Watching 30 for 30: Broke and seeing what 50 Cent is going through reminds us all that you can’t tell a person’s true wealth by what they drive, the house that they have, or the clothes that they wear. I started out my legal career as a bankruptcy attorney and saw many clients that put on a good front for the people around them but had a crushing amount of debt that made their life a living hell. In the tax realm, I represent many people, including some doctors, lawyers, and financial advisors that make more than $20,000 a month, yet they have nothing to show for it but huge amounts of debt.
I sympathize with those clients because I see how that amount of debt ruins their ability to enjoy life. I’ve also seen how a clean slate from filing bankruptcy can give people a lift that they never thought possible. It can be a great tool for those who need it.
If you find yourself contemplating bankruptcy, here are the basics that you need to know.
Two Main Chapters
Individuals file two main types of bankruptcy – Chapter 7 or Chapter 13 (the chapter numbers refer to the particular section of the United States Bankruptcy Code that governs the proceeding). Chapter 7 is known as the liquidation bankruptcy. You expunge all of your debt and get a fresh start. Chapter 13, on the other hand, is a reorganization bankruptcy that involves paying some of your debt back. You pay a percentage of your dischargeable debt (usually 10-100%), and at the rest of what you owe is forgiven at the end of your plan.
To begin the bankruptcy process, you must file a bankruptcy petition in the federal district that your county falls under. The petition, along with the associated schedules, gives the bankruptcy court a complete picture of your income, assets, and debt. You must also submit your past two years of tax returns.
Since the bankruptcy reform in 2005, you have to take a credit counseling class within 180 days before you file your petition. Additionally, your monthly income must be below the state median income in order to qualify for a Chapter 7. If not, you have to pass a “means test” to determine whether filing a 7 would be presumptively abusive, meaning you have the income to pay at least some of your debt back.
If you qualify for a 7, a trustee reviews your petition and gathers you non-exempt assets to sell and pay your credits. The exempt assets vary from state to state, with some states being extremely generous. For example, in Florida, the entire value of you home is exempt from liquidation. In other words, no matter how much equity you have, you still get to keep your home (as long as it meets the acreage limits). Retirement accounts are also usually protected from your creditors.
After the trustee pays your creditors (if applicable), verifies your information, and you complete a financial management course, you will receive a bankruptcy discharge, wiping your slate clean. The entire process lasts about four months from filing. The court charges a $245 filing fee, a $75 administrative fee, and a $15 trustee surcharge. If you get an attorney, you’ll likely pay between $1,200 and $1,900 for his or her work and expertise, which will have to be paid before the case is filed.
As with the Chapter 7, Chapter 13 involves the filing of a petition and associated schedules. But in addition to the schedules concerning your financial picture, you also have to submit a plan within 14 days of filing that shows how much you will pay the trustee every month and how that money will be distributed to the different types of creditors. If the court confirms your plan, the payments will begin and the trustee will distribute the funds accordingly. If the plan does not work for some reason, you will have an opportunity to correct it.
The plan usually lasts three to five years. Once the payments are complete, you will receive your discharge. If you fail to make payments, the 13 may be converted to a Chapter 7. The filing fee for a 13 is the same as a chapter 7; however the attorney’s fees can range from $2,500 – $5,500 depending on your location. Unlike a Chapter 7 bankruptcy, your attorney’s fees are paid as a part of your monthly plan payment.
You Must Weigh the Pros and Cons
Filing a bankruptcy is a tough decision, so you should take time to weigh the pros and cons.
Here are some of the advantages of the process:
- You get a fresh start.
- Once you file a petition, you are protected by the “automatic bankruptcy stay” which prevents any collection action against you by your creditors.
- A Chapter 13 will allow you to catch up on payments such as your house or car, without harassment from your credits.
Here are some drawbacks:
- The stigma associated with filing.
- The bankruptcy will be on your credit report for 7-10 years.
- Your debt can be reinstated if you don’t complete all of the requirements.
If you’re thinking about bankruptcy, I suggest you talk to two or three bankruptcy lawyers in your area until you find someone you trust and feel comfortable with. While hard to initiate, the process can lift a huge burden.