Bankruptcy 101: What Every Consumer Should Know
Despite changes in bankruptcy laws making it more difficult for people to file, the numbers are on the rise. In 2009, nearly 1.4 million people filed for bankruptcy, almost a third higher than in 2008. In the first quarter of 2010, almost 380,000 people filed bankruptcies nationwide, 17 percent more than the first quarter of 2009.
Bankruptcy filers are not simply people who mismanaged their finances. Many suffered a major health crisis or a life-changing event, such as job loss or divorce. Our current economic climate resulted in record numbers of foreclosures—another factor in growing bankruptcy rates where every demographic is represented.
Many people still see bankruptcy as their only solution to a financial crisis. And while it might be the best choice for some, it is not an easy fix for overwhelming debt. People that file bankruptcy should know that the decision has long-term effects and consequences.
Early warning signs
Look for serious financial problems. Getting a handle on these now can help avoid bankruptcy in the future.
Late or missed payments for more than one month
Missed or late payments may mean you are not keeping track of when bills are due or, more seriously, you cannot pay. If this is the case, then find out why and adjust your spending immediately.
Maxed out credit cards
You may be using credit cards to extend your income. Look closely at your finances and cut expenses, so your income can cover them without using credit.
Making only minimum payments
Paying the minimum on your credit card debt will result in more than a decade of payments and possibly thousands of dollars in interest. Stop charging today and start paying more. Even $25 extra a month will substantially decrease the amount of interest and time to pay off.
An interruption of income would cause immediate difficulty paying bills
The simplest way to avoid this is to have three to six months of emergency savings set aside for living expenses. If you do not have, a savings cushion, start today with whatever amount you can afford per month—even a small amount will add up over time—and set it aside.
When to consider bankruptcy
It might be time to look at bankruptcy if you have one or more of these issues:
- Facing foreclosure on your home
- Unsecured debts greater than one year’s gross income
- Wages have garnished to satisfy unpaid debts
- Receiving collection phone calls or letters
- More than 30 days behind on monthly bills
- Repossessed property, such as a vehicle or furniture
- Mounting medical bills not covered by insurance
The decision to file for bankruptcy is very personal. While it might be very helpful to seek advice from professionals, such as credit counselors or attorneys, you should weigh all the information before moving forward.
Chapter 7 versus Chapter 13
The two primary forms of Personal Bankruptcy are Chapter 7 and Chapter 13.
Chapter 7
Often called liquidation, this gives debtors a fresh start. It requires them to turn over non-exempt assets. These may include furniture, jewelry and household contents, which are sold to pay creditors. In return, debtors usually receive a discharge of their debt with the exception of certain types of non-dischargeable debt—things like alimony, child support, certain taxes and student loans. This form of bankruptcy provides for relatively quick elimination of most debts. It does not require payments to creditors after the bankruptcy filing, like Chapter 13however, not all people can file Chapter 7. As an example, people with higher incomes may not be eligible to file a Chapter 7. Filing Chapter 7 does have long-term effects and credit reporting agencies may report a Chapter 7 bankruptcy for up to 10 years.
Chapter 13
Designed for individual debtors who have a regular source of income, this type of bankruptcy often lets them to keep a valuable asset, such as a house. The court proposes a “plan” to repay creditors a portion of the debt over time, usually three to five years. Unlike Chapter 7, debtors are not eligible to have their debts discharged in the beginning of the case. As is the case with filing Chapter 7, credit reporting agencies may report a Chapter 13 bankruptcy for up to 10 years.
The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 added requirements for people considering bankruptcy, including:
- Means test for Chapter 7 eligibility based o¬n the debtor’s income versus the state median income
- Mandatory credit counseling before filing
- Mandatory debtor education before discharge
- New homestead exemption rules
- Mandatory eight year wait instead of six to file Chapter 7 again
- Dismissal of petitions for failure to provide a certificate of credit counseling
- Increased reporting for payments from employers for 60 days before the bankruptcy filing and a statement of monthly net income
Consequences
Filing for bankruptcy can eliminate many of your debts and provide you with an opportunity to start fresh. But it will also have a long-term effect on almost every part of your financial life, such as:
- Credit reporting agencies may include bankruptcies on a credit report for up to 10 years
- Some creditors will extend credit after a consumer files for bankruptcies, but loans may be difficult to obtain and interest rates and services fees may be very high
- Landlords, insurance companies and other service providers may also decline or re-price products and services based on credit history
Alternatives to Bankruptcy
There is no simple solution when a financial crisis arises, but bankruptcy is not the only option. You can take steps to repair troubled finances on your own.
Communicate with creditors
Contact your creditors—talk about options, such as reducing interest rates or setting up a payment plan you can stick to.
Reduce expenses
Carefully review your budget and look for places to reduce or eliminate expenses. Skipping your morning coffee, bringing your lunch to work, carpooling and eliminating extras on your cable bill can add up quickly to reduce your debt.
Increase income
Consider taking a second job to increase the amount of money you have to pay down debt.
Seek help
A certified credit counselor can help review your financial situation. They will provide all the information needed to make the best decision for your and your family. If you are thinking about filing for bankruptcy, be sure to start with a free budget and credit counseling session to see if any other options are available. From there, you might also consider Clearpoint’s bankruptcy counseling as a way to earn your legally required certificates.