Everything you need to know about getting rid of your debt and starting over
Bankruptcy as Debt Relief
You never thought you'd be in this position, but after a bad car accident you're facing the unthinkable: bankruptcy. The hospital and the credit card companies are threatening to sue you. If they win judgments against you, you could be forced to sell your home to pay the bills.
Enter bankruptcy court. Bankruptcy was designed to help those in severe financial trouble to start all over again. This guide explains bankruptcy and what it can (and can't do) for your debt situation. It's not a substitute for legal advice, however. If you're considering bankruptcy, a bankruptcy attorney can give you the specific help you need. Here's what to consider.
There's no doubt bankruptcy is a last resort option.
"It's one of the hardest things people can do," says Ed Boltz, a Raleigh/Durham, N.C.-based bankruptcy attorney and past president of the National Association of Consumer Bankruptcy Attorneys (NACBA). But if you are unable to repay your way out of debt, it's better to file sooner rather than later. Filing for bankruptcy can erase or help you repay most debts, except for back taxes, child support, student loans and a few other types (See "Debts Bankruptcy Can't Erase" below). It can also protect you from aggressive bill collectors while you're working out a debt relief plan.
Bankruptcy may be the right choice for you if
You don't have enough money left to pay down debts after you meet your basic expenses.
You're regularly using credit cards to pay for food, gas, utility bills and other necessities (and not paying them off monthly).
You're paying your credit card bills with another credit card.
Your wages are being garnished to pay debts, leaving you unable to meet basic expenses.
You might be able to save your home by declaring bankruptcy.
You're working several jobs and unable to make a dent in your debt, and a credit counseling agency couldn't work out a repayment plan for you.
You're so stressed out financially that it's undermining your health and relationships.
Bankruptcy may be the wrong choice for you if
You have a steady income and can pay
You're able to pay off your debts another way (such as a debt counseling agency plan or debt consolidation).
You have assets (besides your home) that you can sell to pay off your debts.
Your debts can't be discharged (eliminated) through bankruptcy, because they are child support or court-ordered restitution.
You have no real assets and so are considered "collection-proof."
Bankruptcy could leave a co-signer on your loans responsible for your debt.
Your debt is mostly student loans, but you can't prove it will be impossible to pay them off.
Boltz says that people who wait until they are facing lawsuits to file for bankruptcy often have an especially difficult time getting their finances back on track. "It's better for your credit in the long run" to file earlier, he says. And it can relieve the stress and depression that prevent many from being able to make good choices.
A major benefit: While it's in process, bankruptcy's "automatic stay" immediately stops any lawsuits and most actions by creditors, collection agencies, or government agencies. It stops your creditors from harassing you, taking any actions to collect what you owe, evicting you, garnishing your wages or foreclosing on your home.
MoneyGeek Bankruptcy Guides
PERSONAL BANKRUPTCY: CHAPTER 7 VS. CHAPTER 13
Both Chapter 7 and Chapter 13 bankruptcy are for people with personal debt who need a fresh start. Find out which is right for you.
What type of bankruptcy should you pursue? A bankruptcy attorney could best answer that question. But here is an overview to the most common types.
Chapter 7 Bankruptcy
If you have no property or large assets to your name, this may be your best option for eliminating medical and credit card debt. (See our guide "Chapter 7 vs Chapter 13" for more information.)
Pros: It stops bill collectors from harassing you, wipes out unsecured debt and can let you start over.
Cons: Like other bankruptcies, it is public record and can stay on your credit history for 10 years. If you have a co-signer for your debts, that person is not protected by your bankruptcy, and creditors can go after him or her.
Filing fee: $335.
Attorney fees: Fees vary depending on your case and location but generally range between $500 to $3,000. All fees have to be approved by the court.
Limit on eligibility: Your income has to be equal to or less than the median income for a family of your size in your state.
Chapter 13 Bankruptcy
If you have too many assets to qualify for a Chapter 7 bankruptcy and you want to protect your house or other secured assets from being seized, this type of bankruptcy may be your best option. Chapter 13 can help higher earners and property owners avoid foreclosure.
(See our guide "Chapter 7 vs Chapter 13" for more information.)
Pros: It may be able to save your home and other real estate from foreclosure. It stops bill collectors from harassing you, and it can wipe out unsecured debts.
Cons: It's more complicated than Chapter 7 and may take longer to file and be approved.
Filing fee: $310.
Attorney fees: Fees vary depending on your case and location but average about $2,500 to $5,000. All fees have to be approved by the court.
Limits on eligibility: Your unsecured debts (credit cards and medical bills, for example) must equal less than $394,725 and secured debts, such as mortgages, must be less than $1,184,200. You must also prove to the court that you can afford to meet your repayment obligations.
Chapter 11 Bankruptcy
Chapter 11 bankruptcy — usually a business bankruptcy but open to individuals — is complex and expensive. If successful, you can pay back your creditors, at least in part, while continuing to operate your business. If you think you might want to explore this, Nolo Press provides a good overview.
Debt Relief through Bankruptcy: How Can You Benefit?
There's little doubt that bankruptcy is a tough thing for anyone to go through. "It's hard to get people to talk about it," Boltz says. "They'll talk about anything before they talk about bankruptcy. Numerous studies show that more people would file if they were cold, calculating money machines. But most of these are people who are struggling and suffering. We keep boxes of Kleenex stocked up because people cry. Our job as attorneys is to help them get through that."
Once they make the decision to declare bankruptcy, millions of people have found relief from their debts - and from the crippling stress that accompanies the hopelessness of huge debts. "When they leave our office, they usually have hope they can get out from under it," says James Haller, current president of the NACBA. "It's accepting the reality than what they are doing is not working."
3 Bankruptcy Scenarios You Might Face
When Medical Bills Cripple
Joe, 40, a construction worker, fell off a ladder while washing windows at his home. He broke several bones and needed emergency surgery followed by three months of rehab. His company promised health insurance but hadn't delivered by the time of the accident. Since it didn't happen on the job, he was not eligible for Workers Compensation. Joe and his wife, Elaine, don't have enough savings to pay the $170,000 in surgery and rehab bills, and he can't get unemployment. They are seven months behind on their mortgage and have been living off $20,000 in credit card debt. The hospital and doctors have filed suit. Joe and Elaine are terrified they'll lose their home.
What declaring bankruptcy would do:
Chapter 7 would give this couple a second chance. Joe and Elaine's debts are so great that there is no way for them to catch up. With the lowered income from Joe not working, they qualify for Chapter 7, which would eliminate all unsecured debts (medical, rehab, credit cards). They would have some breathing space to begin house payments. It would also relieve the stress of constant calls from bill collectors.
A Chapter 7 bankruptcy would not remove the mortgage or car loans. They still have to pay these or forfeit the property, but the bank could agree to work out a payment plan to help them catch up.
The bankruptcy stays on their credit record for 10 years and will make it more difficult and expensive to get credit during that time.
Hoping to Save Their Home
Steven and Marie, a couple in their 50s with two college-age kids, were doing OK until Marie lost her job and one of the kids moved in. The expenses piled up, and they took a second mortgage to try to pay off other bills. But a look at the housing market showed that they were upside down on their mortgages. They owe $350,000 on a first and second mortgage for a house that is now worth $150,000. Now they are six months behind on both mortgages, near foreclosure, and are desperately trying to keep the house they have lived in all their married life.
What declaring bankruptcy would do:
This is a tough one, says Haller. Chapter 13 could help them save their home, if they have the income to make payments. Haller said he encourages people to not protect property that has no value. But, he added, everybody has a different attachment to their home.
Steve and Marie insisted at first on Chapter 13 to try to pay off the two mortgages over time. However, their lawyer convinced them to forfeit the house, and with it, the overwhelming debt. A Chapter 7 filing removed the unsecured medical debts, freeing up their income and relieving their stress. They were able to rent a larger place better suited to a blended family than their former house.
Big Debt in a Family Business
Luis grew up building a trucking business with his dad, an immigrant from Mexico. After his dad retired, Luis and his wife Consuelo worked hard to build it up even more, leasing cabs to independent drivers.
Eventually, their monthly income topped $30,000, a seemingly robust amount. But repairs on the trucks and other expenses ran very close to that, and a succession of bad months and major repair bills got them into credit card debt. "Once you take on a little credit card debt, it snowballs, as you keep hoping to turn it around," Haller says. They were still bringing in $30,000 a month but spending $33,000, and ultimately got behind on their mortgage and truck loans.
What declaring bankruptcy would do:
As sole proprietors who personally owned the assets of the company, the couple would be able to file Chapter 13 bankruptcy. They could write off credit card debts and work out a plan to pay off other debts.
Their credit rating would nosedive, and higher interest rates would affect their ability to buy another truck. But they could overcome those obstacles with careful money management going forward.
What Bankruptcy Can't Erase
Bankruptcy can't be used for all debt. It can reduce or eliminate many kinds, including medical bills, credit card and store card debt and unsecured loans. But it won't help much with some other types such as child support, most tax debt and student loans, according to Nolo Press, a legal advice website and guidelines publisher.
Here's what bankruptcy can NOT do:
Eliminate property liens
Bankruptcy can wipe out much of what you owe, but it can't erase secured debt that is tied to property. If you've put up property as collateral for a loan or if a creditor has a lien on your property, you could lose it if you don't pay that debt. This applies to most mortgages (except second mortgages if the property value is too low to "secure" the debt). Similarly, bankruptcy won't wipe out secured car loans or secured loans for furniture and major equipment.
Wipe out child support and alimony obligations
These obligations can't be wiped out by bankruptcy. Also, if you use Chapter 13, any plan will have to assure these obligations be repaid in full.
Automatically get rid of student loan debt
At present you can only wipe out student loans by proving repayment would cause you "undue hardship." James Haller, current president of the National Association of Consumer Bankruptcy Attorneys, notes the standard is to show there is "certainty of hopelessness." But that's a tough standard to meet. You have to show you can't afford to repay the loans and that there's little chance that you could do so in the future.
However, there are some signs this is changing: Bankruptcy courts have recently approved the elimination of student loan debt in several key cases. In addition, although fewer than 0.1 percent of people filing for bankruptcy include student loan debt in their petition, one study shows that of those who did, 40 percent had some or all of their student loan debt discharged (eliminated). The Student Loan Ranger, among other organizations, urges people crushed by student loan debt to "never say never" to including it in a bankruptcy.
Pay off tax debt
It's sometimes possible to eliminate older debt for unpaid income taxes, but it's not easy and there are many requirements. (See Nolo Press's article on Eliminating Tax Debts in Bankruptcy.)
Discharge fines and penalties for breaking the law
These include debts caused by driving while intoxicated, breach of fiduciary duty and other fines and penalties for breaking the law, such as traffic tickets and criminal restitution.
If you file for Chapter 7, these debts will remain when your case is over. If you file for Chapter 13, these debts will have to be paid in full during your repayment plan. If they are not repaid in full, the balance will remain at the end of your case.
Also, if a creditor convinces a judge that your debt to them was incurred through fraud — perhaps because you lied on a credit application — those debts will remain after bankruptcy. So it's best to be as honest as you can.
How to Find a Bankruptcy Attorney
You don't necessarily need to pay an attorney to file for bankruptcy, but it's generally a good idea to do so, experts say. If you do consult with a lawyer, it's best to find one who is well-versed in the complex laws of bankruptcy. Many or most lawyers specializing in bankruptcy offer a first consult free, Boltz adds.
You can find bankruptcy lawyers through your state's bar association or on websites such as the National Association of Consumer Bankruptcy Attorneys. Check out credentials, and don't be fooled by people who prepare forms and who say they are just as good as a lawyer. "All they are legally allowed to do is type," Boltz said. "They can't give you advice."
If you can't afford a lawyer, you may qualify for free legal services. Try these resources:
Legal Services Corporation
LSC is an independent nonprofit established by Congress in 1974 to provide financial support for civil legal aid to low-income Americans. The Corporation currently provides funding to 134 independent nonprofit legal aid organizations in every state, the District of Columbia, and U.S. Territories. The LSC also helps you find a service near you.
7 Tips on Getting Through a Bankruptcy
How can you best work your way through a bankruptcy, and how do you rebuild your credit (and life) afterwards? Here are some tips.
If you have just lost a good-paying job, consider waiting to file
If you apply for a Chapter 7 bankruptcy, ask your bankruptcy attorney whether you should wait a few months before filing. This is because you'll have to take a means test to qualify for a Chapter 7 bankruptcy. The court averages your income for the last six months to see whether you qualify, so less income may make it more likely for you to qualify.
Don't go on a spending spree
Don't use credit cards to buy luxury goods or take out large cash advances just before filing for bankruptcy. Not only is it unethical, but if you try to game the system, the court will likely expect you to pay back those debts in full after bankruptcy.
"The most important thing is honesty," says bankruptcy attorney Ed Boltz.
"Disclose everything. It's failure to do this that gets people into trouble. Sometimes people don't realize how generous the bankruptcy system is, so they hide [assets]. I ask clients many times if they have told me everything. It's better to tell me so I can help you keep it, rather than hide it."
Cara O'Neill, a lawyer and legal writer for Nolo Press, agrees. "The advice is simple," she says. "Gather together all financial paperwork, such as bank and retirement statements, paycheck stubs and tax returns, and create a list of assets and property that includes the value of each item. A bankruptcy attorney will then be able to review the paperwork and help you decide which type of bankruptcy would best meet your needs. "
Find an attorney specializing in bankruptcy
Bankruptcy laws have become more complex in recent years, so information you find online or in books could be out of date. "If you're going to see a lawyer, see a specialist. You're not going to pay any more -in fact, you may pay less," Boltz says.
Stay in touch with your attorney
You might get letters or notices from creditors or from the court. Don't ignore these - tell your lawyer. Remember: Your lawyer is your guide.
Realize you still have credit
Your credit will suffer, but you may be able to buy things on credit while in Chapter 13. "You can get a mortgage or finance a car for example," Boltz says. But, he adds, "you're going to pay a higher interest rate, and you may need permission from the court."
Pay bills on time, every time
You can begin to rebuild credit immediately. "Make all your payments on time, and this will show positively on your credit. I can't emphasize this enough," Boltz says.
So You Need to Declare Bankruptcy? Expert Advice from the Field
Ed Boltz, past president of the National Association of Consumer Bankruptcy Attorneys, and Cara O'Neill, a bankruptcy lawyer and editor for Nolo Press, answer common questions about bankruptcy.
Who files for personal bankruptcy?
"Everybody," says Boltz. "I've had clients who are disabled, employed, unemployed, blue collar and professionals. I've had people who worked for banks file for bankruptcy."
How complicated is it, and how long will it take?
"It's best to have a lawyer to guide you through the process, although you can do much of the preparation yourself," O'Neill says. "If a filer is transparent about income, property, and prior financial transactions, and supplies supporting documentation to the bankruptcy trustee, the case will move through the process without incident."
If I declare bankruptcy, will I be able to save my house and car?
The answer depends on how much you owe and own, O'Neil says. You may well be able to get a court-approved bankruptcy plan to save your home and your car. In addition, if your home is worth less than what you owe on it (after you subtract any second mortgage or debts associated with it), your house would not be part of a bankruptcy claim, anyway.
Do I have to divulge my bankruptcy on all my financial papers and credit applications in the future?
It's public information. You are not obligated to volunteer this information, but if asked - especially on any application - it's best to divulge it, Boltz says. It's bound to surface.
Do you need a lawyer to file for bankruptcy?
It's best to consult an attorney, because bankruptcies can be complex, O'Neill says, adding, "You don't want to make a mistake." (See "How to Find a Good Bankruptcy Attorney").
Will bankruptcy ruin your credit?
Your credit score will definitely take a hit, but rebuilding credit isn't so difficult, O'Neill says. "The key to improving a credit score — other than making on-time payments — is to maintain a significant amount of unused credit. The more available credit that you have, the higher your score will be. For instance, suppose that you use an entire credit line. You can expect that doing so will depress your score significantly. So how do you turn it around? Pay the balance down to 30 percent or less. In many cases, the score will rise almost immediately — and the effect can be dramatic."
How do I start over after bankruptcy?
For most people, rebuilding a life after bankruptcy isn't much of a problem, primarily because bankruptcy relieves a lot of stress, O'Neill says. "Not only does it get rid of debt, but it frees up financial resources, too," she says. "Once the weight of overwhelming debt gets lifted, most people will reflect on the experience and make sound, life-improving decisions going forward."
About the Author
Judith Horstman is an award-winning journalist who specializes in reporting on science, health and medicine. She has been a Washington correspondent for Gannett, a journalism professor, a Fulbright scholar and a senior editor at Time Inc. She is the author of seven books, including the popular Scientific American Day in the Life of Your Brain series. Her work has been widely published in media from leading newspapers and magazines to universities and websites. A popular public speaker, she is an editorial consultant and offers workshops on writing.