Statute of Limitations on Debt
If you get too deep in debt, your income collapses, or you experience a major life crisis, you may need to consider bankruptcy.
It’s a difficult process, but it may be necessary if you see no way out of your current debt problems.
You’ll have credit issues to deal with after the fact. But it may be more important to get out from under the immediate crisis and work through the credit fallout later.
Table of Contents:
- Most Common Types of Bankruptcy
- Other Types of Bankruptcy
- Should I File For Bankruptcy?
- Are There Steps I Can Take Before Bankruptcy?
- What To Know About Filing Bankruptcy
- What Type of Bankruptcy is Best For Me?
- How Long a Bankruptcy Stays on Your Credit Report
- Removing a Bankruptcy from Your Credit Report
- Credit Repair After Bankruptcy
- Bankruptcy Explanation Letter
The Most Common Types of Bankruptcy
More than anything else, bankruptcy is intended to be a fresh start for consumers, small businesses, corporations, and even municipalities. Sometimes a fresh start is exactly what you need.
There are three primary types of bankruptcy that apply to individuals.
Each type of consumer bankruptcy is structured differently and has its own nuances. Let’s discuss all three.
Chapter 7 Bankruptcy
Chapter 7 bankruptcy is sometimes referred to as total bankruptcy.
That’s because all your debts are legally eliminated through the bankruptcy proceedings.
In most cases, you’ll work with a bankruptcy attorney who will file the necessary paperwork with the bankruptcy court.
After several months, the discharge will be issued.
As soon as you file for a Chapter 7 bankruptcy process, the law will impose an automatic stay, preventing most of your creditors from taking further collection action.
This means they won’t be able to put a lien on your house, seize your bank account, or garnish your wages.
If that sounds too simple, it’s because it is.
Chapter 7 bankruptcy is also called liquidation bankruptcy because the court-appointed trustee can seize your assets to use as a partial repayment to your creditors.
So while you may get out of debt in just a few months, you may still lose substantial assets in the process.
However, each state lets you protect a certain dollar value in specific assets from bankruptcy liquidation. Your exemptions and their dollar amounts depend on the bankruptcy laws of your state.
For example, California lets its citizens retain up to $75,000 in owner-occupied real estate equity if you’re single and up to $150,000 for families.
The exemptions tend to be higher if you’re a senior citizen or disabled. You can also exempt automobile equity up to $1,900, and up to $2,000 in bank deposits from Social Security.
Other states, like New York, let you choose federal exemptions if you prefer, though you could also choose the state exemptions if they better suit your needs.
Typically, employer-sponsored retirement plans are typically exempt, and most states also shield individual retirement accounts (IRAs) as well.
Any amounts you have in excess of state (or federal) exemption limits can be seized by the bankruptcy court and used to pay your debtors. Non-exempt assets often include second homes, investment properties, and taxable investment accounts, among other assets.
Filing for Chapter 7 Bankruptcy
Filing fees for Chapter 7 bankruptcy protection can range from a few hundred to a few thousand dollars, depending on the complexity of your case. You’ll not be able to discharge these fees in the bankruptcy.
There are limitations to Chapter 7 bankruptcy.
For example, you won’t be able to file if you previously filed for bankruptcy within the past six to eight years. Your eligibility will also be based on your ability to repay.
If you have sufficient income left over after paying your necessary living expenses, and it’s considered enough to pay off a large amount of your debt, you may be required to file Chapter 13 bankruptcy instead.
You should also be aware that bankruptcy does not discharge all debts.
Obligations such as child support, tax debts, and student loans cannot be discharged in bankruptcy unless the bankruptcy court determines there are extenuating circumstances.
Also, if a creditor can show you took a loan based on fraudulent information, it may be excluded from the discharge.
Not everyone can qualify for Chapter 7 bankruptcy.
United States courts will administer the Chapter 7 means test to see whether you could repay your debts by restructuring them instead of dissolving them.
The means test compares your income to the median income over the past six months prior to bankruptcy filing. If you earned less than the median income during that period, you can file Chapter 7 bankruptcy in federal court.
Chapter 11 Bankruptcy
Chapter 11 bankruptcy is commonly referred to as reorganization bankruptcy in U.S. courts.
That’s because it allows for the reorganization of the debtor’s business and financial affairs, including debts and assets. It’s typically filed by corporations looking for protection from creditors, and to give them time to restructure their debts.
It’s more similar to Chapter 13 because it doesn’t discharge the debtor’s obligations; it simply gives them time to improve their situation.
Because filing bankruptcy through Chapter 11 is more complicated than filing personal bankruptcy, it’s much more expensive to bring about.
Chapter 11 allows the business to continue operating during bankruptcy proceedings. Many large companies have used this form of bankruptcy to reorganize their debts and survive the bankruptcy intact.
To begin the process, the business will propose a reorganization plan. It may include reducing business operations and expenses, as well as renegotiating certain debts.
The business may even obtain an entirely new financing arrangement as part of the bankruptcy plan. They can also propose liquidating certain assets for payment of obligations. If the creditors are unsatisfied with that plan, they can offer an alternative plan.
In most cases, Chapter 11 is filed by corporations, partnerships, and limited liability companies. However. it is available for personal bankruptcy for those who have an excessive amount of debt or don’t qualify for either Chapter 7 or 13.
Like I said above, the business can keep operating during bankruptcy. However, bankruptcy cases involving fraud, other criminal activity, or gross incompetence may prompt a court to appoint a bankruptcy trustee to run the business during the proceedings.
If that happens, the business will not be able to make certain decisions without court approval. This may include the sale of assets, entering in new business arrangements, or terminating existing ones.
Chapter 13 Bankruptcy
Chapter 13 is a form of consumer bankruptcy that involves a repayment plan. The plan will be based on your income still available after paying the necessary living expenses.
The term of the repayment is normally between three years and five years, though it’s possible to pay it off in less time.
The main advantage of Chapter 13 bankruptcy is that you will not be forced into the liquidation of your assets. Chapter 13 is typically available only if you have a regular income, such as a steady salary.
There are also limits on the amount of debt you can owe to qualify. For example, if it’s clear you won’t be able to pay off a significant amount of debt within the five-year term, based on the income you have available, you’ll most likely be put into Chapter 7.
Chapter 13 bankruptcy does impose a hierarchy on debts. Certain debts referred to as priority claims, must be fully included in the payment plan. These include child support, alimony, and most tax debts.
Secured debts, like a mortgage or car loan, will need to be included if you want to keep those assets.
Unsecured debt will be paid out of what remains after the payment portion for priority debts and secured debts are covered.
These include credit cards, medical debts, and other unsecured obligations. It isn’t even necessary that you’ll be able to pay off the entire unsecured balances, or even any at all.
Though you’ll be able to protect most of your assets from the liquidation using Chapter 13, it will generally require several years of making monthly payments.
And as long as you’re in the payment plan, it will be more difficult to secure new credit going forward.
Other Different Types of Bankruptcy
While Chapter 7 and Chapter 13 are the most common types of bankruptcy in the United States, there are many types of bankruptcy that can apply to a variety of scenarios.
We’ve already discussed Chapter 11 above, but here are some other important but lesser-known forms of bankruptcy code:
Chapter 9 bankruptcy applies to cities or towns. This type of bankruptcy protects municipalities from creditors while a city develops a plan to deal with its debt.
A city may file for Chapter 9 if an industry closes and people leave to find work in other cities. The most well-known example of a city filing for Chapter 9 is Detroit, which is the largest city to ever file for Chapter 9 bankruptcy.
More recently, Fairfield, Ala., filed for bankruptcy protection under federal law after a Walmart distribution center closed.
Other cities and counties have lost revenue during the Covid-19 pandemic and have been considering Chapter 9 bankruptcy proceedings.
Chapter 12 bankruptcy allows family farmers to propose a plan to repay all or part of their existing debts. This form of bankruptcy is very similar to Chapter 11 because the farmer is allowed to remain operational while making payments to lower debt.
Because of the seasonal nature of these professions, allowances are made for when a person can make payments on their debt. However, all payments must be completed within five years of filing.
There are restrictions for who can qualify for Chapter 12 based on annual salary as a farmer. Your debt cannot exceed $4.03 million for farmers or $1.87 million for fishermen.
Chapter 15 bankruptcy is a fairly obscure form of bankruptcy that involves debtors with debts in the United States and abroad. It is a way for foreign creditors to gain access to the US Bankruptcy Courts and sue their debtor for repayment.
These cases typically start as insolvency cases in foreign countries and make their way back to the United States court system.
This is a fairly recent addition to the bankruptcy code. It was added as a part of the Bankruptcy Abuse Prevention and Consumer Protection Act in 2005.
Should I File for Bankruptcy?
Filing bankruptcy is often treated as a last resort when it comes to handling overwhelming debt.
Below are some examples of circumstances in which filing for bankruptcy may be necessary.
You’ve Been Unemployed For Some Time
Just losing your job is not a reason to file for bankruptcy. However, if you have been unemployed for an extended period of time and have no prospects for a regular income in the near future, it may be time to consider filing Chapter 7.
Your Home is Nearing Foreclosure
Filing for bankruptcy can issue a stay on any collections or foreclosure activity which means that creditors cannot continue to harass you for bill payment or repossess your home.
However, bankruptcy cannot prevent creditors from repossessing the property if there is a lien agreement already in place.
A lien states that a creditor can repossess the property if you fail to make payments on time. Consult a professional if you are unsure if a creditor has a lien on your home or car.
You Have Substantial Unpaid Medical Bills
One of the most common reasons that people file for bankruptcy is overwhelming medical bills.
Filing for Chapter 7 or Chapter 13 can help alleviate debt from unpaid medical bills.
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You Have Pending Lawsuits for Unpaid Debt
When creditors aren’t getting paid even after consulting a collection agency, they may turn to lawsuits.
Bankruptcy will stop creditors from continuing collections activities, but it will not help with any court fees.
It is best to file for bankruptcy before creditors pursue court action to avoid accumulating any legal costs.
Your Wages Are Being Garnished
Wage garnishment is usually the result of a creditor successfully suing you for payment. Filing for bankruptcy will stop all your wages from being garnished and can even help you to get some of your garnished wages back.
You’re 90 Days Overdue On All Your Debts
There are certain conditions that determine your eligibility to file for bankruptcy. Most courts will require that you be at least 90 days overdue on all your debts in order to file for Chapter 7 and Chapter 13.
Otherwise, your circumstance may not be seen as dire enough to file bankruptcy.
Are There Steps I Can Take Before Filing Bankruptcy?
It can be difficult to determine if bankruptcy is your best option. Based on some of the situations listed above, you may decide your situation is not severe enough to warrant bankruptcy.
Even if you think your finances are too overwhelming to ever gain control, there are certain steps you can take to help regain control of your circumstances.
Negotiate With Creditors
When you file for bankruptcy, any debt that remains unpaid after filing is dismissed by the court.
Creditors would rather negotiate with you than have the debt discharged. Try negotiating with your creditors to set up a reasonable payment plan based on your income and assets.
If you cannot successfully negotiate with your creditors, you may seek the assistance of a consumer credit counselor.
Credit counseling involves a consumer credit counselor negotiating lower interest rates and monthly payments with creditors.
Typically, a judge will require you to attend credit counseling for a certain period of time before filing for bankruptcy.
If you feel like your finances are headed in that direction, it is definitely worth a shot.
What Should I Know About Filing Bankruptcy?
Once you decide it is time to file for bankruptcy, it is important to file properly and be cognizant of the consequences.
Below are some filing bankruptcy basics.
Hire an Attorney
An attorney can help you navigate the bankruptcy process. Bankruptcy laws are complicated, and you’ll need a professional to represent you.
Attorney fees typically cost anywhere from $2,000 to $4,000. This may seem expensive, but it is better than accumulating penalties and fees by filing incorrectly.
Plus, your bankruptcy lawyer can save you a ton of money by helping you protect assets that are not non-exempt property.
Bankruptcy Will Affect Your Credit
Bankruptcy filings stay on your credit report for seven to ten years.
Your score can be affected anywhere from 50 to 200 points, depending on how high your credit score already is.
This will impact your ability to qualify for certain loans and low-interest rates far into the future. I’ll share some strategies for recovering and compensating for this problem below.
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It Will Become Public Record
While bankruptcy affects your credit for only a certain period of time, it will remain on your public record indefinitely.
Future lenders will know if you have declared bankruptcy in the past and can make decisions based on this.
However, employers cannot terminate you based on your bankruptcy status.
There Is a Fee of About $300
With attorney fees and property liquidation, this fee may feel like salt in the wound.
However, the fee can be waived if your household income is less than 150 percent of the poverty lines.
What Type of Bankruptcy Is Best For Me?
If you are dealing with personal debt, Chapter 7 or Chapter 13 are likely your best options.
These are the most common filings for credit card debt, medical bills, personal loans, or periods of unemployment.
You should consider filing Chapter 7 if you are unable to make monthly payments and have few assets that could be subject to liquidation.
Chapter 13 restructuring is ideal if your debt does not exceed the limit set by the court and you have a consistent income.
Before filing for bankruptcy, consult a professional who is familiar with the bankruptcy code.
An attorney, for example, can help you identify which type of bankruptcy best fits your financial circumstance.
How Long Does a Bankruptcy Stay on Your Credit Report?
According to myFICO.com, a bankruptcy will remain on your credit report for seven years after the completion of Chapter 13, and for 10 years after the completion of Chapter 7.
That may seem like a long time, but the impact of the entry on your credit report will decline over time. Certainly, the greatest negative impact will be within the first two years.
But after that, your credit score should begin to improve – as long as you begin taking new credit and making your payments on time.
As each year passes, your credit score should improve a little bit more – even though the bankruptcy is still showing on the report.
For example, the negative impact will be less five years after discharge than it will be after two years. When it comes to bankruptcy and your credit report, patience truly is a virtue.
You could help yourself with a secured credit card during this time. It’ll prove you can make regular payments without a lender putting any money on the line for you.
Just be aware some creditors have a “no bankruptcy” policy. Even if your bankruptcy was discharged several years ago, and your credit score has improved significantly, they may still decline your application.
Wherever possible, you should determine if a lender has this policy before making an application.
Removing a Bankruptcy From Your Credit Report
Since a bankruptcy appears on your credit report as a public record (from the court), the only way to remove the bankruptcy from your credit report is to wait until the necessary seven or 10 years have passed.
If you’re approached by a credit repair company that claims they can remove it from your report, it’s a bogus company.
The only time a bankruptcy entry can be removed from your credit report is if it appears in error.
That’s a possibility if you have a common name, like John Smith, or if someone in your family with the same name filed for bankruptcy.
If that happens, you’ll need to contact each of the three credit repositories – Experian, TransUnion, and Equifax – and dispute the entry.
They’re required by law to investigate your claim and will remove the entry if more specific information, like your Social Security number, doesn’t match with the actual bankruptcy case.
Credit Repair After Bankruptcy
So much of the benefit of bankruptcy depends on what you do to repair your credit after bankruptcy. You’ll need to begin gradually rebuilding your credit, but be careful.
There are lenders who specifically target people coming out of bankruptcy. They do this because they know that such people are anxious to begin rebuilding their credit.
But also because they know once you file for bankruptcy, you won’t be able to do it for several more years. That will prevent you from discharging a loan from that creditor for many more years.
The problem is that many of these companies are predatory. They’ll charge very high-interest rates, high fees, or a combination of both.
While you may be anxious to begin rebuilding your credit, these lenders are mostly interested in exploiting your situation for high income. Don’t fall for it, there are better ways.
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Secured Credit Cards and Credit Builder Loans to the Rescue
In most cases, the best ways are to open either a secured credit card or what’s known as a credit builder loan.
There are specialized credit card lenders, as well as a very few banks and credit unions, that offer secured credit cards.
In most cases, you’ll need to open a savings account, and the amount of your credit line will be equal to the balance in the account. For example, with a $500 savings account, you’ll be issued a credit card with a $500 credit line.
There are a few specialized lenders that will even approve a credit card with a small credit line with a deposit that’s less than the credit line.
For example, you may be issued a credit limit of $200 for a deposit of $50 or $100. The downside of this type of card is that the credit limits are low, generally no more than $300. They also charge high annual fees, ranging between $75 and $100.
In either case, you’ll be issued a credit card that works like any other when you shop online or with a retailer. Your payments will be reported to all three credit bureaus, giving you an opportunity to build new, good credit.
This will be important to offset the bankruptcy entry on your report. The more good credit you have, the higher your credit score will go.
Credit Builder Loans
A credit builder loan can be even more effective than secured credit cards, particularly if you have no money. They’re offered by many banks and credit unions – in fact, they’re becoming steadily more common across the industry.
Basically, you apply for a loan, say $1,000. Even though you have a very low credit score as a result of the bankruptcy, the bank approves the loan.
But instead of giving you the funds, they’re deposited into a savings account. The monthly payments are then automatically withdrawn from the savings account to pay the loan, guaranteeing on-time repayment. Loan terms are usually between 12 and 18 months.
Once the credit builder loan is paid, not only will you have a perfect payment history on the loan, but you’ll also have a paid-off loan post-bankruptcy. That’s one of the strongest credit entries you can have on a credit report. And all of that will be reported to the three credit bureaus.
If you can get two or three of these loans in place as soon as possible after your bankruptcy discharge, you’ll be able to rebuild your credit score pretty quickly.
Best of all, the whole process will take place out of sight. Since the bank will be making automatic withdrawals from the savings account to pay the loan, you won’t have to worry. In most cases, the most it’ll cost you is maybe $50 or $100 for the interest on the loan.
Bankruptcy Explanation Letter
Should you file for bankruptcy, you’ll need to have a bankruptcy explanation letter prepared as soon as possible.
Anytime you apply for credit – or even for a job or an apartment – you’ll need to be ready to submit that letter.
A good bankruptcy explanation letter will explain the reasons why you filed for bankruptcy.
Your challenge will be to make it clear the bankruptcy resulted from a one-time event, such as a job loss, business failure, divorce, or health-related issue.
The letter will also need to convince the reader you’ve overcome the problem and will be highly unlikely to be in a similar credit position in the future.
For example, if the coronavirus pandemic wrecked your small business, you can cite this factor.
With a convincing bankruptcy explanation letter and two or three good credit references on your credit report, you should begin making steady progress in rebuilding your credit going forward.
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