The Ultimate Guide to Personal Bankruptcy in America

Why It Matters

Should you file for bankruptcy? Here are some things to consider:

Benefit:

► Filing for bankruptcy can provide breathing room that lets you get back on your feet financially.
► It can halt foreclosure proceedings and stops calls from debt collectors.
► Declaring bankruptcy can wipe out unsecured debt such as medical bills, personal loans and credit card debt, or allow your debt to be restructured into a years-long installment payment plan.
► Filing can stop your utilities from being turned off — or if your utilities have been turned off for nonpayment, help you get service back.

Harm:

► In one kind of bankruptcy, a court-appointed trustee can sell some of your assets that are valued above a certain dollar amount to pay creditors. That could be a boat, collectibles, a second car or second home. In some cases, this could mean losing your primary home, but that is not a given.
► A bankruptcy filing stays on your credit record for seven to 10 years, which will make loans and credit cards more difficult to get and likely more expensive.
► Bankruptcies are public record, so if people nose around they can see your financial picture.
► Certain debts can’t be wiped out. Anyone thinking they can get out of paying child support, alimony and certain taxes will be disappointed. It’s also tough to get student loan debt forgiven.

When should I file for bankruptcy? Consumer bankruptcy lawyers stress that you should wait until you know you won’t rack up more debt. The bankruptcy process deals with only the debt you incur up until the day you file. Some unemployed people file for bankruptcy right after they find a job and their debt is at a peak, said Henry Sommer, a consumer bankruptcy attorney in Pennsylvania.

Can anyone file for bankruptcy? Actually, no. You may have too much income. Even if you feel stretched, the numbers may not line up in a way that make you eligible to declare bankruptcy. To file for the most widely used kind of bankruptcy, Chapter 7, you must clear one of two bars. Your income must be less than or equal to the median in your state, for your household size. (You can find the numbers from the U.S. Census Bureau.)

Or, you can do a second calculation that looks at your income and expenses over the past six months to figure out how much money you have left to pay your debts. Those who make too much for Chapter 7 may be able to file for Chapter 13. Payments under the CARES Act and other stimulus payments don’t count toward your income, and neither do Social Security checks.

If you decide to go down the bankruptcy route, here’s what you need to know.

What are the differences between the chapters? Chapter 7 bankruptcies are for people with debts that overwhelm their ability to pay back creditors. If someone filing for bankruptcy has assets that exceed a certain amount per category (jewelry and burial plots are two categories) the assets may be sold to pay creditors. Once that’s done, unsecured debts — credit card debt, medical bills — get wiped out and you get a fresh start.

Chapter 13 cases are three- to five-year repayment plans. These are for people who are falling behind in mortgage and car payments but will have enough disposable income to become current if their debts can be restructured. Secured debt like a mortgage must be repaid in full, while unsecured debt like credit card debt may be reduced to an amount based on your expenses, income and assets. Once you come to the end of the installment plan, the remaining unsecured debt that’s eligible to be forgiven is wiped out.

Do I have to give up my home? Not if you live in Texas, which allows homeowners to exempt an unlimited amount for a primary residence, with acreage and/or residency restrictions. In other states, it depends on whether you’re doing a Chapter 7 or Chapter 13, how much equity you have in your home (your home’s market value less the balance on your mortgage and home equity line of credit) and whether your disposable income is enough to keep you current on mortgage payments.

In Chapter 7, if you’re current on mortgage payments and don’t have a lot of equity in your home, you can probably keep it. But if your home equity exceeds the dollar amount a state allows you to keep (the so-called homestead exemption) your home may be sold to get at that excess equity and pay it to creditors. People who have equity in their home and want to keep it tend to file Chapter 13 cases.

How much equity can I protect in my home? It varies by state, and in New York, it varies by county. In New Jersey and Pennsylvania, there is no homestead exemption, so Chapter 7 filers have to use the federal homestead exemption. That’s $25,150 per person, or $50,300 for a married couple filing taxes jointly.

In North Carolina the exemption is $35,000 a person ($70,000 for a couple filing jointly) for those under age 65, while in Manhattan it is $170,825, or $341,650 for a married couple filing taxes jointly.

What household property will I be allowed to keep? Much of what you own in everyday belongings should be safe. You’re allowed to keep a certain dollar amount in so-called “exempt” property — clothing, furnishings, appliances, jewelry — that varies by state. In North Carolina, the exemption for a motor vehicle, for example, is $3,500, while in Kansas it’s $20,000. Some states have a “wildcard exemption,” which is a dollar amount you can allocate toward the value of any asset you want to keep.

Are there good alternatives? If you’re struggling with debt, always try to negotiate first with creditors. Lenders may modify your loan so it’s easier to pay. Consolidating debts at a lower interest rate is an option, but consumer advocates warn against using debt settlement firms. Taking a loan against your 401(k) is an option, but consumer bankruptcy attorneys say dipping into retirement savings is almost always a bad idea.

Parts of the CARES Act froze foreclosures and evictions, but that protection may not last much longer. Check what programs are available from your state or the federal government that might give you protection or enough breathing room to get caught up on payments.

What are the biggest mistakes people make in filing for bankruptcy? People drowning in debt may take loans against retirement savings or drain 401(k)s or IRAs before declaring bankruptcy, when those accounts are largely protected from creditors. Consumer bankruptcy attorney Sommer says he sees people pay certain debts that could be wiped out in bankruptcy and not pay debts that can’t be forgiven in a bankruptcy.

Also, bankruptcy judges and creditors don’t want to see a spending spree in the months before filing bankruptcy. If someone transfers money or property in the months leading up to filing, or pays back family members, or decides to pay a niece’s full tuition, the bankruptcy trustee may try to get that money back to pay creditors.

How can bankruptcy go wrong? If you don’t disclose all of your assets, your case could be dismissed and you could face criminal penalties. In a Chapter 13 filing, if you stop making the installment payments, the automatic stay that halted debt collections by creditors is no longer in place and creditors can move to garnish your wages, foreclose on your home or repossess property.

A 2019 Bankruptcy Abuse Prevention and Consumer Protection Act report found that in “39% of Chapter 13 cases reported that they had filed for bankruptcy protection during the previous eight years, the same percentage as in 2018.”

Terms You’ll Hear

Automatic stay — Once you file bankruptcy, an automatic stay temporarily suspends the collection efforts of creditors, debt collectors, the government and individuals.

Bankruptcy trustee — The bankruptcy trustee is the middleman between you and your creditors — the payments you make go through him or her. The trustee takes a percentage of all plan payments, capped at 10%, in a Chapter 13 bankruptcy. In Chapter 7 cases, trustees get a small administrative fee and a commission based on the value they get from liquidating your assets to pay creditors.

Chapter 7 — About two-thirds of bankruptcy filers use Chapter 7, which is also called a liquidation. People who file for Chapter 7 tend not to have a lot of assets or disposable income. The cases, which cost an average of $1,250 in filing and attorney fees, usually run four to six months.

Chapter 13 — These cases tend to be filed by people falling behind on home or car payments, but who will have enough disposable income to commit to a repayment plan once debts are restructured. As long as you stay current on house and car payments under the plan, you can keep those assets. Someone in Chapter 13 can expect to funnel all of their disposable income to repayments for three to five years, and at the end the remaining unsecured debt is wiped out. Some people opt for Chapter 13 because, unlike Chapter 7, it doesn’t require attorney fees to be paid up front. The average cost is $3,450.

Discharge: When your debt are discharged, it means they are gone — legally wiped out. You are no longer legally required to pay those debts and the creditor must write off the debt.

Exempt property: Bankruptcy exemptions allow people struggling with debt to keep property up to a certain dollar amount — largely things you need for everyday living and working. Every state has its own list of exemptions, with specific dollar values. Categories include clothing, household appliances and home furnishings, and jewelry. A portion of the equity you have in your home or car is also exempt, and you may be able to keep them as long as you stay current on payments. Social Security and pension checks are also exempt.

Non-exempt property: This is the stuff you don’t get to keep — jewelry above a certain dollar amount, collectibles, a second car or second home, and the equity in your house or car beyond the allowed exemption amount if it’s being sold in a Chapter 7 case. The bankruptcy trustee will sell what they can and give the proceeds to creditors (and potentially some to you, up to the allowed exemption amount).

Qualifying debts: These are the types of debt that can be discharged or restructured in bankruptcy cases. It includes things like medical debt, personal loans and credit card debt. Debts that cannot be discharged in bankruptcy cases include child support, alimony, some unpaid taxes. It’s difficult to get student loan debt discharged in a bankruptcy.