Types of Individual Bankruptcy

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Bankruptcy SignDespite being in a recession, I haven’t seen a lot of personal bankruptcy stories. Many businesses are folding and personal bankruptcies have increased, but the mainstream media hasn’t published many sensational articles spotlighting a remarkable spike in bankruptcies.

Does that mean it’s on the horizon? Or is it simply not news when you can talk about an domestic auto manufacturer calling it quits? Either way, I think it’s important to understand the different types of bankruptcy, even if it is a dirty word, because it could one day help you if you’re in trouble.

U.S. Code, Title 11 – Bankruptcy

When you hear people talk about bankruptcy, they often say things like “Chapter 7” or “Chapter 13” bankruptcy. What do the chapters refer to? They refer to the U.S. Code, specifically Title 11 which covers bankruptcy law. You can read Title 11 at Cornell’s Legal Information Institute. You may recall, from my post on the law that requires us to pay income tax, that the U.S. Code is the codification of the laws of the United States. Each of the chapters covers a different aspect of bankruptcy law with Chapters 7, 12, and 13 being the most pertinent to individuals.

Types of Bankruptcy

Chapter 7 bankruptcy is a liquidation bankrupcy where you are forced to liquidate almost everything. It’s the most common type of personal bankruptcy. You turn over all non-exempt property to a bankruptcy trustee. The trustee liquidates it and distributes it to your creditors and you receive a discharge of all discharge-able debts. A Chapter 7 bankruptcy will remain on your credit report for 10 years from the filing date.

Chapter 13 bankruptcy is called a reorganization bankruptcy and used when you feel as if you can repay your debts over three to five years if you can get slightly more favorable terms. It’s possible to file for Chapter 13 if you can prove you have the income after your expenses to pay back your debts if you can get better terms. This option is available only if you have less than $336,900 in unsecured debt and less than $1,010,650 in secured debt.

Chapter 13 is better than Chapter 7 because you’re usually able to keep your home and car and Chapter 13 bankruptcies remain on your credit report for 7 years from the filing date.

Chapter 12 bankruptcy, which is lesser known, covers bankruptcy law if you’re a family farmer or fisherman. It’s very similar to Chapter 11, which is the business version of Chapter 13, and Chapter 13 except it’s more streamlined and designed to work better for family farmer/fishermen businesses. I won’t go into any more detail because it’s unlikely to affect you. If it does, I recommend reading this article on Chapter 12.

Those are the main types of individual bankruptcy. I like to think of Chapter 7 as the “fresh start” type of bankruptcy, where your assets are liquidated and your debts are discharged, and Chapter 13 as the “battle back” type of bankruptcy, because you get debt assistance from the courts but you still repay your obligations.

Finally, remember bankruptcy isn’t a good thing but it’s not a bad thing either. It doesn’t mean you’re a bad person. A few years ago Harvard Law School and Harvard Medical School teamed up to study bankruptcies in 2001 and saw that half of the personal bankruptcies were caused by illness and/or medical bills and it still remains one of the top three reasons people file for bankruptcy.

(Photo: thetruthabout)

{ 13 comments, please add your thoughts now! }

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13 Responses to “Types of Individual Bankruptcy”

  1. Marta says:

    This is more of a question than a comment. Long story short- a friend lost his job among other things and hasn’t been able to pay the mortgage in over a year. He’s also has severe negative equity, and would be more than happy just to give up the house and try to get back on his feet.

    Problem is the bank doesn’t want it either and won’t foreclose. Two attorneys told him that he can’t file for bankruptcy and clear his debt unless there is a judgment against him for the house. I know most people want to keep their home in bankruptcy, but he’s just the opposite, is he just out of luck?

    • Jim says:

      Marta, thats an interesting situation that he hasn’t paid the mortgage for a year and the bank won’t foreclose. You’d think the bank would want to salvage some of their investment. Wouldn’t ya know it, the one guy in the country that wants to be foreclosed on and they won’t do it. *shrug*

      1) Your friend could simply continue to live in the house for free until the bank decides to foreclose on him. I wouldn’t really consider it ‘bad’ to do so IMO, its not as if he’s taking advantage of the bank, he seems like he *wants* them to foreclose. Free rent might help him get back on track financially eventually and he could even get caught up on payments.

      2) He could look into a ‘short sale’. Thats if he finds someone to buy the home for less than what is owed and the bank agrees to it. Say he owes $150,000 and the home is only now worth $100,000. The bank might be happy to wash their hands of the situation for the $100k and take the $50k difference as a loss.

      3) If all else fails and he needs to move out of the house and move on with his life, he could ‘walk away’. That would be simply abandoning the home for the bank to eventually take over when they get around to it. But there could be consequences to doing this. He could owe the bank the difference in the loan still. IMO he’d be better of with option 1.

      • Marta says:

        Yeah, figures. It does seem bizarre. I’m surmising that with the glut of foreclosures in his area (south Atlanta) the bank doesn’t want to be saddled with the liability and property taxes. He also had a short term consulting gig, and I think they thought that was the light at the end of the tunnel. His checking account was also with them (USAA), and they pulled out money he had deposited, to cover what he owed them at the time for payments in arrears. I’m surprised that was even legal.

        He tried to work out a short sale but that fell through, either no takers, or something on the part of USAA. Its a pretty economically depressed area. He also tried to arrange a deed in lieu, but no dice.

        So, he gave up and has recently exercised option #3. His mother was diagnosed with cancer so he left the state and moved in with her to help out, and to increase his employment options. The only saving grace there is that he has friends keeping an eye on the house so it isn’t vandalized, but its a huge liability.

        What a mess.

        • When they zapped the money from his checking account, it was likely a levy which is a seizure of assets. It’s perfectly legal, but there are rules associated with executing this type of collection. Whenever someone is in serious debt where these levies may come up, I usually tell them to go off grid–meaning stopping direct deposits, turning off the bank account and associated debits, and living strictly on cash and money orders. This alleviates overdraft fees that typically result when the levy drains the account and checks and other debits clear the account.

          Also, if he banked with USAA and the mortgage was with USAA, they may have had an agreement to be able to do the levy without court approval. It may have been embedded within the customer agreement, etc.

          • Marta says:

            That would explain how that was able to happen, though it did exacerbate an already dire financial situation; checks written to pay other living expenses bounced.

            And that’s exactly what he’s done- off the grid in that regard, and working when he can for cash until he finds something permanent. But, job prospects for someone mired in debt, with bad credit, no bank accounts, without steady employment for two years, and living with his mother? I guess that’s a topic for another forum. Something titled “$75K to living with Mom” perhaps?

  2. DebtGoal says:

    One thing is true: those considering bankruptcy should focus on the financial/mathematical justification for declaring or not declaring it, and put aside any emotional or social concerns. Too many individuals fret over the impact of declaring bankruptcy on their personal relationships.

  3. Lisa says:

    I had no debt, yet was practically forced to declare bankruptcy to get out of a lawsuit. Anyone can sue anyone! I was a party to a frivolous lawsuit, where I had to continue to pay legal fees to defend myself – this went on for 8 years. I finally went Chapter 7 and the lawsuit was discharged by the bankruptcy court.

    • Jim says:

      I don’t mean to be nosy but how in the world could a “frivolous” lawsuit drag on for 8 years? If it was totally frivolous it would have been dismissed quickly by the judge with a summary judgment. Why would the other person spend 8 years of legal fees to pursue the case? If it was straight forward how could it drag on for 8 years? It seems a court thought the case was legitimate enough to last 8 years. Or we’re missing some key details here.

  4. Jim:

    In your research, did you find if retirement accounts were protected assets during bankruptcy? If I remember correctly, part of the newer bankruptcy provisions allowed for stronger protection of retirement accounts in that bankruptcy filers could hold on to these assets. Just curious. Thanks!

  5. Ray says:

    I have a friend who filed chapter 7 and was able to keep his IRA intact. Not sure if that would also be true of 401ks etc but his IRA was untouched.

  6. David says:

    What about student loans? I have heard that they cannot be discahrged with a CH 7.

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