What is Personal Bankruptcy?
When someone receives credit, he is promising to repay the principal amount plus the interest. This promise (or contract) lists basic terms and conditions for the repayment of the loan. As long as the debtor continues to fulfill this debt obligation, there are no problems.
If debtors fail to make a payment on time, then creditors have the right to penalize the debtors for failing to abide by the debt contract. After failing to make a number of payments, the debtor might realize that he will be unable to continue to make payments.
Eventually, the debtor might file for bankruptcy, which will permit the court to seize the debtor’s assets to repay creditors, while discharging some of the debt. Personal bankruptcy is the legal declaration of an individual’s inability to pay off his debts. Bankruptcy initiates a court process, where a court-assigned “trustee” liquidates the debtor’s assets in order to repay the creditors in an orderly manner or helps the debtor reorganize his finances. Bankruptcy fulfills the following societal needs:
In 2009, there were 1,410,000 bankruptcy filings in the United States. When times are tough and people lose their jobs, bankruptcy filings increase.
History of Bankruptcy
The word, “bankruptcy” originates from the two words – “Bancus” (bench or table) and “Ruptus” (to break). When a merchant was incapable of repaying his debts, creditors would break his table (used to conduct business in the marketplace) to signal the end of his business.
In 1542, English King Henry VIII passed a bankruptcy law empowering creditors to seize a debtor’s assets and throw him in one of the “debtor’s prisons,” which were as small as dog kennels. In the “English Act of 1825,” the “collusive bankruptcy” was created where both the creditor and debtor could use bankruptcy to discharge debt.
While the United States Constitution recognized the usefulness of a uniform federal bankruptcy code applicable to all the states, American bankruptcy was much more pragmatic, empowering debtors to take on higher levels of debt. When debtors were incarcerated, it was impossible for them to repay their debts.
The “Bankruptcy Act of 1898″ empowered debtors to seek financial relief (called “unconditional discharge”) without creditor or court permission. The United States Bankruptcy Code, Title 11, regulates personal bankruptcy; Chapter 7 governs “Liquidation” and Chapter 13 governs “Reorganization.”
Good bankruptcy laws balance the creditor’s need for profits and the debtor’s need for capital to start new businesses. A healthy economy requires a free flow of capital. While some creditors believe it is too easy to wipe out debts, some debtors believe that it is too difficult to repay loans.
Bankruptcy’s Negative Stigma
Credit is a contractual “promise” whereby a bank places faith in a debtor’s ability to fulfill his debt obligation. Filing for bankruptcy signals a “failure” in this good faith loan. Creditors are annoyed because they will probably only recover a portion of the full debt. Some see bankruptcy filers as lazy, irresponsible, deadbeats. Bankruptcy stays on most credit records for eight years.
Why File for Bankruptcy?
When the debtor realizes that he cannot make his payments, bankruptcy is a “last resort,” which provides a “fresh start.” Bankruptcy will enable the debtor to discharge most debts. Bankruptcy is a legal procedure that stops the following:
- Wage garnishments
- Most lawsuits
Alternatives to Bankruptcy
With a bad economy, more people file for bankruptcy. Governments and non-profits offer free debt relief assistance. The most common alternatives to bankruptcy are credit counseling, debt consolidation loans, and mortgage modifications.
Filing for Bankruptcy
Bankruptcy is a serious choice, carefully weigh all of your options. What do you want to accomplish with bankruptcy? You can file at a bankruptcy court – pay a small fee, submit federal income tax forms and fill out the paperwork. You don’t need a lawyer to file for bankruptcy. The amount of time for the entire bankruptcy process depends on the complexity of your financial situation.
Tips for a Smoother Bankruptcy
The trustee, assigned by the court, has a lot of power, so be honest about your financial circumstances. Carefully assemble all relevant financial documents ahead-of-time, so you will be organized during the bankruptcy proceedings.
Chapter 7 or 13 Personal Bankruptcy
After deciding to file for personal bankruptcy, you must choose Chapter 7 or 13 Bankruptcy. Chapter 7 is “Straight Liquidation,” where the trustee seizes the debtor’s assets and liquidates them for the creditors. Chapter 13 is “Reorganization” providing time for the debtor to repay debts according to a Payment Plan over 3 to 5 years.
Common Bankruptcy Terms
Here are common bankruptcy definitions:
- “341 Meeting” – Creditors ask questions about assets
- “Case trustee” – Assigned by the court to distibute non-exempt property to creditors
- “Collateral” – Financial asset used to secure loan
- “Creditor” – Someone to whom money is owed
- “Debtor” – Owes money to someone
- “Homestead exemption” – Home equity protected against seizure
- “Judgment lien” – Arises from lawsuit
- “Means test” – Income calculation
- “Mechanic’s lien” – Placed by workers
- “Personal property” – Possessions not attached to land
- “Purchase money security interest” – Item bought using credit
- “Tax lien” – Placed by government
Can I keep certain debts off my bankruptcy?
Is filing a long process?
No, it usually takes a couple of days.
Is my mortgage a dischargeable debt?
No, you must continue to make your mortgage payments if you want to keep your house.
Will I lose my home during bankruptcy proceedings?
If you can make your mortgage payments, then you can claim the “homestead exemption” under Chapter 13.
Can I ever get a credit card again?
While your bankruptcy will seriously damage your credit rating, there are companies that target “high-risk” consumers with “high-interest” rate credit cards.