This is Chapter 5 of 5 in our Ultimate Guide to Debt Relief series.
Bankruptcy is a legal process and a formal acknowledgement that you cannot repay your debts. You may find it intimidating. However, bankruptcy is a good option to consider, helps protect your assets, and helps you quickly move on with your life once the process is complete.
Bankruptcy is a legal process that allows you to hit reset on your finances if your debts are beyond what you can pay. A trustee or judge reviews all of your finances to determine whether or not to discharge the debts, which means that creditors can no longer collect. Creditors cannot take any action to collect once you’ve started the bankruptcy process without first seeking and getting permission from the judge.
Bankruptcy does not discharge all of kinds of debt. Alimony and child support are not dischargable. In most cases, income taxes overdue less than three years and student loans are also not dischargable. Meeting with a bankruptcy lawyer to review your situation can help you understand which debts can be discharged and which ones can’t.
You can file bankruptcy as an individual, maried couple, or business. There is even a process for filing bankruptcy if you have debts internationally.
The two main kinds of bankruptcy for individuals are Chapter 7 and Chapter 13.
Chapter 7 bankruptcy fully discharges eligible debt while protecting your assets. Chapter 7 bankruptcy typically protects all of your assets.
Chapter 13 bankruptcy also helps protect your assets, but it doesn’t fully discharge your debt. Instead, Chapter 13 bankruptcy reorganizes your debt and creates a payment plan that lasts up to five years.
“In Chapter 13, clients can reduce the amount owed on secured loans, reduce interest rates, reamortize loans, remove certain liens, extend the time to pay back taxes, reduce the amount owed on unsecured loans sometimes down to zero, and legally break leases,” says Dai Rosenblum, attorney and counselor of law.
To get the best outcome, it’s wise to work with a lawyer with Chapter 13 expertise and experience.
“You need a Chapter 13 specialist. If that lawyer does things correctly, you end up with a confirmable plan that the creditors are stuck with. There is no negotiating,” he adds.
Depending on your situation, you may have to file a Chapter 13 bankruptcy. Otherwise, Chapter 7 is the ideal.
“As a general rule, you prefer to do a Chapter 7. That eliminates all of your debt, and is completed, start to finish, in a few months. You do a reorganization plan because you need to, not because you want to,” says Rosenblum.
While bankruptcy is an effective way to reset your finances and start over, it does have long-term effects on your credit.
Bankruptcy stays on your credit report for seven to ten years, so it can make it difficult to qualify for low interest rates, new loans, and credit cards.
But, it’s not all bad news. Bankruptcy can have a positive effect on your overall credit, too.
“One surprising thing about bankruptcy is that it can improve your credit. All the debt that was formerly on your credit report is reduced to zero. Your credit ratio drastically improves, even though your credit score goes down. That shows a potential new lender that it will be easier to make future loan payments,” says Rosenblum.
However, even though bankruptcy can lower your credit score and stays on your credit report for seven to ten years, bankruptcy can be a wise choice if you really need a reset on your finances.
If your debt has become overwhelming and impossible to pay, bankruptcy is worth considering because it can protect you from creditors. Consulting with a bankruptcy lawyer to learn more about how bankruptcy can help you understand it more and determine if it’s a good fit for you.
“Without legal advice, many take assets that are completely exempt, such as 401(k)'s, and pay on debt that they don't have to.
Most consumer bankruptcy lawyers offer a free first consultation, so there is no downside to gaining knowledge about how best to deal with debt. You shouldn't go to a credit negotiating company. They generally charge more than a lawyer does and reduce the amount of debt less than a bankruptcy does,” advises Rosenblum.
Before you file for bankruptcy, you will be required to take a credit counseling course to help you determine if bankruptcy really is the best choice for you.
Once you file for bankruptcy, you’ll have a meeting with your trustee. Your creditors can attend to ask for more information on your financial situation.
Rosenblum offers more insight:
“You attend a Creditors Meeting, which is conducted by a lawyer appointed as the court trustee. There is no judge and no courtroom. It is rare for creditors to be there. What rational business would pay to send someone to a meeting where they can't get anything out of it? You get a document called a 'Discharge Order' in the mail. With rare exceptions, that's the entire process,” he says.
Once the judge determines which debts to discharge, you’ll no longer be legally required to pay those debts.
While you can represent yourself when filing for bankruptcy, it’s a good idea to work with a lawyer. The judge and the court trustee must remain impartial and cannot help you if you represent yourself. A lawyer can help you avoid pitfalls and help you get a good outcome.
Lawyers can be expensive. If you have a hard time stretching your budget to pay for one, you can find resources available to help or get free legal counsel.
Depending on which kind of bankruptcy you’re filing, you may have the option to represent yourself. However, that may not result in the best outcome for you.
“If you qualify for a Chapter 7, you can be your own lawyer, but there many traps for the unwary, and it is a bad idea. Even lawyers who are not bankruptcy specialists would probably not be able to get a confirmable Chapter 13 plan if they represent themselves. The list all of the things to look out for would be book length,” says Rosenblum.
As you’re choosing an attorney, you’ll want to find one who specializes in bankruptcy law.
“Bankruptcy law is complicated and unlike any other area of law. Lawyers should not dabble in bankruptcy,” says Rosenblum.
Understanding what bankruptcy is and how it works will help you be more confident when seeking professional help with your debts and empower you to take control of your finances.
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