Personal bankruptcy is a legal proceeding, when an individual seeks protection from his creditors, as he can no longer pay his debts. Under US bankruptcy law there are two types of personal bankruptcy; chapter 7 and chapter 13. The vast majority of consumers file under chapter 7.
Chapter 7 is a complete discharge from all non-secured debts, with no further payments due. The only items exempt from personal bankruptcy are child and spousal support, student loans, taxes older than 3 years and any court-ordered payments as a result of an illegal act. Personal bankruptcy is used to remove all unsecured debt, such as credit cards and personal loans.
Secured debt, such as cars or mortgages, may be kept separate from the bankruptcy. The creditors have the right to repossess these assets if the payments are not made. There are state and federal limits on the value of these assets, so check with your bankruptcy advisor.
Once you have filed for personal bankruptcy, all legal actions against you stop, including wage garnishments, lawsuits and foreclosure proceedings. A bankruptcy lawyer works with you to identify your total income and debts. They meet with your creditors on your behalf. and inform the creditors that you are declaring bankruptcy.
Creditors have the right to object if they feel that you are hiding funds and assets. If not, the request is accepted by the creditors. You are required to attend two personal counseling sessions to teach you about money and debt management. Once you have completed these sessions and the creditors have agreed, the final papers are submitted to the court for a judge to review and approve.
After you have been discharged from bankruptcy, all your qualifying unsecured loans are wiped out. The credit rating for each of these debts is changed to R9, which is the lowest credit rating possible. This stays on your credit file for the next 10 years, impacting your ability to qualify for credit and the interest rates available to you.
The purpose of personal bankruptcy is to allow individuals who are unable to meet their obligations to legally stop all collection activities. Most countries have bankruptcy courts and rules in order to address this issue. Historically, debtors who were unable to pay their bills were put into debtors’ prison.
In the US, a chapter 13 bankruptcy is not a true bankruptcy, as the debtor is required to pay off a portion of the debt through monthly payments for the next three to five years. The interest may be frozen, or an agreement made to pay off a portion of the debt. This calculation varies depending on the amount of the debt and the level of disposable income.
Under chapter 13, the debtor keeps all their assets. However, under chapter 7, the trustee is able to take and sell all assets above the state guidelines and use these funds to pay the creditor. In practice, there are very rarely any assets to sell.