I’m Aimee the Attorney, here with answers to your legal questions about how bankruptcies work. Recently, I interviewed Betsy Lynch, an area bankruptcy attorney. Betsy explained the ins and outs of filing consumer bankruptcy. The interview covered many common questions people have about what bankruptcy is, how it works, and what they can accomplish by filing.
What Is Bankruptcy?
Understanding how bankruptcies work can be challenging if you aren’t well-versed in the law. However, you can get a basic idea of what they are and how they work. Bankruptcy is a process designed to relieve people of their debt. Its purpose is to give people a backup plan so that they are motivated to create, invent, start businesses, or take other risks. They know that if their project fails, they can get a second chance, so they’re willing to take those risks. Bankruptcy essentially wipes the slate clean. Bankruptcy takes place in the federal court, although state laws may apply to certain aspects of your case.
What Are the Types of Bankruptcy?
There are two types of bankruptcies that can help individuals: Chapter 7 and Chapter 13. Each type is a different process and has a different outcome. Which is best to file depends on several factors, including how much disposable income you have.
When choosing to file Chapter 7 or 13, each of your debtors has to file a Chapter 7 means test. This is an income qualifying test to determine if you can file Chapter 7 bankruptcy or will have to file a Chapter 13. If you’re current on house and car payments and fall below the median income level for the state, you automatically qualify for Chapter 7. Otherwise, you may qualify, but it will take more work to find out and file it. Betsy described this as being like the difference between filing your taxes on a 1040EZ form or a full 1040 with itemized deductions.
Chapter 7 Explained
So, what is Chapter 7 bankruptcy? It’s a process that allows you to discharge your debt without having to make a repayment plan. Betsy said that, for most people who talk to her about bankruptcy, the goal is to file a Chapter 7. The reasons for choosing a Chapter 7 include:
Chapter 7 Bankruptcy:
- It wipes the slate completely clean.
- It forgives you of all your debt.
- There is no repayment plan.
- It costs less in attorney’s fees.
- It’s shorter.
The filing fee for Chapter 7 is slightly less than for Chapter 13. However, both fees are considerably less than the fee for a Chapter 11, which is a type of reorganization bankruptcy used mostly by businesses. The difference between Chapter 7 vs Chapter 11 is $310 in filing fees for Chapter 7 compared to $1,000 in filing fees for Chapter 11.
What happens when you file Chapter 7? When you first see your lawyer for a consultation, they explain the types of bankruptcies and how bankruptcies work. Betsy mentioned that she gives each client a written timeline of what will happen at each point along the way. There’s about a month of preparation for a standard bankruptcy. Your lawyer should give you a list of the documents they need in order to prepare your case. You come in, go over the paperwork and correct any errors, sign it, pay the filing fee, and your case is filed.
At that point, a stay is issued that puts a hold on proceedings against you. Now, no one can repossess your car, get a judgement against you, garnish your wages, or even call you on the phone or send you collection letters. Finally, you go to a 341 meeting of creditors at the federal courthouse. You’re asked a few basic questions and perhaps some questions specific to your case. Very quickly, the proceeding will be over, your debt will be discharged, and the bankruptcy is complete in 60 days. You do have to do credit counseling before and after the bankruptcy hearing.
Chapter 13 Explained
Chapter 13 bankruptcy is designed for people who don’t qualify for Chapter 7 or who have fallen behind on car and/or house payments and want to keep their car and house. In a Chapter 13, you can restructure debt, such as your car loan, so that you have more free money to pay off some unsecured debt.
However, it’s unlikely you’ll pay off all your unsecured debt. Betsy gave this example: If you had $100,000 in credit card debt and could only pay $100 per month on it, you would end up paying about $6,000 over a five-year period. The $94,000 you didn’t pay would be discharged in the end of the bankruptcy plan. Bankruptcy plans can range from 36 months to 62 months.
A Chapter 13 bankruptcy costs more than a Chapter 7. That’s partly because you’re hiring an attorney for a three- to five-year period. It also takes more time to complete. However, there are some advantages. First, you pay your attorney only a minimal retainer fee, and the rest is paid through your Chapter 13 plan. The other advantage is the opportunity to restructure loans.
Chapter 13 Bankruptcy:
- Good if you want to keep your car and house
- Costs more than a Chapter 7
- Takes more time to complete
- Pay your attorney only a minimal retainer fee, and the rest through your chapter 13 payment plan
- Opportunity to restructure loans
One example of how this benefits you is if you’ve rolled over an old car loan when you bought a new car so that you’re now paying $30,000 on a $10,000 car. When you restructure your debt, you might be able to pay the value of it (the $10,000) rather than the car loan amount. If you don’t qualify to pay only the value, though, you can still restructure that debt and pay it off at a discounted interest rate.
What happens when you file Chapter 13? The process for a Chapter 13, again, starts with a consultation. You’ll need those same types of documents as you would for a Chapter 7. You sign the papers and choose a filing date. The automatic stays are in effect when the case is filed. In 30 days, you go to a 341 meeting of creditors.
For Chapter 13, you have to have a Chapter 13 plan, which will be reviewed by the trustee and you’re your creditors. They can object to the plan or make adjustments. Within two to six months, you can usually get a plan confirmed by the court.
A bar date is set that’s about four months after you file Chapter 13 bankruptcy. By the time the bar date comes, any creditor who hasn’t filed a claim cannot get paid. There are a few exceptions to this, such as a mortgage that is current or taxes. If you owe for unsecured debt and those creditors don’t make a claim, you don’t have to pay them.
When the payment plan is confirmed, you begin making your payments to the court. At the end of the payment plan, once you’ve made all your payments, the bankruptcy is completed. You now have a second chance.
What Does a Person Need to Bring a Lawyer When They Want to Discuss Bankruptcy?
Your bankruptcy lawyer will tell you what to bring to your first meeting. Generally, you’ll need several things before your attorney can start the process:
You'll Need This Before You See a Lawyer About a Bankruptcy
- Basic information about what you own
- Information about who you owe
- A rough estimate of how much you owe
Your attorney can help you with this as well. Betsy said she teachers her clients how to run a credit report and gather the information about who their creditors are and how much they owe them. It’s especially important to know the details of your unsecured debt in order to make the right choice between Chapter 7 and Chapter 13.
3 Questions People Need to Ask a Lawyer About Bankruptcy
It’s always important to ask the right questions. Betsy suggested that you ask these three whenever you begin talking to a bankruptcy attorney:
Questions to Ask a Lawyer About How Bankruptcies Work for You
- Is bankruptcy appropriate for me?
- What chapter am I eligible to file?
- Are there any problems with my case?
Your lawyer might not know these answers immediately, but they should be able to explain the process of how bankruptcies work for you. They should be able to tell you what is needed to answer those questions. For example, if you haven’t brought the information needed or don’t have the money for the lawyer to run the means test, the attorney should be able to explain exactly what you need to do next. They may not be able to offer you any guarantees, but they should be able to articulate a plan.
What If I Have No Money?
So you are starting to understand how bankruptcies work and it may be right for you but what if you are truly broke? Many people wonder how to file a Chapter 7 bankruptcy with no money. Betsy said that what she tells her clients is that her flat fee on a Chapter 7 must be paid before the case is filed. This eliminates the conflict of interest that would occur if she were a debtor at the time of the bankruptcy. In Betsy’s view, this is an ethical question that she resolves by requiring her fee up front. Of course, the filing fee must always be paid before the bankruptcy can be filed.
There are several ways people come up with the fees. They may use the money they free up when they stop paying credit cards that will be discharged anyway. Or, they may use their income tax refund for the bankruptcy fees. Betsy said it’s fine if you get the money from someone you know, such as a grandmother or brother. However, someone who pays for bankruptcies for relatives must understand that you can’t pay them back ahead of other creditors. If you borrow the money from them to file bankruptcy, you can’t pay them back within one year before you file bankruptcy. That’s because the court considers them your debtor, and you have to pay all your debtors back evenly.
Is There Anything That Cannot Be Discharged in Bankruptcy?
Although bankruptcy is intended to relieve you of your debts, there are certain things that you may not be able to have discharged in a bankruptcy. For example:
Generally Cannot Be Discharged in a Bankruptcy.
- Tax debt
- Child support
- Student loans
However, there are exceptions. For instance, you may be able to sue your student loan lender through an adversary proceeding and prove a hardship. The burden is very high in this, however, and the hardship must be extreme such as a severe disability. You not only have to prove that you can’t afford to pay those loans now but also that you will never be able to afford to pay them. In some cases, taxes can become dischargeable as well.
What Happens to My Credit After a Bankruptcy?
What happens with your credit depends partly on how bad it was before the bankruptcy. Betsy said that most of the people who come to her for bankruptcy have terrible credit. In some cases like that, their credit score can actually go up after bankruptcy. One reason is that, with less debt, your income to debt ratio improves. In Chapter 13, your credit may recover to the point that you could even buy a house if you make all your bankruptcy payments on time for one to three years.
For most people, it takes about two to three years to rebuild their credit after a bankruptcy. Your
attorney can give you pointers on how to get your credit score back up. For instance, you might get a
secured credit card, use it regularly, and pay it off each month. Over time, your credit score will increase until you can be financed again.
Filing for bankruptcy is an important decision, but you won’t have to make it without guidance. Your
bankruptcy attorney can answer your questions, guide you through the process, and teach you how to make a financial recovery after it’s over.