How many types of bankruptcy are there? The most widely held misconception about bankruptcy is that it’s the debtor’s version of the “get out of jail free” card in Monopoly. While most people know that bankruptcy affects your credit for 7 to 10 years, very few people know that it’s possible that you’ll have to pay back the debt anyway, even if you file a Chapter 7 “straight” bankruptcy. The formal definition of bankruptcy is “a proceeding in federal court in which an insolvent debtor’s assets are liquidated and the debtor is relieved of further liability.” On the other hand, the commonplace definition of bankruptcy is probably “the process of completely wiping out your debts for free or at little cost” In most cases, the latter definition may be appropriate, but in a small number of cases, it’s possible that even with bankruptcy, you’ll still have to pay back at least a portion of the debt.
So when is it possible that you’ll have to pay back your debts, at least partly? Here are the most common scenarios when you’ll get all the negatives of filing bankruptcy (severe credit impact for 7 to 10 years), but none of the benefits (you’ll still have to pay back at least part of the debt):
Look for various types of bankruptcy if you make more than the average person in your state
If this is the case, then it’s possible that you’ll be forced into a Chapter 13 bankruptcy plan (if you do not pass the “means test”). In a Chapter 13 bankruptcy, the court orders that you pay all your disposable income to a court appointed trustee, who in turn disburses payments to your creditors. Keep in mind that the court determines your disposable income by national and county statistics on average necessary expenses, not what you’re paying. So just because you’re paying a lot for a car doesn’t mean the court will approve it. There are cases when a judge ordered families to stop sending their children to private schools so they can have more money to pay back their creditors. Moreover, if you miss even one payment, the court may consider you to be in contempt and force you to pay the full debt amount back (although by all accounts this is rare). Chapter 13 bankruptcy is so difficult that only about one third of all cases are ever completed.
Let’s repeat that:
“Chapter 13 bankruptcy is so difficult that only about one third of all cases are ever completed.“
According to the US Bankruptcy Court: “28% Percent of the 398,096 cases in which debtors who sought protection under Chapter 13 in 2011, reported they had filed a bankruptcy petition during the previous 8 years.”
Even if you file for bankruptcy you have almost a 30% chance of not being about to avoid bankruptcy a second time within 8 years.
Bankruptcy may not be the best solution if you have assets
If you own a home or car with a lot of equity and it’s not exempt in your state, then it’s possible that the bankruptcy court will force you to sell them to generate sufficient cash to pay back your creditors. If have a good chunk of change invested and it’s not in an exempt account (again this varies by state), then it’s possible you’ll also be forced to liquidate it. If you have a second home or another vehicle (assuming you own both completely and it’s not exempt and has equity), then you may also be out of luck.
To learn about your state’s exemptions and how it relates to your individual scenario, contact a bankruptcy attorney licensed in your state. Fortunately, there are some safeguards to protect consumers from bankruptcy. In Illinois, for example, every resident is entitled to at least $7,500 of the value of their home, $1200 of the value of their vehicle, and $2,000 for anything that they want (known as the wildcard exemption). Also, these values double if you’re married (assuming the property is in both of your names).
What does this actually mean? Consider the following example:
Let’s say you have a house that’s worth $250,000, and it’s in both yours and your wife’s name. You still owe about $200,000 on your mortgage, and you decided to file Chapter 7 bankruptcy due to medical bills. In this example, you may be forced to sell your home, and with the proceeds you would pay back the mortgage company what you owe on the outstanding balance of the loan ($200,000), you’d pay yourself the Illinois real estate exemption ($15,000), and then you’d pay back your other creditors whatever was left, assuming you owe that much ($250K-200K-15K=$35,000). If this is the case, then you may want to consider finding another type of bankruptcy or a better alternative to it. Again, an attorney may be of some help in determining an appropriate path based on your situation.
Bankruptcy may not be the best solution if your creditors can prove you were fraudulent
If your creditors can prove that you were fraudulent and never had any intention of paying them back, then you may want to find an alternative to bankruptcy. It’s possible you may end up with a bankruptcy filing on your credit report, and you will still owe a debt. The reason why is creditors can object to your filing, and if your bankruptcy judge agrees, your case can be dismissed. Of course this is something you would want to discuss with a bankruptcy attorney to determine whether you fit the bill of someone whose creditors can prove that you never intended to pay them back.