Bankruptcy is a last resort for borrowers with unmanageable debt. It is a legal filing that must be approved by a court, and only some borrowers meet the eligibility criteria.

There are several different types of personal bankruptcy that borrowers can file for.

Types of Bankruptcy

Chapter 7 Bankruptcy

In Chapter 7 bankruptcy, a trustee appointed by the court liquidates the filer's assets to pay off debt.

Some property essential for living is exempt from liquidation. These include:

Some Equity in a Home or Car - borrowers can be forced to take out or repay loans for homes and cars, but they cannot lose this property entirely.
Clothes
Items needed for employment
Food
All benefits (e.g. social security) & pensions

All other property is fair game for creditors. The following are examples of non-exempt property.

Collectibles
A second car
Non-residential property and houses
Bank accounts
Stocks and other investment assets

Most other debt is then discharged, meaning the borrower no longer has any responsibility for repaying.

A borrower cannot file for another Chapter 7 bankruptcy for 8 years after successfully completing one.

Not all borrowers are able to file for bankruptcy under Chapter 7. Form 122A determines eligibility.

Chapter 13 Bankruptcy

Chapter 13 bankruptcy allows debtors to pay off their debt without liquidating assets.

Borrowers must first complete a form listing all of their debts, assets, and details about their income. With these details, a court-appointed trustee will work with the debtor to develop a three to five-year repayment plan.

If the court approves the repayment plan, borrowers will begin to submit monthly payments to the trustee, who then pays creditors with this money. Creditors do not have contact with the borrower during this period; the borrower only has to pay the trustee. To ensure that the borrower can meet the terms of the repayment plan, the court can order an employer to set aside part of a borrower's salary to the trustee - a process known as wage garnishment.

Eligibility Criteria

Chapter 13 filers must have no more than $2.75 million in total debt. Unlike Chapter 7, there is no specific time limit that prevents another bankruptcy filing after an initial one.

Types of Debt

Three types of debt are treated differently in Chapter 13 bankruptcy.

Priority debt must be repaid fully in most cases. Some common examples of priority debt include:

Unpaid taxes
Child Support
Alimony
Legal Fees

After the repayment plan is completed, most unsecured debt is discharged. Secured debt, like mortgages and car loans, must be paid in full unless the creditor agrees to forgive them.

Impact of Bankruptcy

Bankruptcy remains on credit reports for seven to ten years. Filing for bankruptcy usually causes credit scores to decline into the 500s, which can make it difficult for most filers to obtain new lines of credit for the first few years after declaring bankruptcy.

In addition to being present on credit reports, bankruptcies are public records that can be accessed through court databases.

Due to these drawbacks, bankruptcy is considered a last resort, when all other credit management options, like debt consolidation, settlement, and credit counseling fail.