BANKRUPTCY IS A BIG step one that will follow you around for seven to 10 years, depending on the route you take. And the requirements have become much stricter than they were a few years ago, thanks to changes in bankruptcy law.
Here are answers to the 10 most frequently asked questions about bankruptcy.
1. What Is the Difference Between Chapter 7 and Chapter 13?
If you file for Chapter 7 bankruptcy, most of your unsecured debts are written off within 90 days of filing. The bankruptcy will stay on your credit report for 10 years. While debts will be forgiven, you'll have to sell some of your property, with the proceeds distributed to your creditors. In most cases, this means you'll lose your home (if you own it), as well as any expensive items such as art, jewelry and pricey consumer electronics.
Chapter 13, on the other hand, is a repayment plan: You set up a three- or five-year schedule with your creditors. Chapter 13 bankruptcy remains on your credit report for seven years. With this type of bankruptcy, you get to keep all your property, including your home.
2. Is Chapter 7 Bankruptcy Right for Me?
You might be a candidate for Chapter 7 if you have no assets to lose, like a house or a car, and if after you pay for your basic monthly expenses, you have no money left to pay off debts. Chapter 7 essentially wipes the slate clean, but you'd most likely lose any valuable possessions.
Just how much a filer will have to hand over depends on where he or she lives, and for how long. If you've lived in your state for fewer than 730 days, you must abide by the exemption rules of the state where you lived before moving. This requirement was introduced to stop people from moving to a state that has better exemptions and declaring bankruptcy the following day. Exemptions vary greatly from one state to another. In Florida and Texas, for example, filers can keep their home no matter how much it's worth, but most other states exempt only a limited amount of home equity or other property.
The exemptions for other assets, such as bank and retirement savings accounts, and property, like furniture and clothes, also vary widely. (Note that 401(k) accounts, Social Security income and individual retirement accounts are federally exempt in bankruptcy.) Bankruptcyaction.com, a bankruptcy-information Web site, has a detailed list of exemptions by state.
3. When Does Chapter 13 Make Sense?
Chapter 13 is typically recommended for debtors who've fallen behind on their payments because of a temporary problem such as a job loss but who could get back on track if given time to catch up. After filing Chapter 13, a repayment schedule is established that eliminates all interest payments as part of the deal.
4. Can I Choose the Type of Bankruptcy I File?
Today's bankruptcy rules impose requirements for filing the potentially more advantageous Chapter 7. According to these rules, you qualify only if your average income for the past six months before filing is lower than your state's median. The majority of bankruptcy filers qualify.
If your income is above the state median, you will have to take the so-called means test, which is designed to determine whether your disposable income is too high to qualify for filing Chapter 7. If you fail the means test, you may still plead with the judge to allow you a Chapter 7 filing if you have extraordinary circumstances, such as having lost a home and belongings in a natural disaster. (For more on that, see our sidebar.)
5. Do I Have to Go Through Credit Counseling Before I File?
Yes. You must be able to certify that counseling occurred within six months before filing your bankruptcy papers, but you do not need to submit the certificate of completion until 15 days after filing. (For a list of the approved agencies, click here.) And if the credit counselor recommends that you go through an independent repayment plan rather than filing bankruptcy, that will be a black mark on your papers if you still decide to go ahead and file. Your Chapter 7 filing may be dismissed or converted to a Chapter 13, with your agreement.
In addition, both Chapter 7 and Chapter 13 filers will have to take a personal financial-management course in order to exit bankruptcy. This is something like traffic school and can be done in person, over the phone or online, according to Elias. (For a list of the agencies approved to provide such courses, click here.)
6. Are There Any Restrictions on the Kinds of Debt That Can Be Discharged?
Yes. Child-support, alimony payments and past tax bills are never dischargeable. Student loans are forgiven only in rare situations, such as poor health that prevents you from working.
Creditors also have the right to object to the discharge of certain unsecured debts, such as large purchases for luxuries or cash advances made within 90 days of filing. And any large cash advance taken within 70 days before filing is also considered nondischargeable.
7. Can I Choose Not to Discharge Certain Debts in Chapter 7, Like a Car Loan or Mortgage?
That depends on how much equity you already have in those properties. Theoretically, you can keep a debt obligation after bankruptcy by signing a reaffirmation agreement with your creditor. With such an agreement, you're basically stating that you'll continue to make payments on the debt, even after all your other debts are written off. So, for example, if a Chapter 7 filer wanted to keep a car, he would sign a reaffirmation agreement with his auto lender and continue to make the car payments during and after his bankruptcy.
Your second option is to "redeem" the asset, which is basically buying it from the lien holder for its replacement value. The replacement value for a car, for example, will be listed in the Kelly Blue Book. In that case, of course, you would have to come up with a lot of cash.
Your third option is to surrender the car to the trustee, who will sell it to pay off the lien holder, give you the amount of the exemption and distribute the rest among your unsecured creditors.
You have to submit a special Statement of Intention along with the bankruptcy papers announcing which of the three options you choose. If you don't, the creditor can repossess the asset at any time.
8. What Happens to My Credit After Bankruptcy?
The most obvious thing that happens when you file for bankruptcy is that you get a notation on your credit report. Your credit score, which is the number creditors use to evaluate your credit-worthiness, will likely take a hit. Just how badly it will suffer depends in part on how high it was before you filed (scores can range from 300 to 850; the higher the number, the better) and how many accounts you're including in the bankruptcy.
The good news is, a low credit score won't stay low forever. While bankruptcy is a major bruise on your report, it doesn't mean you can't build good credit again.
9. How Do I Rebuild My Credit?
After filing bankruptcy, many folks are afraid to take on new credit. After all, it was credit that got them in trouble in the first place. But not doing so can hurt you later on, particularly if you plan to take out a car loan or mortgage eventually. With the following credit-rebuilding plan, you could see your score shoot above 600 in six months.
First, you need to make sure all your accounts are listed in your credit reports as charged off or included in bankruptcy. For Chapter 7, they should also show balances of zero. These accounts will remain on your reports for seven years, but you may call your creditors and ask them to stop reporting them to the bureaus. They don't have to comply, but it doesn't hurt to try. If you were able to remove even a couple of charge-off accounts from your record, it would boost your credit score.
Next task: Get new credit cards. Credit-card companies won't be clamoring to extend you new credit once they see the bankruptcy note on your record, but you could get a secured credit card, which is basically a regular credit card backed by a security deposit you leave with the card issuer for as long as you have the account. Your credit limit will be equal to the amount of your deposit, which will be returned to you in full when you close the account or graduate to a regular, unsecured card. One thing to keep in mind is that secured credit cards usually carry an annual fee and higher interest rates.
Another fast (and perfectly legal) credit-rebuilding strategy is "piggy-backing" on someone else's credit by asking a friend or relative to add you as an authorized user on one or more credit-card accounts. You won't be responsible for the bills, and you won't have access to the credit cards unless the original owner wants a copy to be sent to you. The primary cardholder's credit record won't be affected in any way by your bankruptcy. You, on the other hand, get the benefit of their credit history right away. The potential drawback is that your own credit could be damaged if your credit benefactor gets into financial trouble.
10. How Soon Can I Consider Larger Loans, Like a Mortgage or Car Loan?
You don't have to wait for the bankruptcy notation on your record to expire before you apply for a mortgage or car loan. Most mortgage lenders want to see two years' worth (sometimes more or less, depending on how cautious lenders are) of on-time payments on various accounts, which may include things like utility bills. Needless to say, you won't get the lowest rates possible. The same applies to car loans.