The Credit Handbook

Considering Bankruptcy

In 2017, there were 767,721 personal bankruptcy filings—down from the 1.5 million filed in 2010. Several studies suggest that medical debt is a significant cause of many of the bankruptcies in America.

Bankruptcy is designed for people caught in severe financial circumstances. If you have excessive debt, bankruptcy is a federal court process designed to help you eliminate your debts or repay them under the protection of the bankruptcy court. Most bankruptcy petitions are voluntary. The definition of a debtor who may file bankruptcy can be found in the Bankruptcy Code. Deciding whether to file bankruptcy is a complicated question. You may need to consult with an attorney, financial advisor, or credit counselor to determine if you want to file bankruptcy.

You may need to consider bankruptcy if most of these statements apply to you:

If you are considering filing bankruptcy, beware of fly-by-night bankruptcy filers. These people will take your money in exchange for filing a form petition, but they cannot offer sound legal advice.

What Is an Automatic Stay?

After you file for bankruptcy, you have the protection of an immediate, but temporary, “automatic stay.” The automatic stay can, for example, immediately stop a foreclosure, an eviction, car repossession, or wage garnishment. It can also stop debt collection, harassment, and disconnection of utilities.

The automatic stay may provide a powerful reason for filing for bankruptcy. In most of the situations listed above, the automatic stay can buy you a few days or weeks in which to figure out your next move. If your primary motivation in filing bankruptcy is to gain the benefits of the automatic stay, you don’t need to file all of your papers at once. You just need to file the three-page petition, a signature declaration, and a listing of your creditors. In addition, within 180 days prior to filing, you will have to visit an approved credit counseling agency for advice and budget analysis. You will have to file a certification of such counseling when you file your petition. You have 15 days in which to file the rest of your papers. If you don’t, your case will be dismissed.

Once you file, a creditor cannot take further action against you unless the creditor has permission from the bankruptcy court. The creditor will ask the bankruptcy court to remove (or “lift”) the automatic stay if it is not serving its intended purpose. For example, if you file bankruptcy to stop a foreclosure, but you have no equity in the house and no income with which to make mortgage payments, the creditor is likely to ask the court for permission to proceed with the foreclosure. In a case like this, permission will probably be granted.

Different Types of Bankruptcy

For individuals, there are two main types of bankruptcy cases. Most individual debtors file for Chapter 7, which can also be described as “straight” bankruptcy or “liquidation.” Under this plan all non-exempt assets are converted to cash (liquidated), and secured creditors may have the item they financed turned over to them (such as a house or car), unless the debtor reaffirms the debt with the court’s approval prior to obtaining a discharge. Chapter 13, also called “reorganization,” is an option for people with regular income and debts that are less than the limits allowed by law. When you complete a Chapter 13 plan, you have the satisfaction of keeping your assets, paying your creditors, and possibly discharging some of your debts.

Bankruptcy is a serious step. If you choose to file Chapter 7 or Chapter 13, you will probably need to hire an attorney. Be sure to find an attorney who has experience handling the type of bankruptcy case you plan to file. The following overview of Chapter 7 and Chapter 13 will give you some idea of what’s involved.

Chapter 7

Under Chapter 7 bankruptcy, you ask the bankruptcy court to discharge the debts you owe, meaning you don’t have to pay them anymore. People with no steady income and few assets most often use Chapter 7. It eliminates most debts but also requires immediate liquidation of some assets. Co-signers to your debts can be required to make good on the contracts they have entered into with you. In most cases, if you file Chapter 7, you are allowed to keep your home if you only have a small amount of equity, an inexpensive car, and limited personal property. A person may obtain a bankruptcy discharge only once every eight years. Therefore, you should carefully consider your need for a bankruptcy discharge and your timing.

What Property Will I Give Up if I File Chapter 7?

The following property will probably be considered non-exempt and subject to liquidation in order to pay your debts:

What Property Will I Get to Keep if I File Chapter 7?

If you file Chapter 7, you can claim either state or federal exemptions. Exemptions place some property outside the reach of your creditors. But exemptions may not be applied to secured property to defeat a security interest. For example, a homestead exemption would only apply to the amount of equity you have in the home, not to the amount you still owe on your mortgage.

Both state and federal exemptions include motor vehicles, your homestead, basic personal property, and tools of your trade. Minnesota law provides exemptions in more categories and provides a more generous exemption for your homestead. The federal exemptions provide a little cushion you can use if you do not need the homestead exemption. Your attorney should help you determine which exemptions are best for your situation. You must claim either state or federal exemptions, you cannot mix and match. Exemptions generally include:

How Does Chapter 7 Work?

The nuts and bolts of Chapter 7 are that it moves fairly quickly, is less expensive than other chapters, and doesn’t take too much of your time. Generally your debts will be discharged approximately four to six months after the date the bankruptcy petition is filed. You will need to pay a filing fee, which does not include attorney’s fees. And, usually you will just make one trip to the courthouse. If you wish to file a Chapter 7 bankruptcy petition, you will have to pass a “means test” to determine whether you have the means to pay back portions of your debt. Depending on your income and the amount of debt you owe, you may have to file a Chapter 13 petition instead.

The steps in a Chapter 7 case usually go like this:

  1. First, within 180 days prior to filing a petition, you will have to visit an approved credit counseling agency for advice and budget analysis, unless certain exigent circumstances exist. Your attorney can help you find an approved credit counseling agency and determine if you have exigent circumstances present to exempt you from this requirement.
  2. Next, you or your attorney will file your petition and other forms with the Clerk of the United States Bankruptcy Court in your area. You must list all of your debts and creditors. You must also detail the property you own, your income, money owed you, insurance policies owned, current monthly living expenses, property you are claiming as exempt, as well as money that may be inherited within six months. You must also list property you owned, sold, or gave away.
  3. Once your attorney files your bankruptcy petition, the automatic stay goes into effect. This stops your creditors from trying to collect what you owe them. The automatic stay stops wage garnishment, lawsuits, and other negative action. (See page 36 for more information on the automatic stay.)
  4. After the bankruptcy petition is filed, a trustee will be appointed by the court. The trustee’s primary duty is to the creditors. This means the trustee will be interested in what you own and what exemptions you are claiming. The more the trustee recovers for creditors, the more the trustee is paid.
  5. The trustee will review your file and hold a hearing called the “creditors’ meeting.” At the meeting the trustee will ask you questions. You must attend this meeting, but creditors rarely do. These meetings generally last about five minutes.
  6. After this meeting, the court-appointed trustee takes control of your property that is to be sold and delivers property to the secured creditors, if appropriate. Once property is sold and administrative costs are paid, the remaining cash is paid proportionately to all creditors.
  7. The bankruptcy court later holds a hearing to inform you whether your debts have been discharged or not. Debts may not be discharged if someone objected or if the debts are nondischargeable.
  8. Prior to receiving a discharge, you must complete an instructional course concerning personal financial management.
  9. If you want to keep property that is used as collateral, like your car, you can continue making the payments on it. The creditor may ask you to “reaffirm” the debt, meaning you agree to keep making payments on it again. Talk to your attorney about whether it is better to keep making the payments without reaffirming the debt. The bankruptcy court must approve all reaffirmations of debts.

When Is Chapter 7 a Bad Idea?

If you are judgment or garnishment proof (meaning you have absolutely no non-exempt assets to protect), bankruptcy may be a waste of time and attorney’s fees. If this is your situation, you may want to talk to an attorney or credit counselor to use other options to stop harassing phone calls and similar practices. Other reasons Chapter 7 bankruptcy may not be the right step for you include:

Chapter 13

Chapter 13 reorganizes your debt rather than liquidates your assets. When you file under Chapter 13, a debt repayment plan is designed to pay off as much of your debt as possible, usually within three or five years. When you file Chapter 13, you agree to pay approximately 25 percent of your income to the court. A bankruptcy trustee will supervise the plan, handle your money, and distribute it to pay off the debts covered by your plan of reorganization.

Chapter 13 is also called personal reorganization because it is most often used by people with regular incomes and less than $394,725 in unsecured debt and less than $1,184,200 in secured debt. These limits are valid as of June 2018, but federal law changes these limits periodically. (Examples of unsecured debt include credit and charge card purchases, medical and dental bills, rent, and loans from family or friends. Secured debts are home mortgage loans and vehicle loans.) The actual amount of money paid to creditors depends on the amount you owe, your salary, and the payback time frame. Depending on your income level, Chapter 13 payment plans may be proposed for 36 months, but most often plans are for 60 months. The maximum time allowed is five years.

When Should I Consider Chapter 13?

The bottom line on Chapter 13 is that it takes longer, requires discipline, and costs you more. First, your plan may be approved in four to six months. Second, for the three or five years specified in your plan, you will pay a good portion of your income to the court to pay off your debts. In fact, only about 35 percent of the people who file Chapter 13 complete their plans. Third, Chapter 13 costs more than filing Chapter 7 because administrative costs can add up. You will pay a filing fee and other costs, including court costs, attorney’s fees, and the trustee’s fees for paying off the debts.

However, despite these drawbacks, there are some good reasons people choose Chapter 13 over Chapter 7. Reasons include:

How Does Chapter 13 Work?

To file under Chapter 13, you will need to contact an attorney who has experience in filing Chapter 13 bankruptcies. You can expect the process to work like this:

  1. First, within 180 days prior to filing a petition, you will have to visit an approved credit counseling agency for advice and budget analysis, unless certain exigent circumstances exist. Your attorney can help you find an approved credit counseling agency and determine if you have exigent circumstances present to exempt you from this requirement.
  2. Your attorney will file your bankruptcy petition with the federal bankruptcy court in your area. To do this properly, you will need to compile the following information:
    • A list of all of your creditors and the amounts you owe.
    • The source of your income and how often you get paid.
    • A list of your property.
    • A detailed listing of your monthly living expenses.
  3. You will either file a plan of repayment with your petition, or within 15 days of filing the petition. This plan must provide for full payment of all priority claims, which usually includes secured claims. If the plan classifies claims, it must provide the same treatment for each class of creditors. The plan also details the amount of your future income that you will deposit with the trustee to repay your debts.
  4. When you file for bankruptcy, the automatic stay goes into effect. This stops creditors from trying to collect the debts you owe. See page 36 for more information.
  5. When you file, a trustee is appointed to administer your case. The trustee will collect the money you pay in under your plan and disburse the money to your creditors.
  6. Within 30 days of filing your plan, you must begin making payments to the trustee. This is true even if the court has not yet confirmed your plan.
  7. A “341 meeting” of creditors is held within 20 to 40 days after your petition is filed. You must attend this meeting. Creditors may attend and ask questions about your financial affairs. The trustee will attend the meeting and question you.
  8. Unsecured creditors who have claims against you must file their claims with the court within 90 days after the first date set for the meeting of creditors. If an unsecured creditor fails to file, they may not do so later.
  9. At a confirmation hearing, the bankruptcy judge will determine if your plan is feasible and meets the standards for confirmation. Creditors do not vote on the plan, but they may object to the plan. Creditors most frequently object if they will receive less under your Chapter 13 plan than if you filed Chapter 7 and liquidated all of your assets. If your plan is not confirmed, the money you have already paid will revert to you. As the debtor, you have the right to dismiss your case or convert it from Chapter 13 to Chapter 7.
  10. Once the court confirms your plan, it is your responsibility to make the plan succeed. You will continue making payments under your plan for the three- or five-year period specified in your plan. A confirmed plan may be modified if your financial situation changes. If you stop making payments and the Chapter 13 gets dismissed, your debts are not discharged and your creditors can resume collection.
  11. You are entitled to a discharge when you successfully complete an instructional course concerning personal financial management and your plan payments.

What Debts Cannot Be Discharged in Bankruptcy?

The following debts cannot be discharged in either a Chapter 7 or a Chapter 13 bankruptcy case. If you file Chapter 7, you will still owe these debts after your case is over. If you file Chapter 13, these debts will either be paid in full during your plan, or the balance will remain at the end of your case.

Nondischargeable debts include:

In a Chapter 7 and 13 case, a creditor may object, and a judge may agree, to these additional debts being discharged:

For More Information

The Bankruptcy Code is federal law and is found at United States Code Title 11. There is no such thing as state bankruptcy law. A bankruptcy case is filed within the district containing the home address of the debtor. Minnesota has one bankruptcy district with divisions in Minneapolis, St. Paul, Fergus Falls, and Duluth.