What Are the Different Bankruptcy Types?
You’re sitting at the kitchen table, staring at collection notices and figuring out how to work. Perhaps you’ve recently lost your job, and your debt has grown unmanageable. Then it occurs to you—that term you never imagined you’d have to consider: bankruptcy.
When your position appears hopeless, bankruptcy may appear your only option. We understand that you may feel afraid and trapped, but bankruptcy is not a choice to be taken lightly. It’s critical to understand what bankruptcy is and the many types of bankruptcy to choose your circumstances.
What Does Bankruptcy Mean?
In real life, bankruptcy is a lot more severe than just a method to lose a game of Monopoly: It occurs when you appear before a judge and informs them that you cannot pay your bills. Then, depending on the circumstances, they either cancel your debts or devise a repayment plan for you. People file for bankruptcy for various reasons, including job loss, divorce, medical emergencies, and family deaths. In reality, in 2018, almost 730,000 nonbusiness bankruptcies were filed. That’s insane!
However, bankruptcy is a serious life event that has ramifications beyond your pocketbook. It can track you down while applying for jobs, buying a house, or starting a business. Even though it may appear to be a “new beginning,” bankruptcy addresses the symptoms, not the underlying problem.
Student loans, government obligations (taxes, fines, or penalties), reaffirmed debt (when you recommit to a current loan), child support, and alimony are excluded from bankruptcy. If those are your sole debts, bankruptcy is not an option.
What Kinds of Bankruptcies Exist?
Even though the primary purpose of bankruptcy is to eliminate debt, not all defaults are made equal. There are six primary sorts of bankruptcies:
- Liquidation
- Plan of Repayment
- Significant Reorganization
- Farming Families
- Used in International Cases
- Municipalities
You may have zoned out for a second after looking at this list. That’s OK. You’ll almost certainly only be dealing with the two most popular types of personal bankruptcies: Chapter 7 and Chapter 13. (A chapter only refers to the law’s location in the United States Bankruptcy Code.) However, we’ll go over each type so you know your possibilities.
Bankruptcy under Chapter 7
Chapter 7 bankruptcy, often known as the liquidation or straight bankruptcy, is the most prevalent type of personal bankruptcy. The liquidation (selling) of your assets (everything you own that has a worth) to pay off your creditors is overseen by a court-appointed trustee (the people you owe money to). Any unsecured debt (credit cards or medical expenses) is usually forgiven. However, as previously stated, this does not include debts that are not overlooked by bankruptcy, such as student loans and taxes.
Depending on which state you live in, the court may not order certain items. For example, most people can keep their homes, cars, and retirement assets while filing for Chapter 7 bankruptcy, but nothing is guaranteed. A foreclosure can’t be stopped with Chapter 7, but it can be postponed. Reaffirming the debt, which involves recommitting to the loan agreement and making payments, is the only way to keep the items you still owe money on. However, most Chapter 7 bankruptcies are no-asset cases, implying there is no property worth selling.
If the court determines that you do not earn enough money to repay your debts, you may petition for Chapter 7 bankruptcy. This judgment is based on a means test, which compares your salary to the state average and examines your finances to see if you have enough disposable income (called the means) to repay a significant portion of your debts. If your income is too low, you may be eligible for Chapter 7.
If you file for Chapter 7 bankruptcy, you will be required to attend a creditors’ conference, where those who owe you money can interrogate you about your debt and finances. That’s about it. A Chapter 7 bankruptcy will appear on your credit report for ten years, and you won’t be allowed to file for it again until eight years have passed.
Bankruptcy under Chapter 13
While Chapter 7 bankruptcy generally results in debt forgiveness, Chapter 13 bankruptcy essentially reorganizes your debt. The court approved a monthly payment plan, allowing you to repay your unsecured debt and all of your secured debt over three to five years. Your monthly payment is determined by your income and the debt you owe. However, the court can place you on a strict budget and monitor all of your expenditures (pain!).
Unlike Chapter 7, this type of bankruptcy allows you to maintain your assets while catching up on non-bankruptcy debts. Chapter 13 can also help you avoid foreclosure by catching up on your mortgage payments.
Anyone who owes $419,275 in unsecured debt and $1,257,850 in secured debt can petition for Chapter 13 bankruptcy. You must also keep track of any tax filings. A Chapter 13 bankruptcy will appear on your credit report for seven years, and you won’t be able to file again for another two years.
Bankruptcy under Chapter 11
Chapter 11 bankruptcy is most commonly used to reorganize a business or corporation. Companies devise a strategy for continuing to operate while paying off their debt, which both the court and the creditors must approve. As real estate investors, some people may choose to file under Chapter 11 if they have too much debt to qualify for Chapter 13 but have a lot of high-value properties and assets. You’re probably not going to tamper with this one unless you’re a pro athlete or a celebrity.
Bankruptcy Chapter 12
This repayment scheme allows family farmers and fishers to avoid selling all they own or having their property foreclosed on. While Chapter 12 bankruptcy is similar to Chapter 13, it is more flexible and has more significant debt limits.
Bankruptcy Chapter 15
Chapter 15 deals with international bankruptcy concerns and provides foreign debtors access to bankruptcy courts in the United States.
Bankruptcy Chapter 9
Chapter 9 bankruptcy is another repayment option that permits municipalities, school districts, and other entities to reorganize and return their debts.
Visit the United States Courts website for more information about bankruptcy laws in your area.
What Are Some Alternatives to Bankruptcy Filing?
It is possible to escape bankruptcy, no matter how deep in debt. You need to be aware of your possibilities. Here are some actions you can take to get out of debt without having to file for bankruptcy:
Prioritize the necessities.
Before you do anything, be sure you’ve covered the Four Walls: food, utilities, housing, and transportation. If you don’t have a place to sleep or food, you won’t have the energy to fight your way out of debt. So make sure you prioritize your health and that of your family. The collectors will have to wait.
Make a budget.
The court places you on a budget and keeps track of your spending in Chapter 13 bankruptcy. However, you can do such things without declaring bankruptcy. Making a budget might be a game-changer if you’re on your last legs. You’ll find the money you didn’t even know you had if you track it instead of wondering where it went.
Budgeting also entails eliminating all extra expenses to pay off debt. Cable and subscriptions must be canceled. No more going out to eat. No more holidays. You’ve switched to survival mode. However, in a bankruptcy case, you get to decide instead of the government instructing you how to handle your money for five years.
Your income is your most potent weapon for wealth creation (and debt reduction). You can throw more money at your debt the more money you make. As a result, you may need to take on a second job or work longer hours at your existing position to stay afloat while you catch up on your monthly payments. Yes, it can be exhausting, but the short-term sacrifice will pay off in the long run.
Sell your items.
Remember how we said that under Chapter 7 bankruptcy, the court liquidates your assets? What if you instead sold your belongings? Sell anything you don’t use to drive to work, such as boats, fancy lawn mowers, or anything with a motor. Anything you don’t need has to go: furniture, collectibles, jewelry, and that guitar you swore to play someday. Sounds far-fetched? This is essentially what would happen if you file for bankruptcy, only you won’t have any say in how your belongings are sold. So go to Craigslist, eBay, or Facebook Marketplace and sell your goods for a quick profit.
Make a strategy!
Did you know that before your debt may be erased, most bankruptcy courts require you to take a financial literacy course? Because the debt has become a way of life for so many people. That does not have to be the case! Financial Peace University (FPU) will show you how to break bad money habits, save and pay off debt like a pro, and create a bright financial future for you and your family. It’s also less expensive than the bankruptcy court charge. This tried-and-true strategy has aided about 10 million people to make positive changes in their lives. Begin your free trial of Ramsey+ today and say goodbye to debt for good!
