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Bankruptcy Facts & How They Affect You

Debt accumulation and unpaid bills may often lead to the threat of wage garnishment or property repossession, forcing many people to consider filing. While this may be a viable option, you need to have a basic understanding about bankruptcy so you will know what the process involves.

The Basics of Bankruptcy

You need to educate yourself about bankruptcy facts & how this decision will affect you before you file.

What is Bankruptcy?

When a person is unable to pay their bills or meet their financial obligations, they can obtain legal protection from creditors. During the proceedings, collection actions will be suspended and the debtor may be allowed to temporarily or permanently avoid paying any debts incurred prior to the date the petition is filed. Debts may be eliminated, or a plan can be designed so a debtor can repay creditors while remaining under the protection of bankruptcy.

Once bankruptcy is filed, the law sets forth the automatic stay which prohibits anyone from pushing for collection on outstanding debts (this includes creditors and debt collectors), and stops any lawsuits or other legal proceedings such as foreclosures or garnishments. Creditors have the right to contest this decision or petition a judge to lift the stay. If a loan is secured, creditors are often allowed to take over the specified property.

The Bankruptcy Discharge

Filing for bankruptcy involves a legal proceeding whereby a person must prove that they are unable to pay their debts, therefore declaring that person ‘bankrupt’. The bankruptcy decision (the court determination the debtor is in fact bankrupt) will result in an order which discharges the debts. This discharge clears the debtor of all debt liability and prevents creditors from attempting to collect on debts listed in the bankruptcy filing, or from making claims on future earnings.

Although bankruptcy provides a fresh start, debtors are required to give all property determined to be non-exempt and requested by the trustee so assets can be liquidated and the proceeds used to pay creditors. Discharge can also be denied if it is discovered that a debtor has been fraudulent in trying to conceal or transfer assets before filing.

Some debts cannot be discharged as noted in the green box, along with debts incurred through theft or fraud. Also, property which has a valid lien against it (legal claim to secure debt payment), may remain after bankruptcy, and this lien can still be enforced by the secured creditor.

Filing Options

Bankruptcy Facts:

Debt Collectors must stop trying to collect on a debt once bankruptcy is filed by a debtor.

There are several different forms of bankruptcy, also known as Chapters. Choosing the right type of bankruptcy will depend on the type of debts, the amounts, assets owned, exemptions available, as well as reliability of income.

Chapter 7: Nearly 1.5 million Americans have filed for personal bankruptcy in the last year, and over 1 million of these were chapter 7 filings. This type of bankruptcy is also known as liquidation. In this case, specific requested assets are turned over to the trustee appointed by the court and are liquidated to pay on the outstanding debt.

A debtor is typically permitted to keep a some property or personal possessions. Any remaining debts are usually cleared, with the exception of those that cannot be discharged. Creditors will receive only what is available following the sale of assets, and cannot make any future collection attempts once a debtor is discharged.

Chapter 13: This type of bankruptcy involves debt adjustment or restructuring, rather than the liquidation of assets, and the debtor is usually allowed to retain most of their property.

The debtor must show a reasonable repayment plan which must be approved by the Court, trustee, and creditors. Any repayment plan must allow the creditors to receive payment that would be equal to (or exceeds) what they could have received during Chapter 7.

Bankruptcy Facts:

Each state provides options for debtors to retain some property for their “fresh start.”

Once a proposed plan is accepted, the trustee will collect the payments from the debtor, who will then distribute the funds to creditors. Chapter 13 depends on the debtor having a reliable source of income and the ability to pay down debt balances. Generally, repayment plans run about three years, although they cannot exceed five years.

During this time, creditors are forbidden from taking any collection action against the debtor. Filing Chapter 13 also allows for protection of co-debtors by preventing creditors from collecting on consumer debt from a liable co-debtor. This way, if a co-debtor is not filing for bankruptcy, their personal assets are not at risk.

Bankruptcy Facts:

Chapter 13 is available to those with unsecured debts, usually credit cards, of less than $1,081,400, and secured debts, such as real estate or car loans, of less than $360,475.

While the retention of property may be considered an advantage, there are also several disadvantages to a Chapter 13 filing.

  • Debtors will be supervised by the court for the full repayment term and will not be allowed to sell assets or open new debts without permission.

  • The debtors will be required to live within a fixed income or budget and may also have to pay any extra funds earned to creditors. According to the Bankruptcy Code, the monthly income received by the debtors is based on the average income and cost of living expenses from the six months prior to the bankruptcy.

  • Even when all debts are paid, your credit report will still show the bankruptcy.

  • Should the debtor fail to make payments or finish the reorganization plan, any creditor can request that the court order the case to be changed to a liquidation under Chapter 7.

Bankruptcy Facts:

When the business owner wants to keep the business operating a Chapter 11 reorganization is best over liquidation.

Chapter 11: This type of bankruptcy usually pertains to corporations and businesses; however, an individual may file for Chapter 11 if they own a company or are involved in some type of corporate enterprise. This option is usually chosen to reorganize debt so the owner can continue operating their business. In this case, existing debts are restructured, assets are retained, and the company can keep functioning but with the supervision of the court.

Taxes and Bankruptcy

Any taxes owing cannot be discharged in bankruptcy; however, the rules do vary depending on the type of bankruptcy filed. Under Chapter 7 (and 11), all tax collection efforts will stop temporarily. However, under Chapter 7, these attempts will resume and the interest or late penalty fees will continue to be assessed. Filing Chapter 13 will prevent additional accrual of penalties and interest, and allow the tax balance to be paid during the duration of the court approved plan.

How Does Bankruptcy Affect Co-debtors?

To prevent the transfer of debt from one spouse to another, it is necessary that both spouses file for bankruptcy.

A bankruptcy may also involve loans that have been co-signed. As mentioned, under Chapter 13, provisions are made to protect certain co-signors as co-debtors from creditor actions, even if they are not part of the petition. The protection will continue if the person filing for bankruptcy presents a plan that includes full repayment on the co-signed debt, and honors the agreement to pay off the value of the loan.

Do you have more questions? Are you interested in getting the process started?

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