The recent recession hit many people hard. But it’s not only recession related issues, such as job loss, that can cause financial problems. A big medical emergency or accident can deplete your finances — even when you have health insurance. Divorce can also result in financial devastation. And, of course, sometimes we make huge money mistakes, only later learning the full depth of the problem.
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When in dire financial circumstances, when you feel that you have done everything you can to rectify the situation, it might be tempting to consider bankruptcy. Personal bankruptcy can be one way for you to get something of a fresh start.
Chapter 7 vs. Chapter 13 Bankruptcy
Before you file for bankruptcy, you need to understand that there are two main types of personal bankruptcy. You should understand the difference:
This is the bankruptcy that most people think about. All of your non-exempt property and assets are submitted to a trustee (check to see whether, in your situation, your home, trade tools, books and retirement account are protected) and liquidated. Payment is distributed to creditors and, in many cases, your debt is discharged. However, you have to realize that a means test will be conducted in cases of Chapter 7 bankruptcy. If a judge determines that you can reasonably afford to better repay your loans, you will have to file for Chapter 13 bankruptcy.
Rather than turning over your property, you make a plan to repay some of what is owed to your creditors. If you have a low income, you repay for three years, and any remaining debt is discharged. Those with a higher income must repay debts for five years before the debt is discharged. A judge must approve your repayment plan, and you cannot have more than $922,975 in secured debt, and no more than $307,675 in unsecured debt.
Filing for personal bankruptcy can give you a chance to get rid of your debt, and start with a reasonably clean slate — as long as payment obligations go. It gives you a chance to get rid of debt that is holding you back, and help you reform your situation so that you can start fresh, living within your means and building wealth.
Bankruptcy May Not Always Be a Fresh Start
Realize, though, that bankruptcy won’t always mean a fresh start. First of all, not all debts can be discharged. Your student loans, child and spousal support payments, and some types of tax debt, cannot be discharged as part of a bankruptcy filing. You will still be expected to repay these obligations in full.
Additionally, bankruptcy is far from a clean start when it comes to your credit score. You will have to work hard to rebuild your credit after bankruptcy. You might find your credit score sunk to below 500. That means that it will be quite some time before you can get a mortgage, or maybe even borrow to buy a car. Chances are that you will need a secured credit card if you want new plastic. You will probably have to pay higher insurance premiums, and you won’t get the best interest rates on any loan for years to come.
In the end, bankruptcy can help you get back on your feet financially, but you do need to be aware of some of the consequences.
Miranda is a professional personal finance journalist. She is a contributor for several personal finance web sites. Her work has been mentioned in and linked to from, USA Today, The Huffington Post, The San Francisco Chronicle, The New York Times, The Wall Street Journal, and other publications. She also has her own personal finance blog: Planting Money Seeds.