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What is Bankruptcy?

Bankruptcy is a legal process that individuals and businesses use to declare that they are unable to repay their debts. It is a process that provides a fresh financial start by either eliminating debt or restructuring debt payments. Bankruptcy is a complex process; anyone considering it should consult an attorney or other financial professional.

This guide will provide an overview of the different types of bankruptcy, the eligibility requirements for each, the bankruptcy process, and the benefits and drawbacks of filing for bankruptcy.

Types of Bankruptcy

There are two main types of bankruptcy for individuals: Chapter 7 and Chapter 13. Each has its own eligibility requirements, benefits, and drawbacks.

Chapter 7 Bankruptcy

Chapter 7 bankruptcy is also known as liquidation bankruptcy. It is designed for individuals who have little to no income and cannot afford to pay their debts. In a Chapter 7 bankruptcy, a court-appointed trustee sells the debtor's non-exempt assets to pay off creditors. Any remaining debt is discharged, meaning the debtor is no longer responsible for paying it.

Eligibility requirements for Chapter 7 bankruptcy include:

  • The debtor must pass a means test, which compares their income to the median income in their state. If their income is below the median, they are eligible for Chapter 7.
  • The debtor must not have filed for Chapter 7 bankruptcy in the past eight years.

Benefits of Chapter 7 bankruptcy include:

  • It provides a fresh financial start by eliminating most unsecured debt.
  • It puts an immediate stop to creditor harassment and wage garnishments.
  • It is a relatively quick process, typically taking three to six months.

Drawbacks of Chapter 7 bankruptcy include:

  • The debtor may lose non-exempt assets, including their home, car, and personal property.
  • Some debts, such as student loans and taxes, are not dischargeable in Chapter 7 bankruptcy.
  • The debtor's credit score will be negatively impacted for up to ten years.

Chapter 13 Bankruptcy

Chapter 13 bankruptcy is also known as reorganization bankruptcy. It is designed for individuals with a regular income who can afford to pay their debts over time. In a Chapter 13 bankruptcy, the debtor creates a repayment plan that lasts three to five years. They make monthly payments to a court-appointed trustee, who distributes the funds to creditors.

Eligibility requirements for Chapter 13 bankruptcy include:

  • The debtor must have a regular income and be able to afford the repayment plan.
  • The debtor must not have more than $1,257,850 in secured debt or $419,275 in unsecured debt.

Benefits of Chapter 13 bankruptcy include:

  • It allows the debtor to keep their non-exempt assets, including their home and car.
  • It puts an immediate stop to creditor harassment and wage garnishments.
  • It may allow the debtor to discharge some unsecured debt at the end of the repayment plan.

Drawbacks of Chapter 13 bankruptcy include:

  • It is a long process, lasting three to five years.
  • The debtor must have a regular income and can afford the repayment plan.
  • The debtor's credit score will be negatively impacted for up to seven years.
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Bankruptcy Process

The bankruptcy process can be complex and time-consuming. It involves several steps, including pre-filing requirements, filing the bankruptcy petition, and attending a meeting of creditors.

Pre-Filing Requirements

Before filing for bankruptcy, the debtor must complete several pre-filing requirements. These include:

  • Credit Counseling: The debtor must complete a credit counseling course from an approved agency within 180 days before filing.
  • Means Test: The debtor must pass a means test to determine eligibility for Chapter 7 bankruptcy.
  • Gather Financial Information: The debtor must gather all financial information, including income, expenses, assets, and debts, to include in the bankruptcy petition.

Filing the Bankruptcy Petition

Once the pre-filing requirements are complete, the debtor can file the bankruptcy petition. The petition includes all financial information and outlines which type of bankruptcy the debtor is filing for. The debtor must pay a filing fee, which varies depending on the type of bankruptcy and the jurisdiction.

Meeting of Creditors

After filing the bankruptcy petition, the debtor must attend a meeting of creditors. A court-appointed trustee conducts the meeting, allowing creditors to ask questions about the debtor's finances. The debtor must answer truthfully and provide any requested documentation.

Bankruptcy Discharge

If the bankruptcy court approves the debtor's bankruptcy petition, they will receive a discharge of their debts. This means they are no longer legally responsible for paying the discharged debts. The discharge can take several months to finalize, and the debtor must continue to follow the terms of their repayment plan until then.

Benefits of Bankruptcy

Filing for bankruptcy can provide several benefits, including:

  • Eliminating Debt: Bankruptcy can eliminate most unsecured debts, such as credit card debt, medical bills, and personal loans. This can provide a fresh financial start for individuals struggling with overwhelming debt.
  • Stopping Creditor Harassment: Filing for bankruptcy immediately stops creditor harassment, including collection calls, letters, and wage garnishments.
  • Protecting Assets: Depending on the type of bankruptcy, individuals may be able to protect their non-exempt assets, such as their home and car, from being sold to pay off creditors.
  • Creating a Repayment Plan: Chapter 13 bankruptcy allows individuals to create a repayment plan that fits their budget and will enable them to pay off their debts over time.
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Drawbacks of Bankruptcy

While bankruptcy can provide several benefits, there are also several drawbacks, including:

  • Negative Impact on Credit Score: Bankruptcy can negatively impact an individual's credit score for up to ten years, making it difficult to obtain credit in the future.
  • Loss of Non-Exempt Assets: In Chapter 7 bankruptcy, individuals may lose their non-exempt assets, including their home, car, and personal property, which can be sold to pay off creditors.
  • Long-Term Financial Impact: Bankruptcy can have long-term financial consequences, including difficulty obtaining credit, higher interest rates, and limited employment opportunities.
  • Legal Fees: Filing for bankruptcy can be expensive, and individuals may need to pay legal fees, filing fees, and other costs associated with the bankruptcy process.

Alternatives to Bankruptcy

There are several alternatives to bankruptcy that individuals can consider, including:

Debt Consolidation

Debt consolidation involves combining multiple debts into a single, manageable payment with a lower interest rate. This can help individuals pay off their debts without filing for bankruptcy.

Credit Counseling

Credit counseling can help individuals create a budget, negotiate with creditors, and develop a repayment plan that fits their budget.

Negotiating with Creditors

Individuals can negotiate with their creditors to work out a payment plan or settle their debts for a lower amount.

Conclusion

Bankruptcy can provide a fresh financial start for individuals struggling with overwhelming debt. However, it is a complex process that should not be taken lightly. Anyone considering bankruptcy should consult an attorney or financial professional to determine the right option for their situation. There are also several alternatives to bankruptcy that individuals can consider.

Hady ElHady
Hady is Content Lead at Layer.

Hady has a passion for tech, marketing, and spreadsheets. Besides his Computer Science degree, he has vast experience in developing, launching, and scaling content marketing processes at SaaS startups.

Originally published Mar 29 2023, Updated Jun 26 2023

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