financial situation by eliminating some debts and keeping other debts. This allows the debtor to rearrange their financial affairs in a way that makes the most financial sense for the debtor.

What Chapters of Bankruptcy Are Available for Individuals?

Individuals generally choose the consumer chapters of bankruptcy, Chapters 7 & 13. Chapter 11 is available for high-income individuals whose debts exceed the Chapter 13 limits. However, Chapter 11 is very expensive and time consuming. For more info on Chapter 7, click here. For more info on Chapter 13, click here.

What Must All Individuals Do To File Bankruptcy?

All individuals, whether filing Chapter 7 or Chapter 13, must complete credit counseling courses in order to file bankruptcy and be awarded a discharge at the end of the bankruptcy proceeding. Before a case can be filed with the court, the debtor must complete a pre-filing course and provide the court with a copy of the certificate showing completion of the course. Without this certificate, you cannot file bankruptcy unless there is some emergency accepted by the court. Do not take a chance on the court's good graces. Make sure to complete the first course before you file. The second course must be completed after the case is filed with the court and before the court closes the case. Failure to complete the second course in time will result in the court dismissing the bankruptcy case without a discharge. This will require the debtor to file a motion with the court and pay a re-filing fee of $260 (plus whatever fee the debtor's attorney charges to handle the additional paperwork and file it with the court). The cost to complete these two courses is generally no more than $60-$75 total.

What Debts Are Typically Kept In Bankruptcy?

Frequently, debtors keep car loans and mortgages on primary residences if it makes sense to do so. In today's market, with so many homes owing so much more than the homes are worth, many people are deciding to relinquish their homes during bankruptcy. These debtors decide that they will reenter the housing market 2-3 years after their bankruptcy is finished. For some, the ability to remove the second mortgage from underwater homes in Chapter 13 makes the home affordable and allows the debtor to keep the home.

Are All Debts Affected by Bankruptcy?

Not all debts are affected by bankruptcy. Some debts, such as some taxes, student loans, spousal and child support obligations and judgments as a result of auto accidents where the debtor was found to have been under the influence of alcohol or drugs at the time of the car crash are not dischargeable (eliminated) in bankruptcy.

Below is a short discussion of the 2 primary bankruptcy chapters that individuals file: Chapter 7 and Chapter 13.

Chapter 7 Basics

For many individuals, Chapter 7 is the bankruptcy chapter of choice. There are many reasons for this, not the least of which is that it only takes about 4 months for the entire process and wipes out all debts except for those debts unaffected by bankruptcy and those debts that the debtors have decided to continue to repay.

Chapter 7 has certain limitations that a debtor needs to be aware of. First, debtors cannot use Chapter 7 to make up past-due payments on a debt. If the debtor wants to keep property secured by a loan, the loan must be current on the loan. Another limitation is that not all debtors will qualify to file Chapter 7. A debtor must qualify now to file Chapter 7 and the qualification criteria are based on income. If the debtor makes too much income, the debtor is precluded from using Chapter 7. For more info on qualifying for Chapter 7, click here.

The biggest advantage to Chapter 7 is that the debtor does not have to pay any portion of the debtor's unsecured debts by making payments to the trustee for 3-5 years. Also, the debtor is granted a discharge of the debts within 4 months and is then able to start building credit again. Speaking of credit, once a discharge is granted by the court, the debtor's credit, while not numerically great, is good enough for creditors to start offering low-cost credit in the form of auto loans and credit cards. The reason for this is that the Chapter 7 debtor can't file bankruptcy again for 8 more years. At the end of the Chapter 7 process, the debtor only has those debts that they want, or can't get rid of through bankruptcy. For an overview of the process of Chapter 7, click here.

Chapter 13 Basics

For those individuals who don't qualify for Chapter 7 bankruptcy, or need the advantages that chapter 13 provides, Chapter 13 provides them with more ability to restructure their debts to fit their budget than Chapter 7. Chapter 13 is called the reorganization chapter because debtors have more flexibility in arranging their finances than Chapter 7. An overview of the Chapter 13 process is discussed below. The process of Chapter 13 is discussed in more detail here.

Chapter 13 takes between 3-5 years to complete. During this time, debtors in Chapter 13 are required to pay some portion of their unsecured debt to the trustee in the form of a monthly payment. The amount of this monthly payment is based on the debtor's income, not the amount of debt. To establish the amount to be paid, the debtor submits a "Plan" of repayment to the court for approval. Usually, the "Plan" payments are less than the debtor owes the unsecured creditors. After all payments in the "Plan" are made, the debtor receives a discharge of the unpaid debt that is dischargeable. Remember, not all debt is dischargeable. For non-dischargeable debts, Chapter 13 provides the debtor up to 5 years to repay them within the protection of bankruptcy. For more info, click here.

A big advantage of Chapter 13 is that Chapter 13 debtors are given up to 60 months to make up past-due payments on loans secured by property that the debtor wants to keep. For example, if the debtor is 12 months behind on house payments, the debtor can force the lender to allow the debtor to pay the past-due amount over 60 months. Try getting a lender to agree to that outside of bankruptcy. Another big advantage of Chapter 13 is the ability to eliminate second mortgages on the underwater property. If the debtor's primary residence is worth less than the first mortgage, Chapter 13 allows the court to eliminate the second mortgage and make it like a credit card debt. The debtor gets to eliminate a substantial debt on the house forever.

Another advantage of chapter 13 relates to debts that are not dischargeable. Some debtors like to use Chapter 13 to pay off taxes and court-ordered obligations without incurring any further penalties. Generally, taxing authorities and courts do not grant 60 months to pay off these obligations. For example, even with a tax debt that is not dischargeable, the debtor can have up to 60 months to pay off the tax without incurring any penalties from the taxing authority and without permission from the taxing authority. This can save the debtor substantial sums of money.

If You Have More Questions

Please contact us if you have more questions or are ready to move forward and start the process of becoming debt-free. Remember, we are here to help you resolve your debt problems, so call us now!

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