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Main Page > Getting Out of Debt - Step by Step Instruction
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What about bankruptcy?
Bankruptcy is the option of last resort for people with overwhelming debt
problems. When you file for bankruptcy, you are asking a bankruptcy judge to
approve a plan that divides whatever assets you have among your creditors
(the people and businesses you owe money). You may also be asking the court to
discharge or cancel your debts if you do not have enough money or property
to pay the debt. In return for a very visible and long-lasting black mark on your
credit record, bankruptcy allows you to pay what you can to your creditors and
walk away from your debts.
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It’s actually fairly simple. Working with an attorney, you file for bankruptcy in
federal court. The filing fees aren’t very expensive. Attorney’s fees vary widely.
You choose between two personal bankruptcy options: Chapter 7 and Chapter 13.
The court reviews your finances and decides whether to allow you to file for
bankruptcy, and which of the two bankruptcy options is right for you.
Chapter 7 and Chapter 13 bankruptcy
Chapter 7, known as straight bankruptcy or liquidation, is the more drastic step
and historically has been the more common choice. (Recent legislation has made
it more difficult to gain a court’s approval to file for Chapter 7 bankruptcy, and
courts are steering more people to Chapter 13 bankruptcy.) Here’s what happens
in a Chapter 7 bankruptcy:
- If the court grants your bankruptcy petition, a court trustee decides which of your assets you can keep. These are called exempt assets. Different states have different rules about what you can keep in order to move on with your life. A federal code applies in all states, and you can choose whether to have your assets reviewed under the state or federal guidelines. Under the federal code, exempt assets include
- a portion of the equity you have in your home (up to $17,425 in 2003) if you commit to keeping up with mortgage payments
- your car, truck, or motor vehicle (up to $2,775 in value in 2003) or a small amount of equity in your car if you commit to keeping up with loan payments
- jewelry (up to $1,150 in 2003)
This is not a complete list, just a sample to show some of the more commonly
used exemptions. Basic household furnishings and work-related tools are also
exempt in most states, for example. The dollar amounts are for an individual.
If a married couple is filing together, the exemptions will be double. And the
amounts are subject to change.
- Other high-value assets that do not qualify for exemption are turned over to the court trustee, who may then sell these assets at public auction and divide up the proceeds among your creditors.
- You are still responsible for certain debts and obligations: student loans, overdue taxes, alimony, child support, and fraudulent loans. (A loan is considered fraudulent if you slightly exaggerated your income on the application or took any steps to hide a bad credit record.) These debts and obligations are still yours to pay even after the bankruptcy is final.
Chapter 13, a more limited form of bankruptcy also known as reorganization,
allows you to keep all of your property while you repay your bills. It is similar in
many ways to the process of working with a credit counseling service, only
the court provides you with full legal protection from your creditors. You qualify
for Chapter 13 bankruptcy by showing that you are employed and have enough
income to pay reduced living expenses and repay your debts over time.
- If your petition is accepted, you submit a detailed budget to the court.
- The court reviews your budget, revises it, and turns it into a monthly debt payment plan.
- You are ordered to make debt payments directly to the court, and the court pays your creditors.
- If you fall behind in your payments to the court, you will be found in contempt of court and your case dismissed. You’ll no longer be protected from your creditors. If you have no other options, you might then file for Chapter 7 bankruptcy (under which your non-exempt assets are turned over to the court and sold, with the proceeds going to your creditors).
When is bankruptcy the right choice and when is it not?
Bankruptcy is relatively easy. Over a million people file for personal bankruptcy
every year. (In 2001, the number was over one and a half million.) For some
people, it’s the sensible option. If a medical crisis kept you out of work or left you
with extraordinarily high medical bills; if an accident or disease has left you with a
disability that reduces your ability to earn an income; or if a divorce has left you
with high debts, child care responsibilities, and a reduced income, your debts may
be beyond your ability to repay.
But a large and growing number of people who file for bankruptcy are doing it
for the second time. For people who’ve arrived at bankruptcy as a result of careless
spending and a casual reliance on credit, bankruptcy can be seen as a quick
fix that will solve a chronic debt problem. It’s not. Bankruptcy doesn’t get at the
underlying root of a debt problem. Only you can do that. If debt spending is your
problem, the only way to solve it is through a long-term commitment to debt
reduction. It’s your money behavior that needs to change.
The problems bankruptcy doesn’t solve
Beyond the fact that it doesn’t solve most people’s debt spending problems,
bankruptcy brings with it some other penalties.
- For the next ten years, your bankruptcy will be reported as part of your credit record when you apply for a loan, rent an apartment, or apply for a job.
- Your bankruptcy will be reported as part of your credit record forever when you apply for a job that pays more than $20,000 a year or for a loan of more than $50,000.
- When you look for a job, an employer may see your bankruptcy as a reflection on your character. It may be the deciding factor against you when you are compared to another candidate.
- When you look for an apartment, a landlord may see your bankruptcy as a warning that you’ll fall behind in your rent, and can use that information when deciding to rent to someone else. You will find it very difficult to re-establish credit, at least for the next few years. You might be able to get a credit card with a low spending limit—but with a requirement that you keep at least that much on deposit at the bank that issues the card. You might be able to lease a car—if you are able to pay 70 percent of the total value of the lease up front.
- The Internal Revenue Service gets a report of the bankruptcy settlement and considers as income any debt from which you are released. You will owe income tax on that amount.
Bankruptcy has its place. For people who have gotten into financial difficulties
that really are beyond their ability to resolve, it offers a way to make a fresh start
on sound footing. But for many—perhaps most—of the people who now use it,
bankruptcy simply extends money problems into a lifetime of juggling and worry.
Getting Out of Debts (Step by Step Instructions)
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