How to File for Personal Bankruptcy

Reader Question: I have a lot of medical bills and other problems, and I feel that bankruptcy is my only option. How do I file for bankruptcy?

This blog offers advice on boosting your credit score and reducing your debt. So most of the information we publish is intended to help people avoid financial hardships such as a bankruptcy filing. But I'm also a realist, so I know that in certain cases bankruptcy is the only option for people. So in this post, I'll explain how to file for personal bankruptcy when you have no other options.

Let's start with a quick definition for the benefit of all readers. Bankruptcy is actually a right given to us by the U.S. Constitution. Basically, it's a process that structures the relationship between the debtor (that's you) and the creditors. It gives the debtor certain protections under the law, such as the ability to keep certain types of "exempt" property. In most cases, bankruptcy also allows a certain amount of debt to be forgiven. This will all be decided by a bankruptcy judge, of course.

Reasons to File for Bankruptcy

We have certain rules on this blog, and one of them is that we don't tell people what to do. We only provide advice and insight so people can make their own decisions. So this article is not recommending that you file bankruptcy in certain situations. Nor does it advise against such a filing. Whether or not to file is entirely up to you. But it may help to know the most common reasons why people file for personal bankruptcy. So let's start with those.

Most of the reasons for filing bankruptcy come from the inability to pay bills. For example, some people file for Chapter 13 in order to avoid home foreclosure. It doesn't make the mortgage payments go away, but it prevents people from trying to collect those payments until you can establish a court-approved payment plan (the main stipulation of Chapter 13 bankruptcy).

The most common reason people file for personal bankruptcy is to get out from under excessive debt. Once again, I have to stress that this is typically a last resort. This type of legal filing will stay on your credit report for up to ten years, and it will make it harder to get credit and financing in the future. So consider your options carefully.

Difference Between Chapter 7 and Chapter 13

As far as personal bankruptcy goes, Chapter 7 and Chapter 13 are the two most common filing options. The primary difference between them has to do with the repayment of debt. With a Chapter 7 bankruptcy, the person filing typically does not pay back any of their debt. With a Chapter 13 filing, on the other hand, the debtor establishes a court-approved payment plan through which they repay most of their debts.

This doesn't mean that Chapter 7 is a "freebie" where your debt is magically forgiven. Many people have this misconception and think that Chapter 7 bankruptcy is an easy way out. In reality, many of your assets will be liquidated (sold off) to pay a portion of your unpaid debt.

With a Chapter 13 filing, you would propose a repayment plan to the bankruptcy court / judge. The plan would be designed to pay back your debts over a three- to five-year period. Some of the debt may be forgiven under this filing option, but it does not "wipe the slate clean" like a Chapter 7 bankruptcy filing.

We often get questions from people who have been through a bankruptcy in the past, and want to know how soon they can improve their credit and qualify for a mortgage after the bankruptcy filing. Obviously, this is a question that only a mortgage lender can answer. But you should know that a Chapter 7 filing will hurt you more in the long run than a Chapter 13.

Think about it from a creditor or lender's point of view. The last thing they want to see is that you've completely walked away from your debts in the past -- which is basically what happens under a Chapter 7 bankruptcy filing. A Chapter 13, on the other hand, shows that you were willing to pay off your debts over time. Something to consider.

Filing for Personal Bankruptcy - By the Numbers

Filing for personal bankruptcy under Chapter 7 or 13 is a legal process. So there are some very specific steps you must follow in order to file bankruptcy in the U.S. The best way for me to present these steps is by the numbers:

• Step 1 -- Before you can submit your filing, you must go through a court-approved credit counseling course. You must undergo this counseling within six months of your bankruptcy filing, and it must be given by an approved credit counselor.
• Step 2 -- When you complete the above-mentioned counseling, you will be given a certificate of completion. You must then take this certificate to a bankruptcy lawyer.
• Step 3 -- You will be given a "means test" to determine your eligibility for Chapter 7 or 13. This is part of the revised bankruptcy law that went into effect in 2005. It measures your financial ability to repay debt, and it's designed to prevent debtors from abusing the bankruptcy system.
• Step 4 -- Next, you must file a petition for bankruptcy with the courts. This is the actual "filing" process that people speak of when referring to personal bankruptcy. It's the first part of the process that officially documents your Chapter 7 or Chapter 13 bankruptcy. You'll also be paying some court admin fees at this point.
  
• Step 5 -- Your petition will be sent to the bankruptcy trustee (also referred to as the United States Trustee).
• Step 6 -- If you are filing for Chapter 13, the trustee will review the debt repayment plan you've proposed. If you're filing Chapter 7, the trustee will take charge of nonexempt property that's going to be liquidated through the bankruptcy process.
• Step 7 -- In most cases, you'll have to take a court-approved personal finance class as well. This typically happens toward the end of the bankruptcy process. The training is designed to help you mange your finances better so you can avoid future debt problems.
  

Filing for personal bankruptcy under Chapter 7 or 13 is a serious action that requires careful consideration on your part. This article explains how to file bankruptcy through the U.S. court system. You should also do some research to learn how this process will affect you down the road, in terms of your credit score and future financing. You need to understand the big picture before you decide to take the first step.

Related Q&A Sessions:

• How can I improve my credit after bankruptcy?
• Improving your FICO score after Chapter 7
• Buying a home after a bankruptcy filing
  

I hope this article helps you make an informed decision, and I wish you all the best with your financial future. Most importantly, I urge you to continue your research beyond this website. Deciding whether or not to file personal bankruptcy is a major step, so you need to do thorough research before taking that first step.