What Are the Consequences of Bankruptcy?

Filing for bankruptcy is a scary mystery to most people. They don’t know how it works and what the consequences are for throwing in the towel.

Besides the financial ramifications, they worry about the stigma and who might find out.

The first bit of advice is Re-Lax.

Your life is disrupted when you file for bankruptcy, but it does not end. There are pros and cons to filing bankruptcy. It’s is not necessarily sunshine and rainbows, but it does offer a fresh start if you’re hopelessly mired in debt. You get a chance to start over and hopefully learn from your mistakes.

It sure beats getting thrown in debtor’s prison, which is what they used to do to people who couldn’t pay their bills. Now all you have to do is file for bankruptcy.

The first decision you’ll face is deciding if you should file bankruptcy. The second is which type of bankruptcy suits you. For most people it’s a Chapter 7 or a Chapter 13.

Chapter 7 is a liquidation bankruptcy and the first choice for most people filing. There were 381,217 Chapter 7 filings in 2020. While most Chapter 7 cases do not result in any property being sold, in some cases, your possessions can be sold, with the proceeds going to pay your debt. The process usually takes three to five months.

Chapter 13 is a reorganization bankruptcy, meaning you come up with a plan to pay off some or all of your creditors. There were 154,341 Chapter 13 filings in 2020, or more than 200,000 fewer cases than Chapter 7. In Chapter 13, your assets are not sold, but you must stick to a court-mandated repayment plan that your creditors agree to.

To be eligible, you cannot have more than $419,275 in unsecured debt (credit cards, medical bills, student loans) and $1,257,850 in secured debt (mortgage, car loans). Your total debt is often reduced, but it usually takes three to five years to complete Chapter 13, and every day is likely to be a penny-pincher.

If you’re ineligible for Chapter 13 bankruptcy due to the income or debt limits, you may be able to file under Chapter 11 bankruptcy.

Here are some common questions about both forms of bankruptcy:

Will I Lose My Home?

Generally, not under Chapter 13. Under Chapter 7, it depends on how much equity you have in house. If you have a lot of equity in it, the trustee could choose to have it sold to pay off creditors.

When you file a bankruptcy petition, you have the opportunity to “exempt” certain property. The type and amount of exemption available varies from state to state. This means you can normally protect a certain percentage of the equity in your house and other property. The federal maximum is usually $25,150 – double that if you are married, your house is jointly owned with your spouse, and you file the bankruptcy jointly with your spouse. Though you may have the option to file bankruptcy without your spouse.

If you have less than that amount in equity, the court-appointed trustee probably won’t sell your house since it won’t produce enough to pay off much debt. Though, your lender can still foreclose on the house if you miss your mortgage payments.

If you have more equity than you can exempt, the trustee likely will sell your house and you’ll receive the exemption amount on sale. For instance, if your house is sold for $200,000, and you were able to exempt for $25,150, you’d get $25,150 on sale and the rest will go to pay off your mortgage and other debts.

Other personal property that can be sold includes jewelry, antiques, appliances, furniture, books, musical instruments, almost anything of value. There are also exemptions for those items in most states.

At least they can’t sell your pet. Well, technically pets are property and can be sold. But unless your poodle is Westminster Dog Show quality worth thousands of dollars, it’s unheard of for a trustee to try to sell that or any other critter.

» More About: Can I Keep My House If I File Bankruptcy?

Can I Keep My Car?

If you can continue to make payments on the car, it’s very likely you will be able to keep it. If you can’t keep up with payments, then it depends on how much you owe; what the car is worth; and how much your state allows you to exempt. The amount varies from state to state and could be as low as $500. If your equity is higher than the exemption, the vehicle could be sold and you’ll receive the exempt portion. That is rare.

If you’re behind on payments, there may be options that would allow you to keep your car. If these options work for you, great! If not, you may end up having the car repossessed by your lender.

Do your best to keep your car because buying a car after bankruptcy and getting a good deal on it is a tough task. Qualifying for a car loan will be the first hurdle. Once you’ve cleared that, finding a decent rate will be tough to come by.

How Much Cash Can I Keep?

It depends on the exemption amount in your state. Most states allow some amount of cash to be kept under either Chapter. Keep in mind that some financial institutions (such as credit unions) may be able to take money from your accounts held with them to satisfy debts to them.

There are some exemptions, like child support payments, alimony and public benefits like Social Security, disability payments and unemployment.

Retirement accounts and pensions are also protected, so at least you won’t have to start dining at the local soup kitchen if you’re over 65 and bankrupt.

Is My Bankruptcy a Public Record?

Only if they’re really nosy.

Bankruptcies are public record, but the information is rarely published unless the filer is famous, like Donald Trump. Bankruptcies are public record, so any member of the public can visit the clerk of the bankruptcy court and ask to see a person’s file.

It’s also possible to access the information via the internet by signing up for a PACER account in the federal court system. But it’s a costly move usually done by bankruptcy attorneys.

One thing to remember is that when you file for bankruptcy you must list all the people you owe money to. No one is bound to secrecy, though the chances of your bankruptcy becoming the talk of the town are not anything to lose sleep over.

Will My Employer Find Out?

Not necessarily. The most likely way would be if a creditor has sued you and is garnishing your wages. If the garnishment stops due to bankruptcy proceedings, your employer has to be notified since it cuts your checks.

But if your wages are being garnished, your employer already knows you’re under financial stress and might be relieved you have filed for bankruptcy to start digging yourself out.

With Chapter 13, the court could order that payments be automatically deducted from your wages and sent to creditors. But the bankruptcy code has rules that prohibit employers from discriminating against employees based solely on bankruptcy filings.

How Long Will It Take for My Credit Score to Rebound?

The exact numbers vary, but it really depends on your starting point.  A good credit score (700 or higher) will likely drop more than 200 points. A lower score will drop between 130 and 150 points. Just about everybody who files for bankruptcy ends up with a credit score somewhere south of 600, some of them way south.

This can mean paying much higher interest rates on loans, assuming you’d even qualify for them.

A Chapter 7 bankruptcy stays on your credit report for 10 years. A Chapter 13 stays on for seven years, but you can rebuild your credit over time by managing your debt smartly.

The best place to start is by making on-time payments and bringing past due accounts up to date. That is the biggest factor in your credit score.

The impact of bankruptcy lessens over time because some of your debt is reduced or discharged. That reduces your credit utilization ratio, which determines 30% of your credit score. FICO estimates it takes about five years for a score that was 680 to fully recover from a bankruptcy filing.

So What’s the Better Option – Chapter 13 or Chapter 7?

That all depends on your particular situation. Obviously, the ideal answer is neither, but sometimes bankruptcy is unavoidable in the wake of medical emergencies or job loss. If you want to be able to keep all of your property, Chapter 13 might be your best bet, but there are cons to Chapter 13 bankruptcy as well. Chapter 7 has harsher consequences, but it might not deliver the financial relief you need.

You can also try to come up with a viable budget and stick to it. If you need help, there are nonprofit credit counseling agencies and debt management programs to get you back on track. They might be able to reduce interest rates and monthly payments to a level you can afford. Credit counseling is actually mandated with most bankruptcies, so you might as well get the treatment before you file.

If you stick to the debt management plan, you might not have to file for bankruptcy at all. Then the fear and mystery around filing for bankruptcy will vanish before it ever begins.