How Bankruptcy Works: An introduction To Chapters 7, 11, 12, and 13

How Bankruptcy Works: An introduction To Chapters 7, 11, 12, and 13
Photo by Fried Dough – CC BY 2.0

Before filing for bankruptcy, consumers should explore all of their financial options and make sure that bankruptcy is the best choice. Because it can so severely damage a person’s credit score, it should only be used as a last resort. However, in many situations, bankruptcy is the best and most sensible option. If a person has truly looked into all of the available alternatives and has still determined that bankruptcy is the right choice, they should then start the research process to understand how bankruptcy works.

There are four different types of bankruptcy that most people use. They are chapters 7, 11, 12 and 13. Although they all share certain similarities, they are slightly different. When most individuals declare bankruptcy, they file a Chapter 7 Bankruptcy also referred to as a liquidation bankruptcy.

Based on laws that came into effect in 2005, only people who are under a certain income level are eligible to file Chapter 7. In order to file Chapter 7, an individual’s income must not have exceeded the average income for the area over the last six months. For instance, if the individual is part of a family of four and the average income in their area for a family of four is $48,000 a year, their income must not have exceeded $4,000 a month for the last six months. If their income falls within the guidelines, they can pursue a Chapter 7 filing.

This is how a Chapter 7 works. The debtor will be assigned a trustee by a court. The trustee will oversee the sale of all the debtor’s assets. The money earned from the sale of the assets will be used to pay back some of the debtor’s creditors. The remaining portion of the debt will be discharged which means that it will be erased, and the debtor will not be obligated to repay it. Depending upon which state the debtor resides in, they will be allowed to keep a certain portion of their assets, which are considered to be exempt. Exempt assets can sometimes include a home that does not have a mortgage on it or part of a vehicle.

If an individual’s income is too high for them to qualify for Chapter 7, their attorney will normally advise them to file Chapter 13. In a Chapter 13 bankruptcy, the court also appoints a trustee to the matter. The trustee will help the debtor work out a repayment plan with his or her creditors. Over a three to five year term, the debtor will repay the creditors a portion of their outstanding debts. The rest of the debt will be discharged or erased. The terms of the repayment plan depend largely upon the person’s income level, but they are also affected by other factors. Some people prefer this type of filing as it allows them to keep many of their assets. However, if you are considering declaring Chapter 13, you should keep in mind that you will usually not be allowed to keep any assets that have a lien on them unless you continue to pay the loan in a fashion that is approved by the lien holder.

If an individual’s secured debts are worth more than $922,975 and their unsecured debts total more than $307,675, they will not be eligible for Chapter 13. Instead, they will have to file Chapter 11, which is normally reserved for businesses. Secured debts are ones that are secured by some sort of collateral. For instance, mortgages and car loans are secured debts because if the debtor fails to pay them, the bank can simply repossess their home or car and thus recoup a portion of their losses. Unsecured debts, on the other hand, are things like credit cards, which are not backed up by any sort of collateral. The fourth type of bankruptcy is Chapter 12, which is primarily used by farmers.

Figuring out how bankruptcy works is fairly simple. If you truly believe that you cannot repay your debts, you may wish to consider bankruptcy. However, in some cases, people have so few assets and so little income that they are virtually judgment proof. That means that if their creditors took them to court, they would get nothing. In those cases, it is not worthwhile to declare bankruptcy, and those people should simply stop paying their bills. In most other cases, however, debtors who feel overwhelmed should contact an attorney and speak to them about bankruptcy options.

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