by Ben Sweiry ·
Modified on 14 September, 2022
Bankruptcy is a legal process that lets individuals or businesses with overburdening debt to eliminate such debts and start over or, in some cases, work out deals with creditors to pay debts off manageably.
Bankruptcy may make sense if you are unable to repay debts as you cover obligations such as retirement, food and shelter.
Declaring bankruptcy will stop collection calls, lawsuits and wage garnishments. Essentially, what bankruptcy does is it erases debt. Despite common misinformation, bankruptcy may even help you to bring up your credit score.
What is Bankruptcy?
Bankruptcy is a legal proceeding involving a person or business that is unable to pay-off their debts. The bankruptcy process begins with a petition which is filed by the debtor, or on behalf of creditors, but this is less common. All of the debtor’s assets will then be measured and evaluated, and the assets may be used to repay a portion of the outstanding debt.
Bankruptcy offers an individual or business a chance to start fresh by forgiving debts that cannot be paid while giving creditors a chance to obtain some measure of repayment based on the individual’s or business’s assets available for liquidation.
All bankruptcy cases in the United States are handled through federal courts and any decision in a federal bankruptcy case is made by a bankruptcy judge, including whether a debtor is eligible to file and whether they should be discharged of their debts.
How Do I Declare Bankruptcy?
There are two major types of bankruptcies for individuals: Chapter 7 and Chapter 13 and each one has specific monetary qualifications.
Chapter 7 Bankruptcy
Chapter 7 is designed for people who truly can’t afford to pay their bills. Some people have income that is too high, and they don’t qualify for bankruptcy. To qualify, you must earn less than the median income for a family your size in your state.
If your income exceeds the median income in your state, you could try to pass a “means test” in which a court trustee examines your income and “reasonable” expenses to determine whether you could pay these bills, or really do need the relief Chapter 7 bankruptcy provides.
Chapter 13 Bankruptcy
The other option is Chapter 13 bankruptcy, which is known as the “wage earner’s bankruptcy” because it requires that you have a steady source of income and unsecured debts (credit cards, medical bills, personal loans, etc.) of less than $394,725 and secured debts (home, car, property, etc.) of less than $1,184,200.
If you exceed those limits, Chapter 11 bankruptcy might be an option.
How Bankruptcy Might Benefit You
Bankruptcy has a stigma, and perhaps this is justified, as you need to be in a certain state financially-speaking to qualify, but it may not all be bad news.
Bankruptcy stops collection calls, lawsuits and wage garnishments and even erases debt.
Credit bureaus and scoring experts often say bankruptcy is the single worst thing you can do to your scores. Foreclosures, repossessions, charge-offs, collections — nothing else can drive your scores down as fast and far as a bankruptcy.
However, in the case of people who qualify for bankruptcy, they will often have struggled for so long with their debt that their credit is already battered by the time they file for bankruptcy. And once they do, their scores typically rise, not fall. If the debt is erased — which is known in bankruptcy court as a “discharge” — scores go up even more.