Living Debt Free

How Bankruptcy Works

For thousands of years, it's been recognized that debts can get the better of even the most conscientious among us. From Biblical times to the present, sane societies have discouraged debtors from falling on their swords and have provided sensible ways for debt-oppressed people to start new economic lives. In the United States, this is done through bankruptcy. Bankruptcy is the solution of last resort - a harsh but legal remedy for staving off financial disaster.

In general, bankruptcy is a 3-step process.

1. You file a petition in federal court saying that you're insolvent (you have no assets to pay debts.)
2. You work out a repayment plan with your creditors and the court.
3. You discharge (settle) your debts, usually for less than their full amount, so that your creditors receive at least some money.

Types of Bankruptcy
It's always smart to consult a lawyer before filing for bankruptcy, and in some cases it is required. There are two standard ways for an individual to file for bankruptcy, each named for the section of the legal code that governs it. The chapter that a consumer chooses is primarily determined by income, the property owned (whether it is exempt or nonexempt from asset liquidation) and the type of debts owed (secured or unsecured).

Chapter 7, or "straight bankruptcy" (lawyer advisable)
This is the most frequently used form. Debtors ask to be released of all their debts and agree to relinquish their assets. Most assets are liquidated by the court to pay creditors. Some assets, like your home, are exempt from sale. Some debts, like taxes, fines, alimony, and student loans must still be paid.

Chapter 13 (lawyer required)
Chapter 13 bankruptcy lets you rearrange your financial affairs, repay a portion of your debts and put yourself back on your financial feet. You repay your debts through a Chapter 13 plan. Under a typical plan, you make monthly payments to someone called a bankruptcy trustee, who is appointed by the bankruptcy court, for three to five years. The bankruptcy trustee distributes the money to your creditors.The purpose of Chapter 13 is to allow people to retain their property and to avoid the stigma usually associated with the term "bankruptcy."

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