The idea of bankruptcy law is to give you a fresh start, free from your previous debts, with enough assets to live on and help you start over. The law sets up different classes of debts and property, which determine what property you can and cannot keep, whether or not your creditors get paid, and how much your creditors get paid.
There are some limits as to how often you can use bankruptcy. You may not file under Chapter 7 if:
- you obtained a discharge under a Chapter 7, 11, 12, or 13 petition filed within the past eight years
- you had a Chapter 7 case dismissed within the past 180 days because you violated a court order
- you had a Chapter 7 case dismissed within the past 180 days because you asked for dismissal after a creditor asked for the automatic stay to be lifted
These limits do not apply to Chapter 13 cases, which may be filed at any time. If your secured debts exceed $750,000 or your unsecured debts exceed $250,000 (as of 2014), you may not use Chapter 13.
Exempt and Nonexempt Property
Each piece of property you own will be classified as either exempt (which means you may be able to keep it) or nonexempt (which means you will have to turn it over to the trustee). Although the Bankruptcy Code is a federal law, the available exemptions are different in each state.
Most states allow you to keep a certain dollar value of:
- real estate
- tools used in your profession
- insurance policies
- household furnishings
- retirement benefits
- public benefits (such as workers' compensation and unemployment)
- other personal items
These are examples of exempt property. However, exempt property may still be lost if you borrowed money to buy it and do not keep up your payments.
Secured and Unsecured Debts
Debts are classified as either secured or unsecured. A secured debt is one that is backed by a certain piece of property. The most common examples are home mortgages and car loans. The papers you signed when you borrowed the money specifically state that if you do not pay, the lender may take the property. You may not keep that property unless you pay for it, even if it would otherwise be exempt property in your state. If you do not want to lose your home or car, you will have to arrange a payment plan acceptable to your lender or keep your payments current.
An unsecured debt is not backed by any property. Examples of unsecured debts are credit cards, department store credit cards, and medical bills. In some bankruptcy cases, the lender of an unsecured debt may not get paid and may not get any property either. Even if you bought your dining room furniture with a credit card, it is still an unsecured debt (unless you also signed some additional paper that states that the property secured the loan).
Since a mortgage is a secured debt, filing for bankruptcy will not allow you to keep your home without paying for it. The best bankruptcy can do is buy you time to make arrangements to catch up on your payments, or allow you adjust the terms of your loan so you keep your home.
When you file for bankruptcy, the law imposes what is called an automatic stay. This prevents any creditor from taking any legal action against you unless it first gets the permission of the bankruptcy court. Therefore, if your lender has already begun a foreclosure action, filing bankruptcy will temporarily stop the foreclosure—probably for a few weeks at most. If your lender has not yet filed for foreclosure, it may not do so until the bankruptcy court lifts the automatic stay.
If you file under Chapter 7 of the Bankruptcy Code, you will either need to bring your payments current or work out some arrangement with your lender by the time the automatic stay is lifted. If you file for bankruptcy under Chapter 13 of the Bankruptcy Code, you may be able to get the bankruptcy court to require the lender to accept new terms for repayment (such as an extension of the time of the loan). The best thing to do is talk to your lender as soon as you find you are having trouble making payments. The longer you wait, the less likely you will be able to work something out.
When you talk to your lender, explain your financial situation and have a plan to present (such as extending the term of the loan). Just be sure you can follow through with the plan you propose. Many lenders would rather work with you than foreclose. For a lender, foreclosure is time consuming and expensive. They really would rather not have to hassle with taking the home back and trying to resell it for enough to recoup the costs.
One other significant part of the law is that there are a few types of debts that cannot be discharged in bankruptcy. The four most common types of nondischargeable debts are:
- taxes (with certain exceptions)
- government-guaranteed student loans
- child support
- spousal support
You still have to pay these debts even if you go through a bankruptcy.
The Bankruptcy Procedure
The bankruptcy procedure can be viewed as a simple four-step process.
- You prepare and file your voluntary petition and supporting documents. This provides information about your income, expenses, property, and debts. It also requests that the court discharge your debts (or approve your payment plan) according to the law.
- The trustee notifies your creditors that you have filed for bankruptcy. This gives your creditors an opportunity to be sure you have given correct information in your petition and to raise any questions or objections.
- You have a meeting with the trustee and your creditors. This is when any questions or objections are discussed and settled.
- You attend a hearing, at which time the judge can discharge your debts (or approve your payment plan). This may even be a mass discharge of many cases at one time, in which you and many others obtain a discharge at the same time.
You should also consider the following things before you decide to file for bankruptcy:
If a friend or relative co-signed a loan for you, that friend or relative will still be liable for the debt.
You may have your case dismissed if the judge determines that you have enough income to pay your debts, if you defrauded your creditors, or if you charged a lot for entertainment, vacations, or luxury items just before filing.
You may not need to file for bankruptcy if your only goal is to get bill collectors off your back, or to avoid having your property or wages attached. Other state and federal laws may be able to accomplish these goals without filing for bankruptcy.