If you're struggling to dig out from under a mountain of debt, you've probably considered your various options many times over. Whether it's better to file for bankruptcy or whittle away at your old debts with payments over time depends on your personal concerns and circumstances.
The Automatic Stay
The automatic stay is one of bankruptcy's greatest advantages. It's something like an impenetrable wall that protects you from your creditors. You move behind the wall the moment you file a bankruptcy petition. Your creditors can't reach you there. They can't file lawsuits against you to collect what you owe, and they can't call you and ask when they might expect your next payment. They can't use judgments they've gotten against you in the past to garnish your wages or bank accounts, taking money you might have earmarked for something else.
A Chapter 13 Plan
Chapter 13 is the bankruptcy plan that involves paying your debts off with your excess income each month after you've met your reasonable and necessary living expenses. You give this money to the trustee, and he in turn apportions it among your creditors. Chapter 13 plans run three to five years. During this time, you can pay off all your old debts just as you might have done without filing for bankruptcy, but you're protected by the automatic stay while you do so. The Chapter 13 trustee pays your debts in an order of priority, and unsecured creditors are last in line. At the end of your bankruptcy plan, these low-priority creditors may not receive all of what you owe them, but that's OK -- the balance is discharged anyway and you're relieved of responsibility for paying the remainder of those debts, even if they've long since gone to collection agencies.
Risks of Chapter 7
If your income exceeds your reasonable living expenses by $166 a month or more, you can't file for Chapter 7 bankruptcy. If you earn between $100 and $166 a month more than your necessary living expenses, the court will decide which chapter you may file. If you don't earn at least $100 more a month than you need to pay your regular bills, you're typically limited to filing for Chapter 7. You'll have the advantage of the automatic stay, but you run the risk of losing some of your assets. The trustee is authorized to take your non-exempt property and sell or liquidate it to pay off as much of what you owe as possible. Exemptions allow you to keep a certain dollar value in various items, such as your automobile. If an asset is not worth more than the exemption, the trustee won't sell it. If you think you have a lot of non-exempt assets, speak with an attorney to find out if paying off your debts on your own might be the better choice.
Effect on Credit
Another big bankruptcy issue is the damage it does to your credit score and report. A Chapter 7 filing stays on your report for 10 years; a Chapter 13 remains for seven. Filing either form of bankruptcy will pull your score down, but if you have a lot of charge-offs or debts with collection agencies, your score is probably already rather low. The question becomes how quickly you can build it back up again. If you file for Chapter 7, you can take out a secured credit card immediately after discharge, which is usually only a few months after you file. Your credit score can begin improving if you pay the account regularly, even though the bankruptcy still appears on your credit report. If you file for Chapter 13, your credit should – theoretically – start improving right away. By law, your creditors must stop reporting your accounts as past due as soon as the court confirms your repayment plan. In reality, creditors often neglect to do this, but you can check your credit report and bring the problem to their attention if they don't.
- United States Courts: Chapter 13 – Individual Debt Adjustment
- United States Courts: Chapter 7 – Liquidation Under the Bankruptcy Code
- United States Courts: Glossary
- Gum, Hillier & McCroskey: How Does Bankruptcy Affect My Credit Score?
- Maydanik Law Firm: How Long Will Bankruptcy Stay on Your Credit Report
- American Bar Association: "Straight" Bankruptcy – Chapter 7
- Robert Weed: Chapter 13 Bankruptcy and Your Credit Report
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