Bankruptcy is a last resort option of debt management. In this legal procedure, certain debts are forgiven, meaning the individual does not have to repay them. The two most common types of bankruptcy are Chapter 13 and Chapter 7. An individual must pay filing and administrative fees plus attorney fees to declare bankruptcy.
What causes bankruptcy?
The predominant cause of bankruptcy is a combination of poor decisions, failure to establish an emergency fund and not insuring against unforeseen events. The typical bankruptcy evolves over a period of time and is then triggered by an event such as loss of a job, illness or divorce. The common scenario is the accumulation of too much debt combined with a triggering event.
The best defense against bankruptcy is to have enough money in the bank to provide for 90 days of operating budget. This typically covers the loss of a job, illness, etc. The proper insurances – such as auto, homeowners, medical and dental – also help buffer unforeseen accidents and illnesses.
Divorce presents a particular dilemma. Typically both parties will need a good credit rating to re-establish themselves as freestanding individuals, yet many marriages end with finances in disarray and bankruptcy. Every effort should be made by both parties to exit the divorce with good credit intact.
Types of bankruptcy:
Chapter 7: In Chapter 7, individuals are able to wipe their debts clean, but they will most likely have to surrender any property or other assets to help pay their debts. Typically, individuals are allowed to keep automobiles, work-related tools and basic household furnishings. Each Chapter 7 filing costs $500 to $1,000 and takes approximately four to six months to complete. A debtor may only file for Chapter 7 once every six years, and it will remain on his/her credit record for 10 years.
Chapter 13: A debtor who files Chapter 13 is allowed to keep his/her property by setting up a debt repayment plan. An individual must have a source of steady income and stick to a very strict payment plan that will be created by the court. Chapter 13 costs on average $950 and typically lasts for three to five years. It will stay on an individual's credit record for up to 12 years. A debtor is eligible to file Chapter 13 every two years.
What are the consequences of bankruptcy?
The biggest consequence of bankruptcy is that it stays on your credit report for at least 10 years. This blemish will make it difficult to get credit, buy a home, get life insurance or sometimes get a job. It is important that you consider all your options before you declare bankruptcy.
- What are the alternatives?
- What can be done to affect the budget?
- Can I sell something that would affect the situation?
- Would additional income change the picture?
- What if my creditors were agreeable to modifying terms?
- How is this going to affect my family?
- How is this going to affect my financial life afterwards?
- Can I get credit again?
- How will financial institutions view me in the future?
- What about renting an apartment or buying another home?
- What about insurances, checking accounts or getting another job?
What are my options if I’m behind on payments?
Contact your creditors and let them know you are having trouble making payments. A creditor may be able to help you with a payment plan.
Contact a credit-counseling agency if you can’t reach an agreement with your creditors. The counselors will meet with you and help you figure out a budget that fits your income. You may find that there are other options besides bankruptcy.
Make sure you keep all of your paperwork. This includes any papers that show how and why you became unable to meet your mortgage payments, whether through job loss, salary cutback, divorce, etc.
Good communication shows your willingness to work this problem out between you and the lender. You both have a stake in these negotiations, and you both have to be clear about what is possible and what is not.