Bankruptcy Basics

8 Jan

There are two main kinds of consumer bankruptcy: Chapter 7 and chapter 13. Each will help in a financial crisis, and each has a different way of solving money problems.

Chapter 7 bankruptcy, or liquidation, is the most common. A Chapter 7 bankruptcy won’t get rid of all debts but is very good at eliminating unsecured debts such as credit cards, medical bills, old utility bills, signature loans, etc. Chapter 7 cases proceed fairly quickly, generally completing in just a few months. If you choose chapter 7, you will complete a fairly lengthy bankruptcy petition. Many of the questions are asked more than once, in different sections, in different ways. The petition requires that you list all of your assets and all of your debts, disclose your income and expenses and significant legal and financial events such as recent windfalls and losses, transfers of assets, marriages and past addresses. 

 A trustee is appointed to oversee the case. In chapter 7, the trustee reviews the list of assets and value claimed for each. One of the first questions people ask is whether they have to give up things they own to file bankruptcy. For most people, the answer is, “No,” you don’t have to give up your house, car, etc., just because you filed bankruptcy. The reason is because each asset is offset by something called exemptions – state or federal laws which protects assets. Exemptions exist so that people can still function even if they are sued or turn to bankruptcy, preventing creditors and trustees from taking the basic necessities of life such as shelter, transportation, retirement savings, medical devices and the like. Only assets that exceed the exemption limits can be liquidated (sold) by a bankruptcy trustee, and the funds raised are used to pay creditors. But most people who file chapter 7 don’t have assets that exceed the exemption limits, so they are able to keep their property.

We said that chapter 7 primarily eliminates unsecured debts. What about secured debt – debts that have specific property (assets) pledged? When you pledge property against a loan, that is said to be collateral. Collateral is used by the lender to guarantee repayment of the loan. If you default on the loan, the lender gets the collateral. Chapter 7 bankruptcy wipes out the personal obligation to repay the loan, but generally does not eliminate the creditor’s right to take property securing the loan. So you have a choice in chapter 7 with respect to property that secures a loan: Continue paying the loan notwithstanding your bankruptcy, or surrender the collateral to the lender and walk away from the loan.

Chapter 13 bankruptcy is often the solution of choice for people who have a lot of secured debt, such as car loans and home mortgages, who want to keep their property but need to reorganize the debt secured by those assets. In a Chapter 13 case, you enter into a repayment plan that gives you 3-5 years to reorganize your finances which can include: Catching up on past due payments; reducing or eliminating some of the secured debt based upon the current market value of the assets securing that debt; and reducing or eliminating other debts.

Chapter 13 is more complicated than chapter 7 because it considers not only the value of your assets (offset by the same exemptions that protect these assets in chapter 7), but also upon your income (less your expenses). In chapter 13, you propose a “Plan” of reorganization based upon your ability to pay. By way of a simple example, let’s say that you have a home with both a 1st and 2nd mortgage (deed of trust in some states) and two cars, each secured by auto loans. You have to file bankruptcy because one spouse lost their job. Upon consulting with a bankruptcy attorney, you learn that the value of your home declined during the recession and is now less than what you owe against the first mortgage. You additionally determine that you can get by with one car now, because only one spouse is working. Using chapter 13, here’s what you can do: Strip the 2nd mortgage, significantly reducing the debt against your home and completely eliminating the payment for the second mortgage; surrender the more expensive car and walk away from those payments without having to worry about being sued for a deficiency; keep the less expensive vehicle and reorganize its auto loan to pay back only what the car was worth on the day you filed your bankruptcy (called a cramdown), over a longer period of time, at a reduced interest rate. These things are not only possible in chapter 13, they are common.

Based upon your budget, you will propose a chapter 13 Plan to make monthly payments, for 36-60 months, to your trustee. After receiving your payment each month, your trustee distributes the money to your creditors, according to your Plan. When you have made all the payments required by your Plan, your bankruptcy commitment is over and any remaining debt that would have been eliminated in a chapter 7 case, is discharged. Chapter 13 cases are more complicated than chapter 7. They generally require the assistance of an attorney who is familiar with the requirements of the trustee and bankruptcy court.

Some debts cannot be eliminated in bankruptcy. These include alimony and child support, student loans, recent taxes, debts associated with fraud or other crimes crimes (anything willful) and DUI. Chapter 13 can be used to create a payment plan for debts that can’t be discharged in bankruptcy.

This has been an overview of chapter 7 and 13 consumer bankruptcy. For more information specific to your needs, here are additional resources:

To consult with a bankruptcy lawyer near you, use Legal.com’s Find a Lawyer search tool. In the search box, type the area of law (such as bankruptcy, or chapter 13), followed by the city and state where you’d like the lawyer to be. For example, “bankruptcy sacramento, ca” (without the quotes).

You can read and post bankruptcy law questions in Legal.com’s Legal Q&A section and shop for bankruptcy, credit collections and foreclosure defense titles in Legal.com’s self-help law book store.

You can also do your own online Legal Research using Legal.com’s easy-to-use yet powerful search tool. You can search for a specific law such as the automatic stay in bankruptcy (type “11 USC 362” in the search box); or type a description of it  (“automatic stay in bankruptcy”); or ask a question (“how can chapter 13 help me?”). It’s an incredible tool, free for you to use, bookmark and share with others.

Additional information contained in the court’s consumer handbook, Bankruptcy Basics, can be found at the Bankruptcy Court home page. Here you can also download any of the official bankruptcy forms.

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