When it comes to the reality of bankruptcy, many people have an ill-conceived idea of what it means. Sure, filing for bankruptcy is often used as a last resort for both individuals and businesses in a tight financial situation. But the truth is, filing for bankruptcy doesn’t mean your life, business, or career is over.
Here’s what happens when you file for bankruptcy, including the process, stipulations, and financial implications.
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When Should You File for Bankruptcy?
Generally, most individuals and businesses file for bankruptcy when there’s no possible way they can meet their debt obligations. Major businesses and corporations file for bankruptcy and completely recover.
A common misconception about this is that people fail to manage their finances properly or spend irresponsibly. But this is not always the case. Some of the most common scenarios for filing for bankruptcy include:
- Suffering a huge financial loss due to a recession
- Involvement in an ongoing lawsuit which bleeds a company or individual of their money
- Digital or product obsolescence
- An unexpected injury or prolonged illness that eats away at funding
- Clients who fail to pay their dues, causing major financial loss
It’s worth noting that filing for bankruptcy does not mean you are completely wiped of all debt obligations. You are still required to pay your dues — how you pay for them depends on the category of bankruptcy you file for.
Common Types of Bankruptcy Categories
While there are numerous categories of bankruptcy, chapter 7, 13, and 11 are among the most commonly filed. Here are the implications of each category:
1. Chapter 7
Filing for chapter 7 bankruptcy really does depend on what state you live in, your financial situation, and whether or not your assets are considered essential. In this category of bankruptcy, you’re required to liquidate your assets to help pay off some of your debt. These assets may be a car or a second home, for example.
In order to file for chapter 7 bankruptcy, you must meet certain requirements, first. One of the most important considerations is your income. If you have little to no disposable income, chapter 7 bankruptcy could apply to your situation.
2. Chapter 13
Chapter 13 bankruptcy allows you to establish a plan to pay off your debts in a time period of 3-5 years. You get to keep your assets and don’t have to liquidate anything. After the 3-5 year period, some of your debts will most likely be discharged.
But there are particular requirements in order to qualify for this category of bankruptcy. First of all, your secured debts (debt that’s backed by collateral) may not exceed $1,149,525. While your unsecured debts cannot be more than $383,175.
3. Chapter 11
This category of bankruptcy is generally reserved for businesses in financial trouble. It works similarly to chapter 13 bankruptcy, but also requires a restructuring of the company. A business is also able to file for chapter 7 bankruptcy, however, this means liquidations of whatever assets they have. This is why chapter 11 bankruptcy is a more realistic or attractive option for businesses.
Essentially, a business is able to hold onto their assets and keep creditors at bay while they stick to a debt repayment plan for a required period of time. Business is able to carry on as usual.
What Happens When You File For Bankruptcy: The Process
So, what exactly happens when an individual or business files for bankruptcy? In short, bankruptcy puts an immediate hold on your debt, which keeps at creditors from collecting what’s owed to them. For businesses, this is a major lifeline. It means that wages cannot be garnished, money cannot be deducted from bank accounts, and unsecured assets are safe, for the time being.
This all sounds good and well, but filing for bankruptcy can be a long and complicated process, and it isn’t free either. Filing for chapter 7 and 13 bankruptcy may cost a few hundred dollars, but filing for chapter 11 could cost thousands. You also cannot file for bankruptcy without a lawyer as bankruptcy laws can be difficult to navigate on your own.
Before you file for bankruptcy, you are generally required to take a credit counseling class for 180 days by your state. You may also have to attend a debtor education course if you want to have your debt discharged.
Once you have filed for bankruptcy you’re required to attend what’s known as a creditors meeting. Basically, this a court meeting which is held between you, your bankruptcy trustee, and the creditors you owe money to. From here, you’ll be questioned regarding your financial situation and your reasons for filing bankruptcy.
After this, the court will come to a decision about your bankruptcy allowances, terms, and debt repayment obligations.
What Happens to Personal Debt and Credit?
One of the worst implications of filing for bankruptcy is the effect it has on your credit score. In truth, you can expect your credit score to plummet. The higher your credit score, the greater it will fall. A low credit score can make life a little more challenging in many ways, especially with regard to business.
When filing for chapter 7 and 11 bankruptcy, this affects your credit score for up to 10 years, and 7 years for chapter 13 bankruptcy. Once your debt repayment terms are all said and done, most of your debts will be discharged. But this doesn’t apply to all forms of debt. This includes personal debt such as:
- Student loans
- Tax debt
- Child support repayments
- Divorce-related debt obligations, including property settlements
- Fines and penalties
- Debt repayment for personal injury or death compensation
Filing for bankruptcy is a last resort option. In essence, it’s a desperate remedy for a tough financial situation. There are long-term effects that can make an impact on the rest of your life, so filing for bankruptcy is not a decision to be made lightly. This being said, knowing how bankruptcy works and the terms that will work for you can make a huge difference.
Get Your Finances in Order with Bonsai Finance
Now that you know more about what happens when you file for bankruptcy, be sure to get on top of your own finances with Bonsai Finance!
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