The decision whether to file for bankruptcy protection is rarely an easy one. You may be concerned about the “stigma” of declaring bankruptcy, of losing your assets, never regaining a decent credit score and other unknown consequences.
Meeting with a bankruptcy attorney or doing some research on your own can dispel many of these notions, but it is important to know if bankruptcy is an option that help resolve your financial difficulties and which chapter to file. You need to know if Chapter 7 or Chapter 13 bankruptcy is right for you.
Filing a Chapter 7
Chapter 7 bankruptcy is a liquidation or elimination of your unsecured debts and the sale of any nonexempt assets. Corporate entities can file under this chapter if they are dissolving and will no longer be operating.
The Means Test
Before you can file for Chapter 7 protection, you must qualify by showing that either having income that is below the state’s median or by passing the means test, which determines if your disposable income is too high. This test is meant to prohibit debtors with substantial incomes from escaping responsibility for paying their debts.
To pass the means test, you have to find out the median income for your jurisdiction. If your income is below the median, you need not take the means test and can file under Chapter 7. If it exceeds the median level, you can still qualify by deducting specific monthly expenses from your average monthly income to arrive at your disposable income. Should your disposable income be less than a certain amount, you may file for Chapter 7 bankruptcy protection. Otherwise, you can only file under Chapter 13.
Filing any bankruptcy will initiate an automatic stay of all civil proceedings including collection activities, garnishments, levies as well as prohibiting creditors from contacting you. If your home is in foreclosure, a Chapter 7 will only temporarily halt the process until the lender or other party files a motion to obtain a lifting of the stay regarding your home.
Dischargeable debt generally refers to any unsecured debt such as credit cards and medical bills. In some cases, past due taxes may be discharged as well. You cannot discharge student loans absent a strong showing of extreme financial hardship. Court fines and penalties are not dischargeable. Personal injury judgments against you may be discharged if the judgment did not involve fraud or intoxicated driving. You can discharge most other civil judgments unless they involved malicious conduct. Regarding secured loans, you may have the option of paying the market value of the secured item, returning the collateral, or continue making monthly payments pursuant to any written agreement.
Filing a Chapter 13
Sole proprietorships and small business owners who are not incorporated as well as individual debtors may choose to file under Chapter 13, or you may have this as your only other option if your income is above your jurisdiction’s median income and you fail to pass the means test. You may choose this option if you wish to repay your creditors and are able to do so within a 3 or 5 year period.
A Chapter 13 is a reorganization of debts, similar to a Chapter 11 except on a smaller and less complicated scale. Under this chapter, you are required to repay your creditors, which may be at a reduced amount.
Continue Operating Your Business
If your small business is in financial trouble, a Chapter 13 allows you to continue operating. You may be able to renegotiate certain contracts or leases to gain more favorable terms. For creditors, they can be assured that their debts will be repaid at some time.
Debts are repaid according to their priority. Secured debts, child support payments, most taxes, court fines and restitution and mortgage payments are priority and are paid first. Non-priority debt includes credit card debt, personal loans and medical bills and are last to be paid, if at all.
Regarding your secured creditors, you may be able to surrender the collateral secured by the loan or the creditor can accept the terms of the repayment plan, which generally means repayment of the entire debt over 3 or 5 years.
Keep Valuable Nonexempt Property
When you file for bankruptcy, you are required to list your claimed exempt assets and property. Exempt property generally has a limit on its value; any amount that exceeds it is not exempt and is subject to being seized by the Trustee and sold. Under Chapter 13, you can keep your valuable nonexempt property, including non-homestead real property and other valuable personal property.
Under Chapter 13, you must continue to make your monthly mortgage payments but if your arrearages can be paid over the life of your repayment plan, then you can prevent the foreclosure of your home.
Discharge Second or Third Mortgages
You may also be able to discharge any junior mortgages. If your first mortgage is fully secured by the value of your home, then at the expiration of your repayment plan, any second or third mortgages will be considered unsecured debt and will be discharged.
Less Effect on Credit Rating
Also, filing a Chapter 13 has less adverse or long-term consequences on your credit rating. If you fulfill the terms of the repayment plan, the credit reporting agencies will take this into account when determining your credit score.
Carefully weigh the benefits of each chapter and consider talking to a bankruptcy attorney before you file. In many cases, a bankruptcy may be your best option for restoring financial sanity to your life.