There are three types of personal bankruptcy: Chapter 7, Chapter 11 and Chapter 13. Each is utilized under different circumstances:
- Under Chapter 7 - many of your assets are seized and liquidated to repay a portion of your debt, with the remaining debt being waived.
- Under Chapter 13 - you propose a payment plan to the bankruptcy court to repay some of your debt and can retain more of your assets. Your unsecured debt must not exceed $360,475, and your secured debt must not exceed $1,081,400. Additionally, you must have sufficient income to repay creditors the amount mandated by the court in your Chapter 13 plan. The repayment period is typically three to five years. Put simply, for the plan to be approved, the court must conclude that creditors will receive a higher level of repayment in your Chapter 13 plan than they would receive under a Chapter 7 liquidation.
- Chapter 11 - is similar to Chapter 13, but is used mainly by businesses to permit them to reorganize and emerge from bankruptcy as a going concern. However, Chapter 11 may also be utilized by individuals whose unsecured debt exceeds $360,475, or whose secured debt exceeds $1,081,400. Individuals whose debt falls under those amounts, but who prefer restructuring to liquidation, may file under Chapter 13.
It is generally preferable to avoid bankruptcy if you can through selling assets to repay debts, negotiating with creditors and downsizing as much as possible. But in some cases, bankruptcy is the only option. If you are in this position, consider the following to determine whether to file for Chapter 7 or Chapter 13:
- Comprehensively List all Debts and Assets – It's extremely important that everything be listed. Hiding assets, whether intentional or not, constitutes fraud. Failing to list all debts may result in unlisted debts being retained after settlement.
- Income Level – In general, the higher your income, the more likely you need Chapter 13. You can only file for Chapter 7 if your income is below the median income in the state for your family size.
- Secured and Unsecured Debts – Secured debt means the creditor has a lien or collateral, such as a car loan or mortgage. Examples of unsecured debt are credit card debts and medical bills.
Generally, Chapter 7 is preferable if most of your debts are unsecured and you have limited assets; Chapter 13 or Chapter 11 is preferable if you have mostly secured debts on large assets, or need to protect a co-signer. (With Chapter 7, cosigners are liable for the debts; with Chapter 13, they have greater protection but may still be liable for some unpaid debts.)
- Non-Dischargeable Debts – Certain debts cannot be waived (discharged). These include child support/alimony including legal fees, virtually all student loans, past-due income tax within the last three years, court judgments for death/injury due to driving while intoxicated, court fines, and penalties. Any debts you fail to list may fall in this category.
In any form of personal bankruptcy, you will need to consider these non-dischargeable debts as you restructure your finances. They aren't going away.
Creditors may choose to challenge some dischargeable debts, including those due to fraud, theft or other criminal activity, intentional injury to people or property, and recent luxury debt.
- Exempt and Non-Exempt Assets – Exempt assets are those you are allowed to keep in a Chapter 7 bankruptcy; non-exempt assets determine minimum repayment rules for a Chapter 13 or Chapter 11 bankruptcy.
Typical exempt assets are one car, some home equity, pensions and 401(k)s, personal effects, home furnishings, appliances, jewelry, and life insurance (limits apply). Typical non-exempt assets are second homes and vehicles, cash and bank accounts (except for accumulated benefits like Social Security, welfare and unemployment), stocks, bonds, IRAs, investments, family heirlooms, and collectibles. Check the rules in your state.
- Asset Ownership – Are your assets jointly owned? If not, you may want to declare bankruptcy only for yourself and not your spouse. In either case, be sure you can properly account for all assets.
Once you have chosen your filing path, retain a lawyer and proceed. The filing will immediately stop wage garnishment and creditor calls (although some may continue to contact you).
For Chapter 7, the non-exempt assets are sold and the proceeds distributed to creditors – after that you are free of dischargeable debt.
For Chapter 13 and Chapter 11, you must submit a three-to-five year repayment plan – typically in the range of 10-20% of your current debt. You must have sufficient income to show repayment capability, and minimum payments to your unsecured creditors will be based on the amount they would have received with selling your assets in a Chapter 7 process. Otherwise, your request may be denied.
Credit counseling is required as condition of any bankruptcy – be sure you attend, as well as following the other bankruptcy court rules, or they may reinstate debt.
Bankruptcy is rough on credit as it remains on your credit report for seven years. Most people can begin rebuilding their credit within several years if they demonstrate good actions, but bankruptcy will make it difficult for you to obtain credit for many years. With proper attention to your spending and finances, you can recover from bankruptcy and prosper – but you should avoid bankruptcy if it is at all possible.