Introduction

Bankruptcy is an oasis in the wasteland that creditors have built. Perhaps surprisingly, the US has one of the most debtor-friendly bankruptcy systems in the world. This is mostly because the bankruptcy system was originally built for small businesses. And most of the bankruptcy system is still built for businesses, but this section is about the part that’s for individuals and families.

The basic idea of bankruptcy is to develop a process for when a debtor cannot pay all of their creditors. It’s an alternative to more brutal systems like debt peonage (where a debtor who couldn’t pay worked as a slave for their creditor until the debt was cleared) and debtors prisons. Instead, bankruptcy sorts out which creditors get what, which get nothing, and allow debtors to move on with their life. Mostly.

At its core, bankruptcy does two things:

• It temporarily stops all creditors from taking any collection action (including garnishment eviction, annoying phone calls—everything).
• It discharges and/or creates an easier payment plan for all a debtor’s debts.

If you’re having trouble paying your debts, bankruptcy can be a crucial lifeline.

Secured vs. unsecured debt in bankruptcy

It is crucial to understand the difference between secured and unsecured debts for the purposes of bankruptcy. Check out this explanation. For the most part, you cannot get a secured debt discharged while still keeping the asset that secures the debt. You have to either figure out a payment plan for the secured debt or lose the collateral that secures it. Unsecured debts, on the other hand, can be discharged without giving up anything.

Two types of bankruptcy

There are a few different types of bankruptcy, only two of which matter to most of us (some are only for businesses and some are only for farmers--we're ignoreing those)

A Chapter 7 bankruptcy (the name refers to the portion of the bankruptcy code that contains its rules) is sometimes called a “liquidation” or a “straight bankruptcy”. The idea is to wipe the slate clean--although some debts cannot be discharged. And, as discussed in the previous section, secured debts can only be discharged if you give up the collateral that secures the debt. If you want to create a payment plan to keep the asset, Chapter 13 is designed for that. Aside from these exceptions, a Chapter 7 bankruptcy results in a discharge of all debts. Depending on how much money and how many assets you have, you may have to pay some money to creditors before you get discharge, but you may not.

A Chapter 13 bankruptcy, sometimes called a “reorganization”, does not include a discharge. Instead, it is a formal process of setting up a plan to pay back arrears while staying current on your debts. In other words: it only makes sense if you can still pay debts on your big assets, but you need help catching up. Working with a lawyer, you come up with a payment plan and then submit it to the court and creditors.

Generally, a Chapter 7 bankruptcy is best for folks who do not have valuable assets like houses that they still owe money on and Chapter 13 is best for folks who do have those assets and can make the payments on them as long as they are adjusted. Also, whereas you can’t file more than one Chapter 7 bankruptcy within 8 years, you can file a Chapter 13 bankruptcy in that time. So if you have filed bankruptcy in the past few years and need to do so again, Chapter 13 could make sense.

Figuring out if you should use bankruptcy

Filing bankruptcy can provide a much-needed relief from threatening creditors, but it is not always (or even usually) the right option. It costs time, energy, and money. If you have other ways to reduce your debt burden or you have valuable assets that you don’t want to lose, it’s better to pursue other options. And if your debts are non-dischargeable (child support or student debt, e.g.), bankruptcy won’t really help. Plus you can’t just do it whenever you want: if you’ve declared bankruptcy in the past 8 years, you’re restricted from filing Chapter 7 again.

If you don’t know whether to file, most bankruptcy attorneys will provide free preliminary advice. Find one in your area with a good reputation, bring your financial documents with you, and see if they’ll help you figure out your situation for free. If you decide to declare bankruptcy, they can also help you file.

Some reasons you might not want to declare bankruptcy:

• You declared a Chapter 7 bankruptcy in the past 8 years and want to declare Chapter 7 again.
• You can pay your debts relatively comfortably. If this is the case, you may be prevented from getting a bankruptcy discharge and you might take a hit to your credit. If you’re ruled to be abusing the bankruptcy system, you could also face penalties.
• You have secured debts (in a house or a car) that you won’t be able to keep up on even if you restructure your debts. Talk with a bankruptcy attorney for details on your situation. Bankruptcy could just be a faster way to lose this asset in this case.
• Your debts are legally questionable. If you have a defense to paying your debts, it’s better to get out of them without declaring bankruptcy than through the bankruptcy process.
• Your debts will not be relieved through bankruptcy. If you have student loans or child support or tax debts and they are the major source of your financial stress, bankruptcy likely won’t help you.

If you can’t pay your debts and/or you’re facing down collectors, bankruptcy can be a lifesaver, though. Reach out to a bankruptcy attorney as soon as possible to figure out what makes sense for you.

Outline of the bankruptcy process

Before you decide whether bankruptcy makes sense, it may help to have a sense of how the process goes. Chapter 7 and Chapter 13 work slightly differently but share many features.

First steps in Ch. 7 and 13

The first step of any bankruptcy process should be to get a bankruptcy lawyer. You can technically file bankruptcy on your own and you may even do so successfully if you are the type of person who likes to research the law, sort through your accounts, and the like. But having a bankruptcy lawyer on your side really makes the process go more smoothly and is often a necessity.

Bankruptcy lawyers generally charge a flat fee for their services. How much they charge depends on where you are in the country and how fancy their firm is, but you could pay as little at a few hundred dollars for a bankruptcy attorney.

Generally you should not use an online filing service in place of an attorney. Some of these are scams and even the non-scams aren’t usually worth the money.

Because creditors like to make sure that every debtor feels shame, they lobbied to force everybody who files bankruptcy to sit through lectures on how to be “responsible” with your money. As such, you have to take an approved credit counseling course less than 180 days before filing. Generally these courses cost between $10 and $40. A list of approved providers is here or you can ask your lawyer or the court for a recommendation. Avoid for-profit companies. These sessions involve a review of your finances and sometimes shaming about filing bankruptcy. Ignore their bullshit and go through the finances. The session should take about an hour.

You can get out of the requirement if you’re disabled or if you’re in emergency circumstances. Courts are generally stingy with granting these waivers, but if you think you might qualify ask your bankruptcy attorney.

Once you’ve completed the course, you can file for bankruptcy. Filing involve filling out a petition, including a certificate from the credit counseling course, and extensive documentation of your finances. The forms are here. Again, all of this is easier if a lawyer is doing it with you.

After filing, all debt collection activity against you—including evictions, foreclosures, calls, everything—should stop. This is because filing for bankruptcy invokes what is called the automatic stay so that everything can be left as it was before bankruptcy and the bankruptcy court can work out who gets what. If creditors keep trying to collect on you, tell the court (or get your bankruptcy lawyer to do so). If your bankruptcy petition was filed improperly, the automatic stay may not apply.

At this stage Chapter 7 and Chapter 13 bankruptcies diverge.

Chapter 7 bankruptcy process

For Chapter 7 bankruptcies, a trustee will take charge of your case, determining how to dispose of your assets among creditors. You will likely get to keep most of your assets because they are exempt. Which assets are exempt depends on your state, but generally includes anything that is not especially valuable.

You may be required to show up to a meeting of creditors where you will have to answer questions from the trustee about your financial situation. Despite the name, it is likely that none of your creditors will show up—the trustee will ask all the questions. At this meeting or afterwards a creditor might try to get you to reaffirm a debt. This is usually not a good idea—talk with your bankruptcy attorney about your situation.

Then you will be required to endure yet another session of shaming, this time in the form of an “educational course” in personal finances that you have to be $20 to $50 for. They’re going to teach you that being broke is bad. Lovely. Screw them, but you gotta do it. Here is a list of providers.

If things in your case are complicated or one of your creditors is a real pain in the ass, you might have to go to court, but that’s pretty rare.

Finally, you will get your bankruptcy discharge.

Chapter 13 bankrutpcy process

For Chapter 13 bankruptcies, you and your bankruptcy attorney will have to come up with a bankruptcy plan, a schedule for paying off your debts. Usually you have to start paying on the plan within 30 days of filing.

Once you come up with a plan, you have to submit it to the trustee. The trustee then reviews the plan and calls a meeting of creditors to ask you questions about your finances and your plan. Although the trustee does have a say, they are not the final say on whether it gets approved. If they disapprove of your plan, you can appeal to the bankruptcy judge.

Within 45 days of the meeting of creditors, there is often a confirmation hearing in court where the bankruptcy judge reviews your plan and either approves or denies it. Sometimes this hearing is not held if no creditors object.

If your plan is approved and you stay current on your payments, you receive a bankruptcy discharge. But wait! You still have to complete yet another session of shaming, in the form of an “educational course” in personal finances that you have to be $20 to $50 for. As long as you do this before you finish your last payment, you can receive a bankruptcy discharge.

If your plan is not approved (even if you've tried to modify) and/or you miss payments, your case will either be dismissed and you’ll be left to creditors’ mercy or you can convert your case to Chapter 7. Scroll up to see how Chapter 7 works. If you faced an unexpected financial setback, you can get a hardship discharge instead.

Consequences of bankruptcy

At the end of bankruptcy, you receive a discharge (with some exceptions). That means that all the debts that are discharged you do not owe anymore.

Some debts are non-dischargeable in bankruptcy:

• Tax debt (with some exceptions)
• Fines and penalties to most government agencies, including criminal fines
• Debts you took on fraudulently
• Debts you owe to somebody because you intentionally harmed them
• Child support and alimony debts
• Debts you did not include in your petition and those you agreed to repay/reaffirm during the bankruptcy proceedings

Student debt is discussed below.

Just because a bankruptcy ends in a discharge, does not necessarily mean you get out of your debts without losing anything. As discussed above, if your debts are secured, they cannot be discharged unless you pay them off or give up the asset that secures them. And if you have enough assets, you may have to either pay or give them up even for unsecured debts. That depends on the exemptions in your state.

Bankruptcy goes on your credit report. Whether it harms your credit or not depends on how bad your credit was before bankruptcy. Bankruptcy can actually improve your credit, since it improves your debt/income ratio, making creditors more interested in lending to you. Be careful about offers you get right after bankruptcy: some creditors target people who have just received a discharge. Depending on where you live and, often, the color of your skin, you might have the opposite result: creditors avoiding you or giving you worse deals because of your bankruptcy.

A note on student loans

Before the 1970s, all student loans were fully dischargeable in bankruptcy. But as more and more student debt accumulated, creditors were worried about debtors being able to get out of it: they wanted to squeeze students for all they had. So they lobbied to limit the circumstances in which people with government-backed student loans could be discharged. Back then, nearly all student loans were backed by the government but issued by private lenders. In the 1990s, private student loans not backed by the government began to grow. So, in 2005, student lenders successfully lobbied to expand the limits on student loan discharges to include private student loans.

Technically, student debt is still dischargeable in bankruptcy, but only in cases of “undue hardship”. Most judges that have interpreted this standard have held that it means somebody must be in very extreme circumstances without any ability to get work (despite showing evidence of having tried over and over again). Some judges have been more lenient. But the standard has not been tested that many times, since many lawyers just assume it’s impossible and don’t want to take the time to litigate.

If you have student debt and think that bankruptcy makes sense, you should try to find a bankruptcy lawyer who is willing to fight to get your student loans discharged. They may be hard to find and you may not win. But it might be worth fighting if it otherwise makes sense to file bankruptcy.