Bankruptcy
Bankruptcy is a legal process of canceling a large part of your debts and one of the major decisions of your financial life. In this brief guide, we’ll take a closer look at how bankruptcy works, tackle its most common chapters, and discuss whether you should consider going bankrupt in the first place.
What Is Bankruptcy, and How Does It Work?
Bankruptcy is the legal status of individuals and businesses unable to repay their outstanding debts and obligations. Deriving from the Italian banca rotta, which stands for broken bank, bankruptcy typically follows a pattern: after gathering the necessary financial documents and determining which chapter to file under, the debtor fills out a bankruptcy petition. It’s followed by asset evaluation, proceedings in federal court, and a bankruptcy judge’s decision on whether the debtor should be relieved of the debt.
In some cases, bankruptcy may be a win-win for the debtors and the creditors: individuals and businesses get a fresh start, while creditors can get back at least part of their debt.
Most Common Bankruptcy Types
Choosing the right chapter of the Bankruptcy Code to fill out your petition is crucial for successful proceedings. Let’s discuss the key categories you’re likely to encounter.
Chapter 7
With 381,217 cases filed only in 2020, Chapter 7 is one of the most common bankruptcy types. This category is typically suitable for individuals with unsecured debts, like personal loans, medical bills, or credit card loans. Also known as liquidation bankruptcy, this chapter requires debtors to sell non-exempt assets to repay a part or the entirety of their unsecured debts. In reality, although there are cases where applicants are required to sell non-exempt assets, they are rare.
Chapter 13
Unlike the previous category, this chapter is more suitable for debtors with a consistent income. It allows individuals to catch up on their debt with a repayment plan. Typically created in installments, debt plans can take three to five years and allow debtors to keep their property.
Chapter 11
Business owners can apply for bankruptcy under Chapter 11, which allows their companies to continue working. This bankruptcy type helps companies operate under an established debt repayment plan: as the business owners continue their activities, they also repay their stockholders.
Is Going Bankrupt a Right Choice? Pros and Cons
Debt write-offs aside, bankruptcy may not always be the right choice. Although declaring it will allow you to avoid constant letters from creditors, it shouldn’t be regarded as a fresh start, as you are likely to suffer repercussions. Let’s consider the biggest pros and cons of going bankrupt.
Pros:
- Avoid dealing with creditors and constant legal threats, letters, and telephone calls.
- Protect your future earnings from creditors.
- Keep some of your assets, like your home, car, etc., with bankruptcy exemption laws.
Cons:
- Negative impact on your credit score for up to 10 years, which reduces your chances of getting approved for a new loan.
- You may have to sell part of your non-exempt assets, like luxury items.
To wrap it up, bankruptcy should typically be regarded as a last resort. Although it may provide relief from creditors, it’s not a perfect choice in every situation. To ensure you’re choosing the best route and going bankrupt is the right choice, consider evaluating your financial situation with the help of a credit counselor.