Bankruptcy is a court proceeding in which a judge and a court trustee examine the assets and liabilities of individuals, partnerships, and businesses whose debts have grown so large that they no longer believe they can pay them.
The court decides whether to discharge the debts, which means that those who owe are no longer legally obligated to pay them. The court may also dismiss the case if it believes the individual or business has sufficient assets to pay their bills.
Bankruptcy laws were enacted to allow people to restart their lives after their finances had collapsed. Whether the collapse was the result of bad decisions or bad luck, lawmakers may recognize that a second chance is an important safety net in a capitalist economy.
The good news for anyone who is on the fence about filing for bankruptcy is that nearly everyone who does so is given a second chance.
In 2020, there were 544,463 bankruptcy filings. With 381,217 filings, Chapter 7 was the most popular form (70 percent ). Chapter 13 had 154,341 cases (28.3%), while Chapter 11 had only 8,113. (1 percent ).
In his 2020 study, Ed Flynn of the American Bankruptcy Institute (ABI) discovered that 94.9 percent of Chapter 7 filings were successfully discharged. Only 21,677 of the 442,145 completed cases in 2020 were dismissed.
Individuals who filed for Chapter 13 bankruptcy, also known as “wage earner’s insolvency,” did not fare as well. In fact, only 43.2 percent (106,476) of the 246,369 Chapter 13 cases completed in 2020 were successfully discharged. The vast majority of cases – 139,893 – were dismissed and thus failed.
Definition of Bankruptcy
When a company is unable to meet its financial obligations or make payments to its creditors, it declares insolvency. A petition is filed in court for the same, in which all of the company’s outstanding debts are measured and, if not paid in full, are paid out of the company’s assets.
Bankruptcy is a legal procedure used by a company to discharge its debt obligations. Debts that are not paid in full to creditors are forgiven by the owners. Bankruptcy laws differ from country to country.
In the United States, three main chapters are followed: Chapters 7, 11, and 13. Let’s take a closer look at each of them.
Under US bankruptcy law, a person or organization files for Chapter 7 bankruptcy, in which they liquidate their assets to repay their debt obligations. When you file for Chapter 7, all collection efforts from all creditors must be halted immediately.
Under US bankruptcy law, Chapter 11 means that a company will attempt to restructure its debts in order to meet its financial obligations. This bankruptcy code is only applicable to businesses and not to individuals. Chapter 11 demonstrates the company’s intention to pay off its debts, which is a good sign. It allows them to stay in business while also attempting to find ways to pay off their debts.
According to Chapter 13, individuals will attempt to restructure their resources or cash flow in order to pay off debt. Individuals and self-employed people can file for Chapter 13 bankruptcy, but corporations and partnership firms cannot.
Who Files for Bankruptcy?
Most individuals and businesses that file for bankruptcy have far more debts than money to cover them, and this situation is unlikely to change anytime soon. In 2020, insolvency filers owed $86 billion and had $56 billion in assets. The majority of those assets were real estate holdings, the value of which is debatable.
Bankruptcy, on the other hand, is frequently used as a financial planning tool when you have enough money to repay debts but need to restructure the terms. This is common when people need to repay mortgage arrears or taxes through a structured repayment plan.
What is surprising is that individuals, not businesses, are the ones who file for bankruptcy the most frequently. They owe money on a mortgage, credit card debt, auto loan, or student loan – possibly all four! – and do not have the income to pay it off.
In 2019, 774,940 bankruptcy cases were filed, with individuals filing 75% of them (752,160). Businesses filed only 22,780 bankruptcy cases in 2019.
Another surprise is that the majority of those declaring bankruptcy were not particularly wealthy. The median income for those who filed for Chapter 7 bankruptcy was only $31,284. With a median income of $41,532, Chapter 13 filers fared no better.
Understanding bankruptcy entails understanding that, while it is a chance to start over, it will have an impact on your credit and future ability to use money. It can prevent or delay foreclosure on a home and car repossession, as well as stop wage garnishment and other legal action used by creditors to collect debts.
However, there is a cost to be paid, and you will pay it for the next 7-10 years.
When Should I File for Bankruptcy?
If you’re wondering, “Should I file for bankruptcy?” Consider carefully whether you could pay off your debts in less than five years. If the answer is no, it’s time to file for bankruptcy.
The reasoning behind this is that the bankruptcy code was designed to give people a second chance rather than to punish them indefinitely. If you’ve been financially devastated by a combination of bad luck and bad decisions, and you don’t see that changing in the next five years, bankruptcy is your only option.
Even if you do not meet the criteria for bankruptcy, there is still hope for debt relief. A debt management program, a debt consolidation loan, or debt settlement are all options. Each of these options typically takes 3-5 years to complete, and none of them guarantees that all of your debts will be settled when you finish.
The decision should not be based on how long Chapter 7 bankruptcy takes; the process itself only takes 4-6 months. The important thing to remember is that bankruptcy has serious long-term consequences. It remains on your credit report for 7-10 years, making future loan applications extremely difficult.
On the other hand, there is a significant mental and emotional lift when all of your debts are discharged and you are given a fresh start.
Why File for Bankruptcy?
The obvious reason for declaring bankruptcy is that you are drowning financially and no one will throw you a lifeline – not banks, not online lenders, not family or friends.
Millions of people who lost their jobs or businesses as a result of the coronavirus now have some hope thanks to bankruptcy. They still had bills to pay and, in many cases, no way to do so. That’s what bankruptcy was supposed to solve. This is not a bailout. It was designed to help people get back on their feet financially and regain their peace of mind.
If your debts have accumulated to levels that your income cannot support, having them discharged through bankruptcy is a safe, legal, and practical option.
Bankruptcy in the United States
Bankruptcy filings in the United States fluctuate like the economy. In fact, they are like dance partners; where one goes, the other usually follows.
In 2005, there were just over two million bankruptcy filings. That same year, the insolvency Abuse Prevention and Consumer Protection Act was passed. That law was intended to stem the tide of consumers and businesses who were too eager to simply walk away from their debts.
The number of filings fell by 70% in 2006, but the Great Recession brought the economy to its knees, and insolvency filings skyrocketed to 1.6 million in 2010. They retreated again as the economy
improved, but the COVID-19 pandemic could easily reverse the trend in 2021. Many individuals and small businesses appear to be on the verge of declaring insolvency.
How to File for Bankruptcy
Filing for bankruptcy is a legal process that either reduces, restructures, or eliminates your debts. The bankruptcy court will decide whether you get that chance. You can file for insolvency on your own or hire a bankruptcy lawyer, which most experts recommend.
Attorney and filing fees are included in insolvency costs. If you file on your own, you will still be responsible for filing fees. If you cannot afford to hire an attorney, you may be able to obtain free legal services. If you need assistance finding an affordable bankruptcy lawyer or locating free legal services, contact the American Bar Association for resources and information.
Before you file, you should educate yourself on what happens when you file for bankruptcy. It’s not as simple as telling a judge, “I’m broke!” and throwing yourself at the mercy of the court. Individuals and businesses must follow a process that can be confusing and complicated at times.
The steps are as follows:
Compile financial information:
Make a list of all of your debts, assets, income, and expenses. This helps you, anyone assisting you, and, eventually, the court, understand your situation.
Get credit counseling within 180 days of filing if you haven’t already:
You cannot file for bankruptcy unless you have completed the required bankruptcy counseling. It assures the court that you have exhausted all other options prior to filing for bankruptcy. The counselor must be from an approved provider listed on the website of the United States Courts. Most credit counseling agencies provide this service online or over the phone, and once completed, you will receive a certificate of completion that must be included with the paperwork you file. If you do not complete this step, your application will be rejected.
Fill out the petition:
If you haven’t yet hired a bankruptcy attorney, now is the time. Although legal counsel is not required for individuals filing for bankruptcy, you are taking a significant risk if you represent yourself. Understanding federal and state insolvency laws, as well as which ones apply to your situation, is critical. Judges and court employees are not permitted to give advice. There are also numerous forms to fill out, as well as some significant differences between Chapters 7 and 13 that you should be aware of when making decisions. If you do not understand or follow the proper procedures and rules in court, it may have an impact on the outcome of your case. You also run the risk of the insolvency trustee seizing and selling your property if you don’t seek legal counsel.
Attend a meeting with creditors:
When your petition is approved, your case is assigned to a bankruptcy trustee, who arranges for a meeting with your creditors. You must attend, but the creditors are not required to do so. This is their chance to question you or the court trustee about your case.
Individuals, married couples, and businesses can file for various types of bankruptcy. Chapter 7 and Chapter 13 are the two most common types.
Bankruptcy under Chapter 7
For those with a low income and few assets, Chapter 7 bankruptcy is usually the best option. It is also the most common type of bankruptcy, accounting for 63 percent of all individual bankruptcy cases in 2019.
Chapter 7 bankruptcy is an opportunity to obtain a court judgment that releases you from the obligation to repay unsecured debts. You may also be allowed to keep key assets that are classified as “exempt” property. The non-exempt property will be sold in order to repay a portion of your debt.
The majority (or all) of your debts will be discharged at the end of a successful Chapter 7 filing, which means you will no longer have to repay them. Alimony, child support, certain types of unpaid taxes, and certain types of student loans are examples of debts that will not be discharged in bankruptcy.
Property exemptions differ from one state to the next. Depending on your state, you may be able to keep more possessions if you follow either state or federal law.
Exempt property can include some equity in your home, a car, work-related equipment, Social Security checks, pensions, veteran’s benefits, welfare, and retirement savings. These items cannot be sold or used to pay off debts. However, because exempt property differs so greatly from state to state, there is no comprehensive list of exempt property. If you are thinking about filing for bankruptcy, you should consult with a lawyer to see if your property is exempt in your state.
Excess cash, bank accounts, stock investments, coin or stamp collections, a second car or second home, and so on are examples of non-exempt property. Non-exempt items can be liquidated – sold by a bankruptcy trustee appointed by the court. The proceeds will be used to pay the trustee, cover administrative costs, and repay your creditors as much as possible if funds are available.
For ten years, a Chapter 7 bankruptcy will appear on your credit report. While it will have an immediate impact on your credit score, it is possible that it will improve overtime as you rebuild your finances.
Those who file for Chapter 7 bankruptcy will be subject to the United States Bankruptcy Court’s Chapter 7 means test, which is used to weed out those who may be able to repay some of their debt by restructuring their debt. The means test compares a debtor’s income over the previous six months to the median income in their state (50 percent higher, 50 percent lower). If your income is less than the median, you are eligible for Chapter 7.
If it is higher than the median, you may be able to qualify for Chapter 7 bankruptcy. The second means test compares your income to your essential expenses (rent/mortgage, food, clothing, and medical expenses) to determine your disposable income. If you have a low enough disposable income, you may be able to qualify for Chapter 7.
However, if a person has enough money coming in to pay off debts gradually, the bankruptcy judge is unlikely to allow a Chapter 7 filing. The greater an applicant’s income is in comparison to their debt, the less likely a Chapter 7 filing will be approved.
Keep in mind that filing fees and lawyer fees must be paid in order to file for insolvency. While some people may not qualify due to their high income, others may simply be unable to afford Chapter 7 bankruptcy due to the fees and expenses.
You may file for bankruptcy more than once as long as you do so after the waiting period expires. The waiting period for Chapter 7 bankruptcy is eight years, beginning on the date you first filed.
Bankruptcy under Chapter 13
Chapter 13 bankruptcies account for approximately 36% of all non-business insolvency filings. In a Chapter 13 bankruptcy, you repay some of your debts in order to have the remainder forgiven. This is an option for people who do not want to give up their property or who do not qualify for Chapter 7 bankruptcy due to a high income.
People can only file for Chapter 13 bankruptcy if their debts do not exceed a certain amount. Individuals’ unsecured debts could not exceed $394,725 in 2020, and secured debts could not exceed $1.184 million. The specific cutoff is reevaluated on a regular basis, so consult with a lawyer or credit counselor for the most recent figures.
You must create a three-to-five-year repayment plan for your creditors under Chapter 13. The remaining debts are erased once you successfully complete the plan.
However, the majority of people fail to complete their plans. When this occurs, debtors may decide to file for Chapter 7 bankruptcy. If they are unsuccessful, creditors may retry to collect the full amount owed.
Bankruptcy under Chapter 11
Chapter 11 is also known as “reorganization bankruptcy” because it allows businesses to continue operating while reorganizing their debts and assets to repay creditors.
This is primarily used by large corporations such as Hertz Rental Cars, J.C. Penney, Stein Mart, and the XFL, all of which filed for Chapter 11 bankruptcy protection in 2020. This form is appropriate for any size business, including partnerships and, in rare cases, individuals. Though the business continues to operate during the insolvency proceedings, the majority of decisions are made with the approval of the courts.
In 2019, there were only 6,808 Chapter 11 filings.
The central tenet of bankruptcy is that you are given a second chance with your finances. Chapter 7 (also known as liquidation) eliminates debt by selling non-exempt possessions with some monetary value. Chapter 13 (also known as the wage earner’s plan) allows you to create a 3-to-5-year plan to repay all of your debt while keeping what you own.
Both represent a new beginning, but often without some of the property (real estate, cars, jewelry, and so on) that may have caused the financial problem in the first place.
Filing for bankruptcy has an effect on your credit score. insolvency stays on your credit report for 7-10 years, depending on which chapter you file under. A Chapter 7 filing (the most common) remains on your credit report for ten years, while a Chapter 13 filing (the second most common) remains on your credit report for seven years.
During this time, an insolvency discharge may make it difficult to obtain new lines of credit and may even cause problems when applying for jobs. If you have loans that were co-signed by family or friends, they may be responsible for repaying at least a portion of the debt.
If you are considering bankruptcy, your credit report and credit score are most likely already harmed. Your credit report may improve if you pay your bills on time after declaring bankruptcy.
Nonetheless, due to the long-term consequences of bankruptcy, some experts believe that at least $15,000 in debt is required for insolvency to be beneficial.
Where Bankruptcy Doesn’t Help
Bankruptcy does not automatically discharge all financial obligations.
It does not discharge the following types of debts and obligations:
- Student loans from the government (unless you meet very strict criteria).
- Alimony and child support are ordered by the court.
- Debts incurred following the filing of a bankruptcy petition.
- Some debts incurred in the six months preceding the filing of the insolvency petition.
- There are some taxes.
- Loans obtained through deception.
- Debts incurred as a result of a personal injury sustained while driving while intoxicated.
It also does not protect those who have co-signed on your debts. Your co-signer agreed to pay your loan if you couldn’t or didn’t want to. Your co-signer may still be legally obligated to pay all or part of your loan if you declare insolvency.
Most people consider bankruptcy only after they have exhausted their options for debt management, debt consolidation, or debt settlement. If none of these options are available, it may be worthwhile to investigate low-cost bankruptcy options.
Debt management is a service provided by nonprofit credit counseling agencies that aim to lower the interest rate on credit card debt and come up with an affordable monthly payment to pay it off. Debt consolidation is the process of combining all of your loans in order to help you make regular and timely payments on your debts. Debt settlement is a method of negotiating with your creditors to reduce your outstanding balance. If you are successful, it will directly reduce your debts.
However, if you are thinking about debt settlement instead of insolvency because of how it will affect your credit, it may not be the best option. In many cases, debt settlement is reflected on your credit report as a negative item, much like insolvency. Before making a decision, consult with legal counsel to determine your best course of action.
When deciding whether to file for bankruptcy, there are numerous factors to consider. Your decision will be heavily influenced by your personal circumstances and financial objectives.
Most types of debt, including credit card debt, medical bills, and personal loans, are dischargeable in Chapter 7 bankruptcy. When the bankruptcy court grants you a bankruptcy discharge, you are relieved of your obligation to pay these types of unsecured debt.
There is no minimum debt required to file for bankruptcy, so the amount is irrelevant. Credit card debt, cash advance (payday) loans, and medical bills are examples of unsecured debts. Secured debts: If you are behind on your mortgage or car payment, now may be an excellent time to file for bankruptcy.
Unemployment, large medical bills, severely overextended credit, and marital problems are all common reasons for declaring bankruptcy. Your assets’ cash is distributed to creditors such as banks and credit card companies.
If your annual income is less than $84,952 (as calculated on line 12b), you may be able to file Chapter 7 bankruptcy. If it is more than $84,952, you must proceed to Form 122A-2, which we will discuss in the following section. It should be noted that each state calculates median income differently.
To be eligible for the fee waiver, you must file Form 103B – Application to Have the Chapter 7 Filing Fee Waived – which should be included with your bankruptcy filing. This form requires you to certify your income and the fact that you are unable to make installment payments.
Although your employer may become aware of your bankruptcy case, rest assured that in most cases, your bankruptcy will have no impact on your current employment. However, it may prevent you from later obtaining employment in the private sector.
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