Bankruptcy is a legal process, initiated when a person or business cannot meet their financial obligations. There are different types of bankruptcy, and all are governed by federal law. Consumer bankruptcy is one such type, which is filed when a person cannot pay back the debts they have incurred for personal needs.
Once the bankruptcy proceeding has reached its end, the person who filed for bankruptcy is no longer held liable for the debts they have incurred. This is accomplished by the bankruptcy court entering a discharge order, which releases them from their debts. Because of this, they have a clean financial slate; however, the bankruptcy will remain on their credit report for up to ten years.
Consumer bankruptcy includes both Chapter 7 bankruptcy and Chapter 13 bankruptcy. These differing chapters will be further discussed below. In order to avoid having a bankruptcy petition dismissed, it is important for the person filing for bankruptcy to keep in mind some considerations prior to filing. Whether to file for Chapter 7 or 13 is one such consideration, as well as being aware of what debts cannot be discharged.
What Are the Differences Between Chapter 7 Bankruptcy and Chapter 13 Bankruptcy?
Chapter 7 Bankruptcy is also known as “liquidation bankruptcy.” This specific chapter of bankruptcy allows a person to discharge all debts that can be legally discharged. In order to be eligible, the person’s income must be equal to or below the median income in their state.
However, each state has different income requirements. If their income is above the requirement, the court will apply a “means test” based on their previous six months of income. Should the test show that the person filing for bankruptcy has the means to repay their debts, they will not be eligible to file for Chapter 7 bankruptcy.
To summarize the process, the court will issue an automatic stay which prevents creditors from attempting to collect debts. From there, a creditor’s meeting will be scheduled, then a discharge meeting. At this meeting, the borrower’s unsecured debt is discharged.
There are some specific types of debt that remain after a bankruptcy discharge, meaning, they cannot be discharged:
- Child support payments;
- Tax debt, although some federal tax debt may be discharged if specific criteria are met;
- Debt that exists because of fraud; and
- Student loans, unless a court determines that there is undue hardship associated with this particular debt.
Once the Chapter 7 bankruptcy process is complete, creditors may no longer collect or attempt to collect on debts that were discharged.
Chapter 13 Bankruptcy is also known as wage earner’s bankruptcy, and is a way for a borrower to restructure their debt in such a way that they are able to afford payments. Those who have higher incomes and wish to keep their property generally choose Chapter 13 over other chapters.
While some debts may be eligible for discharge, other debts may require payment in full through a payment plan. Such a plan is generally set for three to five years.
A debtor may be eligible for a Chapter 13 bankruptcy filing, if they meet the following requirements:
- They are an individual or married couple;
- They own an unincorporated business, or are self-employed;
- Their total secured debts are equal to or less than $1,184,200.00;
- They have not had a bankruptcy petition dismissed within the last 180 days because they failed to appear or comply with the court; and
- They receive credit counseling through an approved counselor within 180 days of filing.
The biggest difference between Chapter 13 bankruptcy and Chapter 7 bankruptcy is that the borrower keeps, or attempts to keep, most of their property. They are still required to make payments. Similar to Chapter 7, Chapter 13 bankruptcy can affect the borrower’s credit for up to ten years post filing. During the Chapter 13 bankruptcy payment plan process, the borrower must adhere to a strict budget, and without lines of credit. It is important to note that because of this, many borrowers drop out of the payment plan.
Is Any Property Exempt From Creditors’ Claims?
Something else to consider before filing for bankruptcy is whether any property is exempt from creditors’ claims. An exemption allows a debtor to keep certain property or assets after bankruptcy is filed. These exemptions differ by state, and exempt property cannot be seized or sold in order to satisfy the debts of the debtor. In Chapter 7 bankruptcy, exemptions help determine which property the debtor will keep after the bankruptcy discharge has been granted.
In Chapter 13 bankruptcy, exemptions help determine how much the debtor must pay to their unsecured creditors. This can mean the difference between getting the payment plan confirmed, and getting knocked out of Chapter 13.
Property exemptions are only available to debtors located in certain states. These items are considered to be necessary for the debtor to keep, in order for them to make a fresh start. An example of this would be a home or a vehicle. A debtor must note the exemptions in a list that is then submitted to the bankruptcy court. Generally speaking, it will take thirty days after the meeting of the creditors for the property exemptions to be allowed. Creditors are allowed to challenge any or all of the exemptions.
Federal bankruptcy law allows each state to determine which assets a debtor is allowed to keep. A state may allow a debtor to choose between federally-created exemptions, as defined in 11 U.S.C. 522, or state-created exemptions. Alternatively, a state may limit a debtor to only the state-created exemptions. Debtors are allowed to use the exemptions from only one statute; meaning, either the federal or the state, but not both. States that provide more than one exemption statute or system allow the debtor to use the exemptions from only one statute.
Examples of exempt property may include, but not be limited to:
- Some vehicles, up to a specific value;
- Some jewelry, up to a specific value;
- Necessary items, such as clothing, some furniture, and household appliances;
- Tools of the debtor’s trade, up to a specific value;
- Some unpaid earned wages;
- Pensions; and
- Benefits including welfare, unemployment, and social security, if held in a bank account.
Examples of non-exempt property may include, but not be limited to:
- Second vehicles;
- Other motor vehicles;
- Second homes;
- Vacation properties;
- Valuables such as antiques or coin collections;
- Funds in bank accounts;
- Cash; and
- Securities, such as stocks or bonds.
What Are Some Other Bankruptcy Considerations Prior to Filing?
As previously mentioned, some of the biggest considerations are which chapter to file for, and being cognizant of what types of debt can and cannot be discharged through the bankruptcy process.
Another consideration is whether a debtor needs an income in order to file for consumer bankruptcy. Generally speaking, no, a debtor need not be employed at the time of filing. However, it is important to note that the debtor does need an income at some point during the six month period preceding their filing. This is so the court can determine whether the debtor has the means to repay their debts.
Debtors cannot temporarily get rid of or dispose of property they want to protect from creditors. This includes transferring assets to another person in order to prevent them from being included in the bankruptcy. The bankruptcy court could deny the petition if the debtor transfers any assets within one year of filing for bankruptcy.
Do I Need an Attorney For the Bankruptcy Process?
If you are filing for bankruptcy, you should consult with an experienced local bankruptcy attorney. Because state laws vary so widely in terms of what debts may be discharged, as well as what property may be exempt, an experienced local bankruptcy attorney will be best suited to handling your case according to your state’s laws. A bankruptcy attorney will help you consider which chapter to file for, and will also be able to represent you throughout the entire bankruptcy process.