What is Bankruptcy? | The Basics

James is 30 years old and requests that $90K of debt be discharged in a Chapter 7 bankruptcy. He has no assets other than his $30K Toyota Camry.?

After his divorce, he moved states and lost his job.?

He has been struggling for years to pay off his debts exceeding his annual income of $60K.

James is looking for a fresh financial start to begin living again. Will he get approved for Chapter 7 bankruptcy?

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In today’s newsletter, we will be discussing bankruptcies.?

• The terminology you need to understand
• The pros and cons of filing
• The eligibility requirements of Chapter 7 and Chapter 13
• The process to file for each
• Four ways to avoid bankruptcy
• And how to rebuild your credit once you are approved

Disclaimer- This information is for educational purposes only. This is not legal advice. Please consult with a bankruptcy attorney for guidance on your specific situation.

Why Choose Bankruptcy?

Bankruptcy is a way for honest yet unlucky people to get a fresh start on their finances; otherwise, we would live in a society like Squid Game, where you would have to risk your life to pay off your debts.

Bankruptcy is most commonly used for people whose debts exceed at least 25% or more of their annual income.?

This likely means that they’ve exhausted all options for paying down their debt, and this is their last resort to resolve their debt problem.

In past years it was much easier to get approved for bankruptcy; however, consumers racked up debt and left their creditors at a loss, so new legislation was introduced in 2005 to prevent this from happening so frequently.

Today, it is more challenging to get approved for bankruptcy, depending on which state you live in.

Before we discuss the two most common types of bankruptcy, which are Chapter 7 and Chapter 13, let’s break down some terminology to help you understand what’s being discussed.

The terminology you need to understand

1. Whenever you hear automatic stay, any collections activity is taken against you, such as a foreclosure, judgment, or wage garnishments, must temporarily cease.

2. A discharge is ultimately the main objective of filing a bankruptcy; this releases personal liability of debt from the debtor.

3. Secured debt is a loan backed by collateral such as a mortgage and car loan. If you get too behind on payments, they can take back ownership of the property even if you get a discharge and don’t have to complete your payment agreement.?

4. Unsecured debt has no collateral attached; however, you have a moral obligation to repay what was borrowed. This includes credit cards and medical bills. As a side note, unsecured debt is more favorable than secured debt when asking for debts to be discharged.

5. Now, let’s talk about dischargeable debts, meaning debts that, if discharged, you are no longer responsible for paying back. They include auto loans, medical bill debts, rent, credit card debt, and utility debt.

6. The last term is nondischargeable debts, which means even if you get approved for bankruptcy, you are still responsible for paying back the following debts: alimony, child support, student loan debt, taxes, and court-ordered damages.?

The Pros of filing for Bankruptcy

• It gives you a fresh financial start.?
• It also can help you see where you went wrong because you will have to work with an approved credit counselor to be eligible to file.

The Cons of filing for Bankruptcy

• Nondischargeable debts such as alimony, child support, taxes, student loans, and court-ordered damages must still be paid.
• A bankruptcy will remain on your credit report for up to 10 years affecting your credit score by a minimum of 200 points.
• Borrowing money may be more difficult for the ten years after you file.
• You may be restricted from getting approval for "preferred housing." You may need to pay a larger deposit or need a co-signer to gain approval.
• Your insurance premiums will increase.
• Finding employment may become more difficult, especially if your career requires a license and needs to access your credit report.
• Your confidence might get challenged after realizing that you could not pay off the debt you owe without having to make such a major sacrifice.

Now let’s move on to the eligibility requirements for chapters 7 and 13 and the process to file for each.

Chapter 7 Bankruptcy

Chapter 7 is the most common form of bankruptcy. About 70% of people get approved for this chapter. It is also known as liquidation because although you aren’t responsible for paying back the debts, you don’t get to keep all your assets.?

How do you qualify for Chapter 7?

1. Simply put, the more money you make, the less likely you will be able to file for Chapter 7 bankruptcy. You must have earned less than the median income for your state in the last six months. They call this passing the means test.
2. Six months before you file for bankruptcy, you must get mandatory credit counseling from a court-approved nonprofit credit counselor. Be sure to get your certificate as proof of attendance; otherwise, it will delay approval. The cost of credit counseling can range from free to $50.
3. Once approved, you must complete an approved debt management course to get discharged from bankruptcy.

Chapter 13 Bankruptcy

Next, we will transition into Chapter 13, also known as wage earner bankruptcy.

How do you qualify for Chapter 13?

1. In Chapter 13, you must take the same means test used in Chapter 7 to determine your income. In this case, exceeds your state's median.
2. Next, you must receive credit counseling with the same requirements as Chapter 7.
3. The difference between chapters 7 and 13 is that with chapter 7, the debts are being discharged, and you usually have to give back your assets. With Chapter 13, you can keep your assets, but you have to repay the debt, usually over a 3-5 year timespan. Any debt remaining after this time will go unpaid.
4. Lastly, just like Chapter 7, once approved, you must complete an approved debt management course to get discharged from bankruptcy.

4 Ways to Avoid Bankruptcy

At the beginning of this episode, we discussed James in our case study wanting to file for Chapter 7 bankruptcy.?

The fact is that James's finances took a big hit after getting a divorce and losing his job, which were both outside of his control.

But let’s say this wasn’t the case, and he simply lost control of paying back the debt he borrowed. What are ways that he could avoid filing for bankruptcy?

1. He could listen to my podcast episode on How to Remove Collection Reports Even If You are Not a Professional to see how he could resolve his debt directly with his lenders.
2. He could have found ways to increase his income by getting a new job, starting a side hustle, or selling items that he no longer uses.
3. He could buy my book How to Manage on ANY Income to determine which expenses he can reduce and get an overall picture of his finances.
4. He could:

• Subscribe to my e-mail community for exclusive tips
• Subscribe to my LinkedIn Newsletter ‘Let’s Talk Money’
• And subscribe to the Build Young Grow Wealthy podcast to learn how to manage, protect, and grow his income.

How to rebuild your credit once you are approved.

It takes 4-6 months from filing for bankruptcy to get approval for Chapter 7.

By now, James has completed his mandatory credit counseling as well as his debt management course.?

What should James now understand about how to rebuild his credit after getting approved for bankruptcy?

1. He should ask if he can reaffirm some of his debt. This means keeping a few lines of credit that he is in good standing with and can afford to make monthly payments in order to have his older accounts show some signs of his ability to pay in the future.
2. Apply for a secured credit card. This works like a regular credit card, except the account uses a deposit that guarantees your ability to pay. Be sure your institution will report your payments to the credit bureaus.
3. Take out a credit builder loan and pay the fixed monthly payments every month.
4. Lastly, learn from his mistakes. Really vet whom he decides to marry and always look for ways to keep some type of cash flow into his bank account.

Conclusion

So, do you think James made the right decision to file for bankruptcy, or should he have exercised other options first?

Be sure to leave me your comment below.

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