Bankruptcy filings have increased more than 500% since the early ‘80s, and well over 1 million people now file each year. Interestingly enough, the dramatic rise in the “popularity” of bankruptcy has coincided with our increased societal reliance on credit cards.
“Overall, the increase in credit card and possibly mortgage debt levels since 1980 provides the most convincing explanation for the increase in bankruptcy ﬁlings in the United States,” Michelle J. White, a professor of economics at the University of California, San Diego and a research associate at the National Bureau of Economic Research, wrote in an article for the Journal of Economic Perspectives. “But adverse events and debt levels interact with each other in explaining the increase in bankruptcy ﬁlings because, as debt levels increase, any particular adverse event is more likely to trigger ﬁnancial distress and bankruptcy.”
In other words, it’s now easier for us to habitually spend beyond our means, and we are putting our finances in jeopardy by doing so, especially during times of economic turmoil when debt can easily become unsustainable. This is not to say that we should all forgo credit card use or that bankruptcy is always the answer to serious debt, but rather that understanding the bankruptcy process is certainly worthwhile in this day and age.
With that in mind, you can find information on the following topics below.
Types of Bankruptcy
There are six different chapters of bankruptcy under U.S. code, but Chapter 7 and Chapter 13 are undoubtedly the most common for consumers.
Chapter 7: Often referred to as “straight” bankruptcy, Chapter 7 provides for the discharge of unsecured debts (i.e. those not backed by property such as a car or a house), as well as the liquidation and sale of certain assets by a designated trustee in order to repay creditors.
“In a chapter 7 bankruptcy, most bills are done away with (discharged) and you get to keep almost all of your property because it is exempt under state or federal law or is secured,” according to Bruce Comly French, Director of Clinical Programs and Professor of Law at the Ohio Northern University Pettit College of Law, who says roughly 80% of consumer cases are Chapter 7.
As French notes, many assets are exempt from liquidation and can be kept after filing. The exempt assets vary from state to state, but typically include your primary automobile, certain tools used for business, personal belongings such as furniture and clothing (up to some maximum), and part or all of the equity in your personal home. It’s also important to note that a number of debts can’t be discharged and will still be due after filing. They usually include certain current taxes, certain fines, fraudulently incurred debt, family support obligations (including child support and alimony), and federally insured student loans.
Chapter 13: Often referred to as “consumer reorganization” bankruptcy, Chapter 13 bankruptcy requires debtors to restructure their debts and create a three-to-five year repayment plan. Under the repayment plan, the debtor will use his future income to pay off, in full or partially, his creditors. As such, Chapter 13 bankruptcy is applicable only to debtors with regular income. The process of a Chapter 13 repayment plan is supervised by an impartial trustee that is appointed by the court.
- Chapter 11: Often referred to as “corporate reorganization” bankruptcy, Chapter 11 is typically utilized by indebted businesses to restructure their operations in the name of financial relief. Chapter 11 bankruptcy enables a business owner to refinance debts and cancel certain contracts without ceding ownership in their company, unless the company’s debts exceed its assets – in which case equity may fall to the company’s creditors. Chapter 11 bankruptcy is typically regarded as the most complex and most expensive type of bankruptcy.
- Chapter 12: This type of bankruptcy is quite similar to Chapter 13 but is targeted to farmers and fishermen.
- Chapter 9: This segment of the bankruptcy code applies to municipalities (e.g. cities, towns, and school districts) and helps them restructure debts. More specifically, Chapter 9 bankruptcy offers local governments and other similar organizations protection from creditors as they seek to extend the terms of their loans, refinance interest rates, garner forgiveness for certain amounts of interest or principal, and other forms of debt relief.
- Chapter 15: This chapter provides for cooperation between U.S. and international court systems in bankruptcy cases involving multi-national corporations.
Bankruptcy Means Test
The bankruptcy means test is m a way for the courts to determine whether you are eligible for Chapter 7 bankruptcy based on your income, assets, debts, and liabilities, or if Chapter 13 bankruptcy (or no bankruptcy at all) is more appropriate. Chapter 7 is the form of bankruptcy most favorable to the filer, after all, as it enables debtors to completely avoid paying certain bills, rather than having to do so on an extended timeframe or with a lower interest rate – as would be the case with Chapter 13.
The means test can be broken down into four basic steps, only two of which necessarily apply to all potential filers.
- Calculate Your Current Monthly Income (CMI): The word “current” can create confusion, but what this really means is that you need to calculate your average gross income (before taxes and credits) for the last six months.
- Compare Your CMI to the Median in Your State: If your current monthly income is less than the median for a family of your size in your state, according to data published by the Census Bureau, then your means test is done – you qualify for Chapter 7 bankruptcy. If it is above the state median, you will need to complete steps 3 and 4.
- Determine Your Disposable Income: To find your disposable income, subtract from your CMI the following expenses (using IRS averages for your area): housing, food, clothing, medical care, transportation, debt payments, taxes, charitable donations, etc.
- Figure Out Where You Fall: If your monthly disposable income falls below a certain amount ($117 in recent years), you are eligible for Chapter 7 bankruptcy. If your monthly disposable income falls above a certain amount ($195 in recent years), then you must file for Chapter 13 bankruptcy instead.What happens if your income lies somewhere between $117 and $195? That’s a bit more complicated. If you can afford to repay 25% of your “non-priority unsecured debts” – such as your credit card and personal loan balances– within 60 months, you must opt for Chapter 13 rather than Chapter 7. If not, you are likely eligible for Chapter 7 bankruptcy.
Benefits & Repercussions of Bankruptcy
Deciding whether or not to file for bankruptcy requires careful consideration of the inherent pros and cons of doing so – of which there are many of both.
|Debt Forgiveness||Often entails forgiven amounts owed or lower monthly payments.||Monetary Expense||Bankruptcy can be expensive, with attorney’s fees and filing charges.|
|Legal Protections||Filing for bankruptcy puts into effect an “Automatic Stay”, which stops most creditors from trying to collect.||Credit Score Damage||Bankruptcy will remain on your credit reports for 7-10 years from the date of filing.|
|Line of Sight to Debt Freedom||A defined plan will give you peace of mind and the ability to make strategic decisions.||Reputation||Bankruptcy may be frowned upon by creditors and community.|
When to File for Bankruptcy
Bankruptcy is merely one of the various forms of debt relief that are potentially available to consumers, and it should be treated as such. In other words, you shouldn’t make up your mind that bankruptcy is necessary until you fully explore your options and exhaust all other, potentially less-damaging courses of action.
“Use bankruptcy as a last resort,” says UCLA Law Professor Kenneth N. Klee. “Once you get a discharge, there is an 8 year bar to getting another one. Don’t use the safety valve unless you need it.”
You can find more information about when bankruptcy is necessary in CardHub’s How to File for Bankruptcy guide. You can also get more advice from Klee and other bankruptcy experts below.
How to File for Bankruptcy
Filing for bankruptcy should begin with a trip to a bankruptcy attorney to determine your options and next steps. Not only will an attorney help you evaluate your financial situation and make a decision regarding bankruptcy, but he or she will also help you navigate the complexities of the bankruptcy code, gather together and submit all of the required documents and forms, and ultimately leverage the bankruptcy process to maximum value. Corporations and partnerships are required to have an attorney.
Nevertheless, some individuals do decide to try do it yourself (DIY) bankruptcy. This isn’t advisable, particularly given the ban on multiple Chapter 7 filings within an eight-year timeframe, but you can check out CardHub’s article on How to File for Bankruptcy if that is your chosen course of action.
The best course of action, however, is to interview a few bankruptcy attorneys who offer free consultations, read some reviews about them, and at least consider professional assistance before deciding how exactly to proceed.
Bankruptcy Filings by Year
Ask The Experts: Bankruptcy FAQ
CardHub consulted bankruptcy experts – both professors and practitioners – from around the country for insight into some of the most common questions people have about the bankruptcy process. Hopefully their advice can help you navigate these treacherous financial waters as safely as possible.
- What part of the bankruptcy process do you think people understand least?
- What advice do you have for people who are contemplating bankruptcy?
- What are the best ways to recover from bankruptcy?
- Does bankruptcy have a social stigma?
- How often are bankruptcies misrepresented on credit reports?
- To what extent has the BAPCPA changed the bankruptcy landscape for individuals and small business owners?