- 1 DROM: BANKRUPTCY
- 1.1 IT'S BETTER THAN NOTHING (SOMETIMES)
- 1.2 A SHORT HISTORY OF DEBT FORGIVENESS
- 1.3 A TALE OF TWO CHAPTERS
- 1.4 THE CREDITORS FIGHT BACK
- 1.5 THE BATTLE OVER CHAPTER 13
- 1.6 WHO FILES FOR BANKRUPTCY AND WHY?
- 1.7 IN THIS SOCIETY, EVERYONE WANTS YOUR MONEY
- 1.8 SO SHOULD I FILE FOR BANKRUPTCY OR NOT?
- 1.9 COLLECTIVE SOLUTIONS
- 1.10 RESOURCES
- 2 KYD - Bankruptcy
- 2.1 Introduction
- 2.2 Secured vs. unsecured debt in bankruptcy
- 2.3 Two types of bankruptcy
- 2.4 Figuring out if you should use bankruptcy
- 2.5 Some reasons you might not want to declare bankruptcy:
- 2.6 Outline of the bankruptcy process
- 2.7 Consequences of bankruptcy
- 2.8 A note on student loans
IT'S BETTER THAN NOTHING (SOMETIMES)
Bankruptcy, for some people, sometimes, can be a way to fight back against the creditors and escape a life of indebtedness. It is basically the modern version of debtors' protection (yes, like consumer protections), but as with any set of legal codes, it reflects the society that created it. And let's remember that it was created by an economic system predicated on maximizing profit at all costs. Accordingly, the protections that bankruptcy offers are anything but clear or straightforward.
Bankruptcy can save lives and offers some people a world of relief. But there are many forms of debt relief out there, and bankruptcy is just one of them-a very legal one at that. Many prefer the route of "private" debt settlement or negotiation, others seek credit counseling or debt management programs, others fall prey to schemes plunging them further into debt and still others simply stop paying and walk away or go off-grid. This chapter aims to lend some clarity as to what possibilities bankruptcy offers, as well as to its limitations.
A SHORT HISTORY OF DEBT FORGIVENESS
Debt forgiveness has a long history. The Bible is literally full of passages about jubilees and other cancellations of debt. The Qur'an also advocates debt forgiveness for those who cannot pay. Of course not every society has protected its citizen debtors. In Ancient Greece, debtors unable to pay often lost their entire families to debt slavery. Even though the right to declare bankruptcy was legislated here in the United States at a much later date than in other industrialized countries, its application has been more debtor-friendly than most.
On the whole, bankruptcy in the United States has been used by businesses more than individuals. Bankruptcy laws in favor of businesses were repeatedly passed and repealed throughout the 19th century. The first truly modern bankruptcy laws in the United States appeared during periods of "economic downturn" in the 1890s and 1930s.
These laws were largely about saving companies and businesses deeply in debt. Businesses in the United States have always taken advantage of bankruptcy, especially in recent years, as companies have used it as a pretext to get out of pension obligations and to break union contracts. But starting in 1978, the United States passed a law that made it significantly easier for individuals and families to get similar benefits and protections. In the 1980s, people began to take more advantage of this possible liberation from debt. In the 1970s, just over one in a thousand Americans filed for bankruptcy every year. That began to rise dramatically over the course of the next decade. By 1990, the rate had tripled to three in a thousand; by the late 1990s, it was up to five.
A TALE OF TWO CHAPTERS
Over the last thirty years, the conflict over bankruptcy law has been a fight between creditors and debtors. It has largely been "a tale of two chapters": Chapter 7 and Chapter 13 of the Bankruptcy Code. Accordingly, there are two basic options if you are considering filing for bankruptcy, and they are named after the relevant sections of the law. With a Chapter 7 bankruptcy, all your eligible debt is wiped away (or "discharged"), and that's it. The huge downside is that your non-exempt assets (these vary by state, but often include basic things like your house, car, etc.) are also liquidated.
With a Chapter 13 bankruptcy, disparate debts are consolidated into a single sum owed to the bankruptcy court, and a rigorous payment plan is set up (usually lasting three to five years). The monthly payments are for many a substantial and unbearable burden, but all creditor efforts at collection must stop. Foreclosure actions are also suspended during a Chapter 13 bankruptcy proceeding (unlike a Chapter 7), although they can be resumed once the case is completed. Many people choose Chapter 13 over Chapter 7 in an attempt to save their homes, cars and other non-exempt assets. The downside is that you must then commit most of your "disposable income" to repaying your debts. This in essence means living in dire poverty for three to five years to satisfy what are likely illegitimate loans and criminal interest rates (the average interest rate on credit card debt is now around 13%). Still, the fact is that many, if not most, Chapter 13s fail during the payback period, ultimately becoming counterproductive and leading to more debt. It's not hard to see why the creditors prefer it to Chapter 7.
Unfortunately, bankruptcy can only eliminate or lessen some types of debt. Consumer debt (credit card, auto, stores, etc.) and medical debt are the major forms, but it can also eliminate other unsecured loans such as payday loans. A major victory for the creditors, however, is that the law prevents you from eliminating student debt, tax debt or mortgage debt.
THE CREDITORS FIGHT BACK
The credit industry was alarmed by the boom in bankruptcies over the last thirty years, and it began a vast lobbying and propaganda campaign to tighten up the code. The line was that a moral rot was spreading throughout the culture, and all the old moral lines about paying your debts were falling by the wayside along with all the other "traditional values."
Industry lobbying to cut back bankruptcies came up short at first. During the Clinton years, bankruptcy overhaul bills were introduced but never made it all the way through Congress. The efforts finally paid off in 2005, when George W. Bush signed the preposterously named Bankruptcy Abuse Prevention and Consumer Protection Act. The original draft of the legislation was done by Morrison & Forrester, a San Francisco-based law firm for the credit card industry. But don't think that "bankruptcy reform" was just a Republican effort-one of the main supporters who ensured this bill got passed was none other than current Democratic Vice President Joe Biden. The effect of this bill was to make it harder and more expensive to file for bankruptcy. But don't let that scare you away-it's still quite viable (if it's the right option for you).
The reform has been very good for creditors. Although there was a spike in bankruptcy filings in the year or two leading up to the passage of the bill-nearly seven out of every thousand Americans filed in 2005, an all-time record-filings then collapsed to just two per thousand in 2006. Filings soon began rising again, but even during the Great Recession of 2008, the filing rate never broke above five per thousand , essentially where it was in the late 1990s, when both the unemployment rate and debt levels were well below where they've been in recent years. According to a little statistical model we have put together, this "reform" has blocked over six million bankruptcies from being filed. (There would have been over 14 million filings instead of eight million.) And a study by the Federal Reserve Bank of New York-hardly an institution known for being hostile to creditors-suggests that tightening up the bankruptcy code also increased the number of foreclosures, because many debtors were denied this avenue of relief.
THE BATTLE OVER CHAPTER 13
Before the 2005 "reform," you had the option of choosing which chapter to file under. Under the guise of "abuse prevention," however, the new law denies the Chapter 7 route if your income is above your state median. (The median income is the one right at the middle of the distribution; half of all households are above the median, and half are below. State medians run from about $37,000 in Mississippi to $66,000 in Connecticut, with the national median around $50,000.) Of course, you could have an above-median income in an expensive region like New York or San Francisco and not be living large at all. But despite the restrictions on Chapter 7 filings, they still account for about 70% of all bankruptcy cases, which isn't much different from the pre-reform share.
The 2005 reform also increased the amount of documentation required to file-tax returns, pay stubs, household budget information, and so on. Because of that, and the increased amount of time that lawyers now have to devote to a bankruptcy filing, fees have risen dramatically. The new law also requires you to complete a counseling course offered by a government-certified provider. All of this contributed to lower filing rates than we would have seen otherwise. It is clear that in the name of "abuse prevention," the creditors and the government are forcing people to either not file for bankruptcy at all, or if they do, to file for Chapter 13. And it is not hard to see why. Chapter 13 is, in many ways, another creditor scam. Unlike Chapter 7, creditors often recover up to 30% of the original loan with Chapter 13. Many of those who file for Chapter 13 end up completely failing: the rate of "discharge" (getting one's debts forgiven) is around 30% according to most studies, and at most 50% according to others. If your Chapter 13 filing fails, you are left in a worse situation than where you started.
And from here it only gets worse. One detailed law study found that bankruptcy laws, specifically Chapter 13, implicitly favor a certain profile, an "ideal debtor," who is usually white and married. Most bankruptcy laws tend to favor wealth over income, ownership over renting, formal dependents over informal dependents and heterosexual married couples, all of which have significantly higher rates in white communities. Before 2005, African Americans filed for Chapter 13 nearly 50% of the time, compared to less than 25% by whites. Why, you may ask? Here's one explanation: a study found that when all other factors are equalized (identical financial cases), lawyers are twice as likely to steer Black clients toward Chapter 13 than they are white clients. The study could find no other cause besides racism in all forms: conscious, unconscious, structural and institutional.
It is an uphill battle if you are an African American debtor: in another display of overt racism, you are 20% more likely to have your Chapter 13 cases dismissed by a judge. This discrimination has had a major impact on African American debtors-they often avoid the option of bankruptcy altogether and seek other solutions: hiding, adopting aliases, refusing to pay and/ or relying on highly predatory fringe financial services. It may appear at first glance that the 2005 act actually began to equalize the playing field across race and gender by introducing the fairly objective "means test," but it has, on the contrary, continued the trend of favoring wealth over income and made the whole process more intimidating and more expensive.
WHO FILES FOR BANKRUPTCY AND WHY?
The banks, government and media would have you believe that people file for bankruptcy to scam the system, or because they are financially irresponsible. This is nonsense of course. Elizabeth Warren made her career by clarifying these myths around bankruptcy: most bankruptcies are simply not caused by financial carelessness but by major life misfortunes such as unexpected joblessness, illness or divorce. The major social reason for the rise in bankruptcy over the decades has been the rise in consumer debt burdens, and the major reasons for the rise in these debts are the stagnation of average incomes, the elimination of caps on interest rates starting in the late 1970s and massive public sector service cuts. The line of argument advanced by the credit industry ignores the source of the debt to begin with: in a time of vulnerable work markets and mass cuts in basic social services, most people have no choice but to accrue debt to simply survive.
There has been a lot of talk about the role of medical debt in bankruptcies in the past few years-and for good reason. Medical debt is a major factor in bankruptcies. But it is not the only factor. Bankruptcy is not "caused" by any one type of debt. Most individuals and families filing for bankruptcy have auto debt, credit card debt, mortgage debt, student debt and also medical debt. The debt burden that households have been forced to take on is impossible to bear. Bankruptcy and mass default in this system are structurally inevitable-bankers make loans they know we can't pay! And it would be a mistake to think, either preor post-2005, that the U.S. bankruptcy laws and proceedings are fair across lines of gender, race and class. Far from it. In terms of gender, it's a complicated story. While the rates of bankruptcy filings are far higher for women, especially single and/or divorced mothers, they also benefit from the structure of bankruptcy laws. Individuals with child support obligations (usually men) who declare Chapter 7 are freed up to then satisfy these obligations, since consumer debt can be discharged but child support cannot. However, after the 2005 act, bankruptcy became more difficult for everyone, both single mothers and those with child support obligations. And all of this begs the question: why are so many single mothers (especially African Americans) declaring bankruptcy? And instead of looking for policy solutions or resorting to moral chiding, how can we avoid these situations of indebtedness in the first place? We haven't seen these questions asked in any serious public forum.
In addition, there have been several reports in the last decade about the connection between race and bankruptcy. Anyone connecting the dots between race, predatory lending and the 2008 financial crisis shouldn't be surprised by these results. Neil Ellington, executive vice president of a credit counseling agency in Raleigh, N.C., had this to say on the matter of race and bankruptcy: "The same underlying issues that created the problem in mortgage lending, with minorities paying higher interest rates than their white counterparts having the same loan qualifications, are present in all financial fields."
So how bad is it? One study, focused on a neighborhood in Chicago, found that the rate of filings by African Americans is triple that of their white counterparts. The reasoning isn't completely clear, but it's not hard to speculate: Black people have found themselves systematically targeted by financial predators who are taking advantage of the hundreds of years of material oppression that African Americans have faced in the United States. Beyond predatory lending, African Americans are targeted by fierce debt reduction schemes, rescue scams and shady financial products promising to save them from their debt burdens.
IN THIS SOCIETY, EVERYONE WANTS YOUR MONEY
Anyone struggling with debt and/or contemplating bankruptcy is likely to confront a lot of dubious operators. Worst of all are the characters who advertise on late-night TV or on the web, offering debt-relief schemes. (Google the term "debt relief " for examples.) In the words of Charles Juntikka, a Manhattan-based attorney who handles many bankruptcy cases, "I've never seen one that was legitimate." Most operate at the margins of the law or beyond. Our advice: avoid them like the plague.
But there are also more legitimate groups and financial advisors who will offer you still-dubious advice against filing for bankruptcy. The standard claim is that bankruptcy is an emotionally wrenching experience that will ruin your credit for years. According to these sources, you'll find it difficult or impossible to get a credit card or a mortgage after filing for bankruptcy. You might even find that it "carries a stigma in your community," according to the National Foundation for Credit Counseling (NFCC), a trade association for the advice industry. Better to tighten your belt and negotiate repayment plans with your creditors, they say. For example, one advocate, Dave Ramsey, who dispenses advice from the perspective of the religious right, suggests selling everything but the bare necessities to placate the creditors.
And they are right in one sense; bankruptcy is no picnic. But neither is "private" debt negotiation or settlement. Few people have the audacity and emotional strength to fight with creditors for months, especially without a lawyer. Groups like the NFCC have been suspiciously silent about releasing data showing success rates in private negotiations, debt settlement plans and other alternatives to bankruptcy. It's hard to know who to trust when everyone wants your money. Organizations like the NFCC will say terrible things about bankruptcy because they're funded by the financial industry and other private sector interests. While they divulge few exact details about their funders, the program for its most recent conference thanks sponsors including Bank of America, Chase, Citi, MasterCard and Experian (the credit rating agency). The conference also featured "breakout sessions" for creditors and a Creditors' Day (as if the other days of the year weren't creditors' days). It goes without saying that advice dispensed by NFCC member organizations is not likely to be debtor-friendly.
NFCC's ideals can be seen in the winners of their most recent Client of the Year Award, Jerry and Sue Bailey of Jackson, Michigan. The Baileys "refused" the temptation of "walking away" from $92,000 in credit card debt, opting instead for a repayment program engineered by NFCC member firm GreenPath. They admit that paying off their debt was a struggle, but it was one "worth making." GreenPath (which, incidentally, paid its CEO about $600,000 in 2010) and other NFCC member firms are precisely the ones who run the counseling programs filers are required to attend.
So who can you trust? Bankruptcy lawyers? Let's not forget that they make money off of debtors too. The only conclusion to arrive at is that every situation is different, and you should research the options that make the most sense for your situation. And the real conclusion is that we shouldn't have this debt in the first place.
SO SHOULD I FILE FOR BANKRUPTCY OR NOT?
Mr. Juntikka (the lawyer quoted above) rejects claims by the credit industry and the academics and counselors on their payroll that the rise in bankruptcy filings over the last couple of decades is the result of spreading moral rot and a growing indifference to debt. Most people are close to their credit limit or behind on their payments-at a time when banks can raise the money they lend you for close to 0%-and getting rid of that rapidly compounding debt can be deliverance for many.
Compound interest can be like a god demanding endless sacrifices with no reward. If you have a $5,000 balance at 18% and make only the minimum payment, it will take you almost twenty-three years to pay off the debt, and it will have cost you nearly $7,000 in interest. Bankruptcy can reduce your credit card balance to zero in a matter of months-and put an end to calls from collection agents too. There are consequences, of course, but being informed and doing it right often makes it worth the risk.
Most Americans are afflicted with a deep sense that not servicing our debts is immoral and suffer immense amounts of guilt over falling behind. Worse still is the common myth that filing for bankruptcy means losing everything. It isn't totally false, but every state has a list of exempt assets, and Chapter 13 is designed so that some can actually save their non-exempt assets. We recommend you research all of this carefully. In the end, filing for bankruptcy can be a tremendous relief.
Mr. Juntikka points out that his clients have suffered visibly. He describes very vividly the emotional state of debtors when they first arrive at his office. They're miserable-sleeping badly, signs of stress written all over their bodies. As they get through the process of filing for bankruptcy, their demeanor changes dramatically. "They're sitting up straighter, their faces look better."
And it's easy to see why-the biggest relief bankruptcy offers is the "automatic stay" provision. In this provision, creditors and their debt collection goonies have to stop harassing you until the bankruptcy filing is completed and the court has ruled. In Chapter 13, the trustee assigned to your case ensures that you no longer have to deal with creditors as you pay back your debt for those three to five years (again, only if you are in the minority that successfully completes your plan).
It can cost as much as $3,000 to file for bankruptcy these days (Chapter 13 is more expensive), which, for people who are barely getting by, is a lot of money. You may be able to find a cheaper lawyer and get your costs down. Or you can often get free legal representation by contacting your local bar association. It is possible to do it yourself using manuals and forms provided by the likes of Nolo.com, but it can be a complicated process (which is how the banks want it). And the failure rates without a lawyer are astonishing: 97% of Chapter 13s failed without a lawyer! So, we recommend getting a lawyer before filing; research carefully how to find a good one. It's worth the money. And it can't hurt to know the law a bit before you go-the study about lawyers discriminating against African American debtors shows this clearly.
What about my credit (and other cautions)?
The consensus in the credit counseling industry seems to be that for most people, bankruptcy is actually, in the long run, good for your credit score. If you're considering bankruptcy, you've probably missed a few payments and are dealing with delinquency and default-which will wreck most people's scores. Counterintuitively, debt management programs or similar plans don't seem to do much for your credit. At that point, you need to make a decision about bankruptcy.
While the jury is not fully out, it seems that filing for either Chapter 7 or Chapter 13 has an equivalent impact on your credit score. Either way, your score will take a nosedive and you won't have access to cheap or fair credit for a while. But there is a difference: most lenders seem to be willing to lend if you file Chapter 7, as you are then clear of past debts and have disposable income. With Chapter 13, on the other hand, few lenders will do any lending during the payback period, which means it will take an extra three to five years to rebuild your credit. And remember, bankruptcy can stay on your credit score for seven to ten years.
After bankruptcy, you will be an ideal target for the predatory loan sharks in the industry; they love people who are struggling. They will tempt you with low interest rates to start with, but then jack up rates and fees the minute that balances rise and payments fall behind. Be careful. The best strategy after bankruptcy is to accept a couple of cards. Study their terms and conditions and use them very carefully. Read up about how to build your credit (carrying a small balance, making regular payments, etc). Although a bankruptcy filing can stay on your credit report for a decade, within a couple of years after a filing, it's possible to get a respectable credit score-and with no late payments and a steady job history, a mortgage could follow a couple of years later. Still, it might be wise to wait longer; remember, you are especially vulnerable to predatory lending at that point. All that being said, it can be disastrous to declare bankruptcy a second time. Few credit scores can recover from that (except patiently waiting seven to ten years).
Lastly, the biggest risk in filing for bankruptcy is that your case will be dismissed, in which case you've wasted time and money, accrued more debt (the interest accrues retroactively to the time of filing) and gained nothing. And, your bankruptcy would still be on your credit report. This is obviously the worst-case scenario. Remember, this happens for nearly 50% of those filing for Chapter 13. Is it a scam? We'll let you decide. We think the whole system is a scam.
Unfortunately, for the most part bankruptcy offers only individual means of fighting the creditors. It is hard to imagine how to use the bankruptcy laws in order to organize mass direct action that would cause serious change in our debt society. In terms of the racist nature of the existing bankruptcy mechanisms, the most likely solutions to these problems would be continuing to fight structural and institutional racism in all its forms. This could of course be combined with launching a massive informational campaign in communities of color to clear up the myths and disinformation surrounding bankruptcy. And, although not ideal for many, there are other options for debtors: debt negotiation or settlement, refusal, living off the grid, leaving the country, etc. One form of collective action is to help each other and build networks of mutual support for those struggling with debt.
With every bankruptcy, a bank or lender loses a certain amount of money-they have rigged the game, so they are probably recovering it in other places. Nonetheless, with every bankruptcy, their books are slightly shaken. One possible action would be a simultaneous mass bankruptcy of those eligible for Chapter 7. This could be organized so that a mass of debtors with debt towards a certain bank declares bankruptcy all at once. We don't know enough about the industry to know what effects this could have. The organizers would need serious legal counseling: bankruptcy laws are laden with fraud protections, which would have to be carefully combed through before taking action. Another possibility would be to organize a critical mass to declare bankruptcy on student loans all at once-knowing they will be dismissed, but defiantly insisting in court that the debts are illegitimate and unpayable. These actions would need years of planning, preparation and organization.
In reviewing the history of bankruptcy and how it has been used in the United States, the conclusion we have come to is that the best way to fight for debt forgiveness, cancellation and a society of fair and equitable credit is to build a debt resistance movement to challenge the most fundamental structures of this unjust economy-all while trying to help each other.
Bankruptcy Data (bankruptcydata.com)
David Cay Johnston, "Five Questions for Elizabeth Warren; Bankruptcy Borne of Misfortune, Not Excess," New York Times, September 3, 2000 (tinyurl.com/ DROMJohnston). Aparna Mathur, Medical Debts and Bankruptcy Filings, American Enterprise Institute for Public Policy Research, July 28, 2009 (tinyurl.com/DROMMathur). Elizabeth Warren, "Feminomics: Women and Bankruptcy," Huffington Post, December 17, 2009 (tinyurl.com/DROMWarren).
1. Thomas A. Garrett, "The Rise in Personal Bankruptcies: The Eighth Federal Reserve District and Beyond," Federal Reserve Bank of St. Louis Review, February 2007 (tinyurl.com/DROMGarrett), 15. 2. Donald P. Morgan, Benjamin Iverson, and Matthew Botsch, "Subprime Foreclosures and the 2005 Bankruptcy Reform," Federal Reserve Bank of New York Economic Policy Review, 2011 (tinyurl.com/DROMMorgan). 3. Wenli Li, "What Do We Know About Chapter 13 Personal Bankruptcy Filings?" Federal Reserve Bank of Philadelphia Business Review, 2007 (tinyurl.com/DROMLi). 4. A. Mechele Dickerson, "Race Matters in Bankruptcy," Washington and Lee Law Review, 61, no. 4 (2004) (tinyurl.com/DROMDickerson), 1725. 5. Tara Siegel Bernard, "Blacks Face Bias in Bankruptcy, Study Suggests," New York Times, January 20, 2012 (tinyurl.com/DROMBernard). 6. Geoff Smith and Sarah Duda, Bridging the Gap II: Examining Trends and Patterns of Personal Bankruptcy in Cook County's Communities of Color (Chicago: Woodstock Institute, 2011) (tinyurl.com/DROMSmith2). 7. Li. 8. "12 Myths About Bankruptcy," Bankrate.com, November 4, 2011 (tinyurl.com/DROMBR).
KYD - Bankruptcy
Bankruptcy is an oasis in the wasteland that creditors have built. Perhaps surprisingly, the US has one of the most debtor-friendly bankruptcy systems in the world. This is mostly because the bankruptcy system was originally built for small businesses. And most of the bankruptcy system is still built for businesses, but this section is about the part that’s for individuals and families.
The basic idea of bankruptcy is to develop a process for when a debtor cannot pay all of their creditors. It’s an alternative to more brutal systems like debt peonage (where a debtor who couldn’t pay worked as a slave for their creditor until the debt was cleared) and debtors prisons. Instead, bankruptcy sorts out which creditors get what, which get nothing, and allow debtors to move on with their life. Mostly.
At its core, bankruptcy does two things:
It temporarily stops all creditors from taking any collection action (including garnishment eviction, annoying phone calls—everything). It discharges and/or creates an easier payment plan for all a debtor’s debts.
If you’re having trouble paying your debts, bankruptcy can be a crucial lifeline.
Secured vs. unsecured debt in bankruptcy
It is crucial to understand the difference between secured and unsecured debts for the purposes of bankruptcy. Check out this explanation. For the most part, you cannot get a secured debt discharged while still keeping the asset that secures the debt. You have to either figure out a payment plan for the secured debt or lose the collateral that secures it. Unsecured debts, on the other hand, can be discharged without giving up anything.
Two types of bankruptcy
There are a few different types of bankruptcy, only two of which matter to most of us (some are only for businesses and some are only for farmers--we're ignoreing those)
A Chapter 7 bankruptcy (the name refers to the portion of the bankruptcy code that contains its rules) is sometimes called a “liquidation” or a “straight bankruptcy”. The idea is to wipe the slate clean--although some debts cannot be discharged. And, as discussed in the previous section, secured debts can only be discharged if you give up the collateral that secures the debt. If you want to create a payment plan to keep the asset, Chapter 13 is designed for that. Aside from these exceptions, a Chapter 7 bankruptcy results in a discharge of all debts. Depending on how much money and how many assets you have, you may have to pay some money to creditors before you get discharge, but you may not.
A Chapter 13 bankruptcy, sometimes called a “reorganization”, does not include a discharge. Instead, it is a formal process of setting up a plan to pay back arrears while staying current on your debts. In other words: it only makes sense if you can still pay debts on your big assets, but you need help catching up. Working with a lawyer, you come up with a payment plan and then submit it to the court and creditors.
Generally, a Chapter 7 bankruptcy is best for folks who do not have valuable assets like houses that they still owe money on and Chapter 13 is best for folks who do have those assets and can make the payments on them as long as they are adjusted. Also, whereas you can’t file more than one Chapter 7 bankruptcy within 8 years, you can file a Chapter 13 bankruptcy in that time. So if you have filed bankruptcy in the past few years and need to do so again, Chapter 13 could make sense.
Figuring out if you should use bankruptcy
Filing bankruptcy can provide a much-needed relief from threatening creditors, but it is not always (or even usually) the right option. It costs time, energy, and money. If you have other ways to reduce your debt burden or you have valuable assets that you don’t want to lose, it’s better to pursue other options. And if your debts are non-dischargeable (child support or student debt, e.g.), bankruptcy won’t really help. Plus you can’t just do it whenever you want: if you’ve declared bankruptcy in the past 8 years, you’re restricted from filing Chapter 7 again.
If you don’t know whether to file, most bankruptcy attorneys will provide free preliminary advice. Find one in your area with a good reputation, bring your financial documents with you, and see if they’ll help you figure out your situation for free. If you decide to declare bankruptcy, they can also help you file.
Some reasons you might not want to declare bankruptcy:
You declared a Chapter 7 bankruptcy in the past 8 years and want to declare Chapter 7 again. You can pay your debts relatively comfortably. If this is the case, you may be prevented from getting a bankruptcy discharge and you might take a hit to your credit. If you’re ruled to be abusing the bankruptcy system, you could also face penalties. You have secured debts (in a house or a car) that you won’t be able to keep up on even if you restructure your debts. Talk with a bankruptcy attorney for details on your situation. Bankruptcy could just be a faster way to lose this asset in this case. Your debts are legally questionable. If you have a defense to paying your debts, it’s better to get out of them without declaring bankruptcy than through the bankruptcy process. Your debts will not be relieved through bankruptcy. If you have student loans or child support or tax debts and they are the major source of your financial stress, bankruptcy likely won’t help you. If you can’t pay your debts and/or you’re facing down collectors, bankruptcy can be a lifesaver, though. Reach out to a bankruptcy attorney as soon as possible to figure out what makes sense for you.
Outline of the bankruptcy process
Before you decide whether bankruptcy makes sense, it may help to have a sense of how the process goes. Chapter 7 and Chapter 13 work slightly differently but share many features.
First steps in Ch. 7 and 13 The first step of any bankruptcy process should be to get a bankruptcy lawyer. You can technically file bankruptcy on your own and you may even do so successfully if you are the type of person who likes to research the law, sort through your accounts, and the like. But having a bankruptcy lawyer on your side really makes the process go more smoothly and is often a necessity.
Bankruptcy lawyers generally charge a flat fee for their services. How much they charge depends on where you are in the country and how fancy their firm is, but you could pay as little at a few hundred dollars for a bankruptcy attorney.
Generally you should not use an online filing service in place of an attorney. Some of these are scams and even the non-scams aren’t usually worth the money.
Because creditors like to make sure that every debtor feels shame, they lobbied to force everybody who files bankruptcy to sit through lectures on how to be “responsible” with your money. As such, you have to take an approved credit counseling course less than 180 days before filing. Generally these courses cost between $10 and $40. A list of approved providers is here or you can ask your lawyer or the court for a recommendation. Avoid for-profit companies. These sessions involve a review of your finances and sometimes shaming about filing bankruptcy. Ignore their bullshit and go through the finances. The session should take about an hour.
You can get out of the requirement if you’re disabled or if you’re in emergency circumstances. Courts are generally stingy with granting these waivers, but if you think you might qualify ask your bankruptcy attorney.
Once you’ve completed the course, you can file for bankruptcy. Filing involve filling out a petition, including a certificate from the credit counseling course, and extensive documentation of your finances. The forms are here. Again, all of this is easier if a lawyer is doing it with you.
After filing, all debt collection activity against you—including evictions, foreclosures, calls, everything—should stop. This is because filing for bankruptcy invokes what is called the automatic stay so that everything can be left as it was before bankruptcy and the bankruptcy court can work out who gets what. If creditors keep trying to collect on you, tell the court (or get your bankruptcy lawyer to do so). If your bankruptcy petition was filed improperly, the automatic stay may not apply.
At this stage Chapter 7 and Chapter 13 bankruptcies diverge.
Chapter 7 bankruptcy process
For Chapter 7 bankruptcies, a trustee will take charge of your case, determining how to dispose of your assets among creditors. You will likely get to keep most of your assets because they are exempt. Which assets are exempt depends on your state, but generally includes anything that is not especially valuable.
You may be required to show up to a meeting of creditors where you will have to answer questions from the trustee about your financial situation. Despite the name, it is likely that none of your creditors will show up—the trustee will ask all the questions. At this meeting or afterwards a creditor might try to get you to reaffirm a debt. This is usually not a good idea—talk with your bankruptcy attorney about your situation.
Then you will be required to endure yet another session of shaming, this time in the form of an “educational course” in personal finances that you have to be $20 to $50 for. They’re going to teach you that being broke is bad. Lovely. Screw them, but you gotta do it. Here is a list of providers.
If things in your case are complicated or one of your creditors is a real pain in the ass, you might have to go to court, but that’s pretty rare.
Finally, you will get your bankruptcy discharge.
Chapter 13 bankrutpcy process
For Chapter 13 bankruptcies, you and your bankruptcy attorney will have to come up with a bankruptcy plan, a schedule for paying off your debts. Usually you have to start paying on the plan within 30 days of filing.
Once you come up with a plan, you have to submit it to the trustee. The trustee then reviews the plan and calls a meeting of creditors to ask you questions about your finances and your plan. Although the trustee does have a say, they are not the final say on whether it gets approved. If they disapprove of your plan, you can appeal to the bankruptcy judge.
Within 45 days of the meeting of creditors, there is often a confirmation hearing in court where the bankruptcy judge reviews your plan and either approves or denies it. Sometimes this hearing is not held if no creditors object.
If your plan is approved and you stay current on your payments, you receive a bankruptcy discharge. But wait! You still have to complete yet another session of shaming, in the form of an “educational course” in personal finances that you have to be $20 to $50 for. As long as you do this before you finish your last payment, you can receive a bankruptcy discharge.
If your plan is not approved (even if you've tried to modify) and/or you miss payments, your case will either be dismissed and you’ll be left to creditors’ mercy or you can convert your case to Chapter 7. Scroll up to see how Chapter 7 works. If you faced an unexpected financial setback, you can get a hardship discharge instead.
Consequences of bankruptcy
At the end of bankruptcy, you receive a discharge (with some exceptions). That means that all the debts that are discharged you do not owe anymore.
Some debts are non-dischargeable in bankruptcy:
Tax debt (with some exceptions) Fines and penalties to most government agencies, including criminal fines Debts you took on fraudulently Debts you owe to somebody because you intentionally harmed them Child support and alimony debts Debts you did not include in your petition and those you agreed to repay/reaffirm during the bankruptcy proceedings Student debt is discussed below.
Just because a bankruptcy ends in a discharge, does not necessarily mean you get out of your debts without losing anything. As discussed above, if your debts are secured, they cannot be discharged unless you pay them off or give up the asset that secures them. And if you have enough assets, you may have to either pay or give them up even for unsecured debts. That depends on the exemptions in your state.
Bankruptcy goes on your credit report. Whether it harms your credit or not depends on how bad your credit was before bankruptcy. Bankruptcy can actually improve your credit, since it improves your debt/income ratio, making creditors more interested in lending to you. Be careful about offers you get right after bankruptcy: some creditors target people who have just received a discharge. Depending on where you live and, often, the color of your skin, you might have the opposite result: creditors avoiding you or giving you worse deals because of your bankruptcy.
A note on student loans
Before the 1970s, all student loans were fully dischargeable in bankruptcy. But as more and more student debt accumulated, creditors were worried about debtors being able to get out of it: they wanted to squeeze students for all they had. So they lobbied to limit the circumstances in which people with government-backed student loans could be discharged. Back then, nearly all student loans were backed by the government but issued by private lenders. In the 1990s, private student loans not backed by the government began to grow. So, in 2005, student lenders successfully lobbied to expand the limits on student loan discharges to include private student loans.
Technically, student debt is still dischargeable in bankruptcy, but only in cases of “undue hardship”. Most judges that have interpreted this standard have held that it means somebody must be in very extreme circumstances without any ability to get work (despite showing evidence of having tried over and over again). Some judges have been more lenient. But the standard has not been tested that many times, since many lawyers just assume it’s impossible and don’t want to take the time to litigate.
If you have student debt and think that bankruptcy makes sense, you should try to find a bankruptcy lawyer who is willing to fight to get your student loans discharged. They may be hard to find and you may not win. But it might be worth fighting if it otherwise makes sense to file bankruptcy.