How Bankruptcy Works

If you lived in Ancient Greece and were unable to pay your debts, the system came down pretty hard.

Your creditor could put you and your family into “debt bondage” and force you to work however he saw fit.

Until your debts were paid off… or you died.

Today, thankfully, in the vast majority of the world “debt slavery” is a figure of speech, as opposed to, well… real slavery.

But the stress caused by mounting debt can still feel like you’re dragging along a ball and chain.

Massive medical bills, spiraling credit cards, out-of-control student loans can make the strongest among us weak at the knees.

If only there was some magic phrase you could just shout to make it all disappear… I...

Declare...

BANKRUPTCY!!!

As you know and Michael Scott quickly learns, “bankruptcy” isn’t just a word you declare and your debts disappear.

It’s a complicated legal status that is designed to provide relief to those who are financially insolvent.

If you’ve cut your expenses down to a barebones lifestyle, and still can’t make minimum payments on your loans, it might be time to think about bankruptcy.

That relief can seem like a life-preserver when you’re caught in a rising sea of debts.

But how does bankruptcy work?

What are the risks?

And can it really make all your problems disappear?

In the United States, there are multiple forms of bankruptcy you can declare for debt relief.

There’s bankruptcy for businesses, farmers, even municipalities.

But the most common forms of personal bankruptcy you’ll hear people talk about are Chapter 7 and Chapter 13.

The first thing you need to know is that, believe it or not, it actually costs money to file for bankruptcy!

$335 dollars in fact to file for a Chapter 7 and $310 for a Chapter 13.

If you choose to hire a bankruptcy lawyer, you will also be responsible for paying the lawyer’s fees which will likely be somewhere between $1,500 and $4,000 dollars depending on which kind you file for and the complexity of the case.

Chapter 7 bankruptcy is a liquidation bankruptcy where non-exempt property is sold and used to pay off your debts.

It’s generally meant for people with limited incomes who do not have the ability to pay back all or some portion of their debts.

But The government doesn’t allow just anyone to file for it.

First, you must pass the Chapter 7 “Means Test”.

The easiest way to pass is if your annual income is below your state’s median.

This number usually falls between Forty and Seventy Thousand Dollars, again, depending on your state.

You can find the specifics for each state here.

If your income isn’t low enough, you might still be able to pass the test by proving you don’t have a lot of “disposable income”.

To find out if you pass either of these tests, you can simply fill out government forms 122A 1 and 2.

If you qualify, the court will decide what is up for grabs to sell off.

But states usually have a list of personal property exemptions, such as a basic vehicle, some equity in your home, even cash you’ve got in bank accounts and retirement savings.

So you won’t end up living on the street or without transportation.

If you’re married and filing together, that can typically double the value of exemptions.

But there’s definitely downsides.

You won’t be allowed to use credit cards for quite a while, maybe years.

And those student loans you hate…yeah…the lenders will have to stop harassing you with calls, but they’re not going anywhere.

Unfortunately student loans are not eligible for forgiveness.

If you can’t meet the requirements of Chapter 7, you might want to check out Chapter 13, also known as reorganization bankruptcy.

Your property is not sold when you file, but you will be required to complete a three-to-five year court-mandated payment plan.

If you play by the court’s rules and don’t miss a payment, any unsecured debts that remain after that time period, like credit cards and medical bills, may be “discharged” or forgiven.

To be eligible you have to have regular income; unsecured debts under $394,725 dollars and; Secured Debts under $1,184,200 dollars.

But, as with Chapter 7, even if you successfully complete the process, there are certain types of debts not eligible for forgiveness, like tax debt, child support, and yep, once again… student loans.

It’s also probably no surprise that bankruptcy can dramatically decrease your credit score, and will stay on your report for 7-10 years.

This can cause issues with potentially finding a place to rent or even change jobs since many employers now look at credit reports.

But if you were already behind on debt payments before you filed, your credit score is most likely already shot and it won’t make it that much worse.

And don’t despair.

Bad credit scores are like broken bones, they’re designed to heal over time assuming you follow doctors orders and don’t engage in the behavior that broke it in the first place.

Keep in mind this bankruptcy is also going to be on public record.

It’s not like you’ll be forced to wear a Scarlet B on you chest, but if the court decides to take your payments from your paychecks directly, your employer will be notified as will any co-signers that may be on your loans.

Then there’s one last thing you’ll be required to do.

Before your debts are discharged you’ll have to attend an approved course on consumer debt.

These tend to focus on financial education and lessons on budgeting, and are designed to help prevent you filing for bankruptcy again.

If there were only a place to learn these lessons beforehand… Bankruptcy is not a simple or fast process.

Filing and acceptance can take many months, and you have to be 100% diligent about following every court order to the letter, and paying every bill you’re still on the hook for, like property taxes or student loans.

If it’s used as a last resort, bankruptcy can offer you the relief you need.

It might put you through the ringer, but at some point, it will end and you can start over.

And that's our Two Cents!

If you or someone you know has gone through personal bankruptcy, what do you wish you had known beforehand?

Let us know in the comments.