Bankruptcy – What it is, When it’s Used, and How it Works – Adapted from Debt Free for Life

I had the pleasure of receiving a publisher’s copy if David Bach’s latest book Debt Free for Life – The Finish Rich Plan for Financial Freedom. Rather than give a general overview of the book, I’m going to talk about chapter 14 – How Bankruptcy Works, When to Use it, How Long it Will Take to you to Recover.

Bankruptcy is pretty much a last ditch effort to help save your financial situation (and perhaps your overall health and life).  The hope is that no one will ever need to know about bankruptcy but the truth is over a million and a half people in 2010 will file for personal bankruptcy.

First off about bankruptcy – if your financial situation is in dire straights and you are even remotely considering bankruptcy, get some professional financial help as soon as possible.  The sooner you speak to a professional the better your situation can be.  Bankruptcy should be a means to help someone stay afloat but many wait too long and put themselves in a real bad situation and end up giving up more assets than they may need to.  Bankruptcy can be complex and you want advice to help you through it.

Bankruptcy also takes a mental toll on a person.  Face it, people don’t plan on being bankrupt.  Having to live up to your financial situation is a hard thing.  Understand that if you feel you need to discuss bankruptcy that you are not alone.  It does happen to other people.  And you know what?  People get through it.

What Bankruptcy Is

Bankruptcy is a legal declaration that you can’t repay your financial obligations on time or at all.  Depending on the type of bankruptcy declared (more on the types in a bit) you can either wipe out most debt or be allowed a payment plan to give yourself more time to pay.  The bankruptcy declaration also gets your creditors (those you owe money to) off your back, in that they can’t chase after you for payments (not that they won’t necessarily get paid later on though).

A successful bankruptcy can essentially make some debts disappear, never to be bothered with again.

Two Types of Personal Bankruptcy

Perhaps you’ve heard the terms in the news or on TV – Chapter 7 and Chapter 13?  The chapter part refers to the part of the legal code that defines the particular bankruptcy.  There are other types of bankruptcy but these are the two that most people will deal with personally.

Chapter 7 Bankruptcy

This form of bankruptcy can basically wipe-out most, or all, unsecured debt (secured is when something backs the loan such as a car or a house, where unsecured is more like credit card debt).  It’s a popular, yet sever, form of bankruptcy.  A person declaring Chapter 7 is in such bad financial shape that there’s essentially no way they can pay back their loans.  It’s severe in that most assets you own, with some exceptions, can be sold off to pay your creditors.  It can also be a quick process that can have your debt discharged in as little as 4 months.

Chapter 13 Bankruptcy

In this form of bankruptcy, the person filing establishes a court-supervised re-payment plan for the person to re-pay their debt.  This type is for those in which re-payment is a real possibility, they just need a little extra time.  It can also allow more assets to be kept than in a Chapter 7 bankruptcy.

You need to have steady income to prove you can fulfill your re-payment plan, which you have 3 to 5 years to pay back.  Some debts will be re-paid in this time while others will only be partially re-paid or even not paid at all (depending on what the bankruptcy judge approves in the plan).

Unfortunately, less than half of those who declare Chapter 13 actually complete their plan.  Re-payment takes real discipline and dedication and many who declare find too much temptation to wander off their plan to stay with it.

When to Consider Bankruptcy

You should seriously consider bankruptcy when the amount of unsecured debt you have is so large that there is essentially no way you could repay it within five year.  Also consider bankruptcy if your car and home loans are past due but you need extra time to catch up to pay them off.

Other Considerations in Bankruptcy

– How much you earn.  If your income is greater then the median income in your state then you may not qualify for Chapter 7 bankruptcy and may only have Chapter 13 as an option.  When considering your income, what you have made in the past six months is used to calculate whether you can, and what, debt you can pay back.  If you have been laid off then timing is crucial in this determination as the longer you have been out the less income you have to count against your debt.

– What kind of debts you owe.  You need to look at where your debt is coming from.  Most bankruptcy is used for unsecured debt such as credit cards or medical bills.  Debt that is secured will most likely not be wiped out but it could be made easier to manage under a payment plan (or what is securing the debt can be sold off to pay off your debt).  Bankruptcy can help those with upside-down home loans eliminate that part of their mortgage above the current value of their home (otherwise, in a sale or foreclosure, you can still be held responsible for the difference).  There are also cases where you can turn a secured loan into an unsecured loan and have some or all of it eliminated.  An example would be if you were upside-down on a second mortgage.

Some debts you can’t wipe out in bankruptcy.  Examples include alimony; child-support; most cases of student loans (there are instances where a loan can be discharged if you prove “undue hardship” though this is unpredictable); recent income taxes; recently acquired debt (like if you ran up your debt knowing you were going to declare bankruptcy); legal judgements against you; and anything you don’t put into your filing.

– What state you live in.  Exact laws on bankruptcy change from state to state.  You need to be aware of your specific state’s laws to see what you may be able to exempt from bankruptcy.

– Your retirement accounts.  Don’t cash out your retirements accounts to pay off debt without speaking to an expert first!  In most cases, retirement accounts, such as your 401(k) or IRA, will be protected in bankruptcy.  But if you cash out the accounts first then that’s it, the money is no longer in a protected retirement account.  This is just another great reason why it’s important to speak to a bankruptcy expert as soon as possible rather than waiting too long.

As you can see, bankruptcy can get complex.  You want to sort of professional bankruptcy expert to help guide you and the earlier on you can do this, the better.

There is more great information on bankruptcy in David Bach’s Debt Free for Life that I didn’t even get to.

I found the information on bankruptcy to be really informative and solid.  Bach makes the case that, although it’s not the preferred route to handling debt, it is a way for a person to get back on their feet financially.  If you need to declare bankruptcy, it’s OK.  It happens, and the sooner you work towards the bankruptcy, the sooner you can emerge and re-build you finances, and in many cases your life.

I’m eager to jump back in Debt Free for Life and read the rest of the chapters.  Just glancing through the book I found some great information on finding unclaimed money that I plan to implement.

If you have debt and you are looking for a way to get out of it and you want to start on the road to financial freedom then I think you should give Debt Free for Life a look.

Have any of you read the book already?  What do you think?

You can find Debt Free for Life on Amazon (and probably at your local library as well).