Going into debt for one thing or another has become a fact of life for many Americans. We live in a society that promotes buying things, even if it means overextending ourselves.
Credit card debt continues to flirt with all-time record-high numbers as people borrow at increasing rates. This becomes a real problem when we can’t pay our bills.
Creditors begin by sending letters asking you to settle your debts. If that doesn’t work, they typically turn the matter over to a collection agency. Then comes the torrent of snail mail, emails and phone calls. It’s at this point that many people start considering bankruptcy as an option.
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There are different types of bankruptcies depending on whether it’s for personal debts or a business. Individuals usually file Chapter 7 or Chapter 13 bankruptcy.
Chapter 7 typically is for people who are destitute, while Chapter 13 is more of a repayment assistance plan scenario. In typical Chapter 7 bankruptcies, a trustee is appointed to your case and they have the authority to sell your non-exempt assets to pay your creditors.
“Chapter 7 is where the debtor does not have the discretionary income needed for a Chapter 13 and usually has no assets that are worth very much — or even if they have assets such as a home or car, neither has equity,” longtime bankruptcy attorney Bernd Stittleburg of Duluth, Georgia, tells Team Clark.
“This then allows that debtor to eliminate all unsecured debt and keep secured debt and the assets associated, assuming he or she can continue making the payments,” he says.
A secured debt is something you owe money on that is a physical piece of property (think house or car), while an unsecured debt is not tied to an asset.
If you’re in a situation where you’re trying to decide which type of bankruptcy to file, there are some considerations.
“The prime candidate for a Chapter 7 case would be one who has recently lost a job, has no income or even if still employed, does not have enough income to pay all of his or her debts,” Stittleburg says.
“Usually in these circumstances, the debtor has too much debt for the amount of money he or she is bringing into the household. Filing a Chapter 7 case in this situation would allow the debtor to eliminate debt and have a chance to recover and rebuild.”
“Basically when a debtor files bankruptcy, the credit score will take a heavy hit, somewhere to the tune of around 200 points,” Stittleburg says.
That means if you had a fair score of around 600, after bankruptcy it could drop as low as 400, which is considered very poor by the three major credit-reporting agencies Equifax, Experian, and TransUnion.
The real-world effect of that credit score will mean that lenders will consider you risky, effectively locking you out of borrowing, except at very high interest rates.
Another thing to keep in mind is that a Chapter 7 bankruptcy will remain on your credit report for 10 years.
The primary way you can emerge from Chapter 7 is to demonstrate solvency and the ability to make sound money decisions.
If you’re unemployed, Stittleburg says, that might mean getting a job. “For these types of debtors to be able to rebound and rebuild their credit worthiness … they would have to be able to return to the workforce and start earning a wage again.”
For those who are already employed, it would entail showing that you can continue to make payments on a regular basis.
One way a debtor who does have a job, home and/or car at the time of filing can show advancement is to continue to pay on those possessions. “Keep those debts and assets and show [you] can make on-time payments, which will help facilitate the rebound in a quicker fashion,” Stittleburg says.
Money expert Clark Howard says many consumers file for bankruptcy as a first resort rather than a last. HIs advice is that you should always seek pre-filing bankruptcy counseling, whether you’re thinking about Chapter 7 or 13. Here’s when he says you should seriously consider bankruptcy as an option.