How Does Bankruptcy Work? A Beginner’s Guide

  • David M. Offen,
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Many people ask the question of How Does Bankruptcy Work? Filing for bankruptcy is an honest and legal way to get out from under debt. It provides a chance to get a fresh financial start, and is shrouded in a great deal of myth and legend. If you are considering bankruptcy, you might feel overwhelmed, anxious, and unsure of where to begin. Here is what you need to know to decide whether bankruptcy is the best choice for does bankruptcy work

How Does Bankruptcy Work?

Bankruptcy in various forms has been a part of human society since ancient times. Its protection is particularly strong in the United States today, due to concerns about human rights and people being given a chance for a fresh start. Bankruptcy releases people from obligations that, due to unforeseen circumstances, they can no longer pay, and helps to ensure that they do not become effectively enslaved by predatory lenders. Of course, there are also laws in place to protect creditors and to ensure that people do not run up fraudulent debts that they never intended to pay and then file for bankruptcy to get rid of them. The system has checks and balances on both sides.

What Bankruptcy Can and Cannot Do

Bankruptcy’s biggest strength is its ability to wipe out unsecured debts, or those that are not tied to a specific piece of collateral. Credit card debts, medical debts, deficiency balances that remain after repossession, collection agency accounts, and many other types of debts fall into this category. Bankruptcy also grants an automatic stay against further collection activities, giving you time to catch up on  secured debts such as missed mortgage or car payments, and preventing wage garnishment or bank account seizure. It can also help with some tax debts.

However, bankruptcy does not eliminate all forms of debt. For example, child support and alimony payments are not wiped out. Neither are recent income tax or student loan debts. If you have secured debts, you have the option to continue making payments (perhaps on a renegotiated contract) and keep the property, or to wipe out the debt but surrender the property. You cannot keep secured property without paying for it.

Chapter 7 vs. Chapter 13

Consumers have two choices for bankruptcy, Chapter 7 and Chapter 13. Chapter 7 is what most people think of when discussing bankruptcy. Your dischargeable debts are cleared without further payments, you can renegotiate your payment plans for secured property that you wish to keep, and you receive a fresh start quickly.

Chapter 13 is a sort of debt restructuring plan. Instead of eliminating your debts, you enter into a 3 to 5 year payment plan that is based on your monthly income, expenses, and ability to repay. Depending on your individual circumstances, you might repay none, some, or all of your unsecured debts. Certain debts must be paid in full under a Chapter 13 plan, such as child support and alimony. It also allows you to get caught up on mortgage or car payments. Your bankruptcy is not discharged until your Chapter 13 repayment plan is completed.

The Means Test

Why would anyone choose Chapter 13 instead of Chapter 7? One major reason is the means test, introduced in 2005 to reduce bankruptcy fraud. This test considers your income and expenses over the past six months. If your monthly income is lower than the median income for your area, you are presumed to be eligible for Chapter 7 bankruptcy. If it is higher, then you must complete a more detailed test that balances your income against your expenses. Due to your individual financial picture, you might qualify for Chapter 7 even with a high income. If not, then Chapter 13 is your  bankruptcy option.

Property Exemptions

When filing for Chapter 7 bankruptcy, you are allowed to claim exemptions for certain types of personal property, up to a certain dollar amount. Each state has its own laws regarding what specific property is eligible, and what the dollar limitations are for each kind of property. In addition there are Federal exemptions which most people choose when filing Pennsylvania. In general, most Chapter 7 filers lose nothing due to these exemptions. However, if you own a great deal of non-exempt property, you might prefer to file for Chapter 13 bankruptcy to avoid losing any items.

Should I Use a Lawyer?

Technically, a lawyer is not required when filing for bankruptcy. However, if you undertake your own filing you should have a great deal of familiarity with government forms and the Bankruptcy laws. Bankruptcy law is complex, and simple mistakes could derail your case or cause you to lose property that a lawyer could have completely protected. A qualified and experienced bankruptcy lawyer will ensure that every document is filed properly and on time, so that your case proceeds smoothly.

Impacts on Future Credit

Many people are under the impression that they cannot obtain credit following a bankruptcy, but this is simply not the case. It is true that bankruptcy remains on your credit report for 10 years, and that it has an impact on your credit score. However, creditors also know that you can file for Chapter 7 bankruptcy only once every 8 years. This means that you are not as poor a credit risk as someone who is in serious financial difficulty but has not yet filed for bankruptcy.

In the weeks and months after your bankruptcy is discharged, you will receive credit offers with high interest rates. Obtaining and responsibly using new credit will help you rebuild your score. With careful credit management, you should be able to purchase a car at a reasonable interest rate within a year, and a home within 2 years. As time passes, your bankruptcy will have less and less of an impact on your ability to obtain good interest rates.

If you are ready to take the first steps toward financial freedom, call The Law Offices of David M. Offen today at (215) 625-9600 to schedule your free initial consultation. We’re here to help you every step of the way.

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