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    Declaring Personal Bankruptcy
    Declaring Personal Bankruptcy

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    In the hit tv show “The Office,” Michael Scott finds himself wallowing in debt he can’t pay off. While trying to escape his creditors, he yells, “I Declare Bankruptcy!” Unfortunately, as Michael Scott learned, getting out of debt is not as easy as stating – sorry, declaring your financial status. 

    Many people helplessly watch as their credit card debt goes off the roof and wonder if filing bankruptcy is a “free pass” out of debt. While declaring bankruptcy is a (pretty extreme) way to correct debts, it should be the absolute last resort. 

    Bankruptcy can severely damage your credit score, and sometimes it may not even be enough to get rid of debt. If you do need to file for bankruptcy, though, you have the opportunity for a financial rebirth. So who needs to file bankruptcy, and what is it?

    What is Bankruptcy?

    Misfortune seems to strike you from all corners, with unexpected medical bills, job loss, and the rising cost of living leaving you hopeless. Your credit card has reached its limit; your old debts are past due dates…  you know bankruptcy is staring at you. 

    Bankruptcy is a legal process where a couple, individual, or business incapable of repaying their debts can deliver payment under a specified plan or be relieved of the debt. The debtor files a petition or, in some instances, a creditor will. Your existing personal assets will be evaluated and sold to repay a portion of the outstanding debt.

    Now that’s a lot of “legalese” to throw at you, so here’s what it means in plain English. When you file bankruptcy, a court of law will take a look at your current financial situation, including everything you own (your “assets”).

    Then, the court might determine that you need to pay some or all of the debt on a payment plan. If the situation is extreme enough, all of your debt will be forgiven, and your “assets” may be sold to pay a portion of the debt instead.

    How Bankruptcy Works

    Filing bankruptcy is a complex process, and you should reach out to a bankruptcy attorney for help. You can go through the process alone, but consulting an attorney helps the process go smoothly. More importantly, an attorney can ensure you’re complying with bankruptcy rules and regulations. 

    The courts will examine if you meet the requirements before filing bankruptcy. These include the inability to repay your debts and how much debt you have. 

    Most likely, you’ll also be required to complete credit counseling with a government-provided credit counselor. The counselor helps you examine your finances, create a budget plan, and look at your options.

    Credit counselors can help, but they can’t solve everything, so you may still need to move on with bankruptcy. First, you’ll need to decide what type of bankruptcy you are filing. There are two kinds: Bankruptcy Chapter 7 and Bankruptcy Chapter 13. Let’s take a quick look at each.

    Bankruptcy Chapter 7

    This type of bankruptcy is also called “straight” bankruptcy and is generally what you think of when you hear “bankruptcy.” However, it’s much harder to qualify for, and the conditions may make you think twice about jumping to Chapter 7 filing.

    Chapter 7 bankruptcy mandates the federal court trustee to oversee the liquidation of any non-exempt assets. 

    Simply put, this form of bankruptcy will wipe out your debt… but sell all of your stuff (with the exception of what you need to live). 

    Some “reasonably necessary assets” include personal items, tools of the trade, social security, pensions, part of home equity, and a personal automobile to a certain value.  

    The sale proceeds are then used to offset your creditors, and the debt balance is eliminated. Chapter 7 doesn’t get rid of taxes, alimony, student loans, or child support, so you’ll still be responsible for these debts.

    Bankruptcy Chapter 13

    This bankruptcy allows you to keep your property, but you will need to pay back your debt – partially or in full – over a period of 3 to 5 years.  Once you complete the repayment plan as agreed, the debt will be discharged. 

    Chapter 13 bankruptcy is kinder to your credit score than bankruptcy chapter 7 because it requires partial or full payment on debts. 

    How Filing Bankruptcy Affects Your Credit Score

    Bankruptcy filing is a tradeoff. On one hand, it reduces or wipes debts you can’t pay. On the other, it informs potential creditors that you’re a credit risk. 

    Bankruptcy trashes your credit score, making it difficult to get a mortgage, bank loan, or credit card. The dust will settle, but it could take up to ten years of positive credit action. 

    On the plus side, you probably already have a low credit score if you’re filing bankruptcy, and getting out from under all that debt can help you rebuild.

    Before you run to filing bankruptcy, it’s important to know the consequences. All potential lenders will be alarmed when they see “bankruptcy” on your credit report. 

    This might be a big problem if you’re planning to, say, buy a home within the next ten years. If you’re not planning to make any big purchases and you’re willing to put in the work, though, bankruptcy can help you “start over.”

    How to Rebuild Creditworthiness after Bankruptcy

    Bankruptcy is not a financial Armageddon, dealing damage you’ll never recover from. There are practical steps you can take to improve your credit score and rebuild your reputation.

    Examine your credit report

    Familiarizing yourself with your credit report is a perfect place to start. When you know what contributes to your credit score, you can make changes that increase it. This is also a good time to identify inaccurate information hurting your credit score and correct it.

    Follow up on your credit score.

    Once the bankruptcy proceeding is complete, don’t forget to confirm your score. Monitoring your credit score will also help you spot anything that could raise red flags, such as identity theft or fraudulent loans applied in your name. 

    Practice responsible credit habits

    Habits that help you build a positive credit score are pretty easy. Make payments on time (including bills!) and keep your credit utilization under 30%. This means that if you’re approved for $5,000 on a credit card, you should use no more than $1,500 before paying it off.

    Utilize credit-builder Loans

    Speaking of credit cards, you may want to check out credit builder loans. A credit builder loan lets the lender keep money in a secured account in your name. 

    Then you’ll make regular monthly payments until the loan and interest are repaid. Your bank often reports your repayment history of credit-builder loans to credit bureaus, which improves your score.

    Avoid Bankruptcy Fraud

    Filing bankruptcy is a legal process. This means that giving inaccurate information to “get around” the law can have serious consequences, such as a hefty fine or criminal charge. Some of the most common forms of bankruptcy fraud include:

    • Hiding assets to avoid forfeiture
    • Giving misleading information 
    • Turning in incomplete forms
    • Filing for bankruptcy several times in different jurisdictions
    • Trying to bribe an appointed trustee

    Bankruptcy Isn’t the End

    Finding that you need to file bankruptcy can be a nightmare, but it may offer you a financial lifeline when you’re out of other options. Before filing bankruptcy, make sure you’ve exhausted all your other options. Bankruptcy can wreck your credit score for a long time, making it hard to get back to a baseline. 

    On the other hand, you can’t do anything when you’re drowning in debt. No matter where you are in your financial journey, education is the first step. That’s why Penny Calling Penny has a newsletter! When you sign up, you’ll get practical tips, and more articles like this one delivered right to your inbox, so you never miss a single one.

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