Some financial gurus call bankruptcy the “nuclear” option because they consider it to be the ultimate way to get rid of debt and get a fresh start on a person’s financial life. There are two types of personal bankruptcies, a chapter 7 and a chapter 13. But a chapter 7 is the most popular one and is considered to be the “nuclear” alternative.
The differences
Without getting too technical, the major difference between a chapter 7 bankruptcy and a chapter 13 is that a chapter 7 is a “liquidation” bankruptcy while a chapter 13 is a “reorganization” bankruptcy. It’s goal is to give you time to reorganize you finances and pay off your creditors. In comparison a chapter 7’s objective is to get rid of most, if not all, of your debts to get you a “fresh start.”
You could lose assets
If you choose a chapter 7 bankruptcy, you could lose some of your assets. This is because your bankruptcy judge has the power to take over your assets and liquidate them or turn them into cash that can be used to pay off your creditors. However, that’s more in theory than in practice. Here’s why. In a chapter 7 bankruptcy you’re allowed to “exempt” some of your assets. For example, you will be allowed to exempt some amount of the equity in your home and your automobile(s). This varies from state to state. In some states you might be allowed to exempt only $10,000 of equity in your house while in others you might be able to exempt up to $50,000 in equity. Of course, if you have no equity you will be allowed to keep your home with no arguments.
Your automobile
You should also be able to keep you vehicle, again depending on how much equity you have in it. This also varies depending on where you live but a good rule of thumb is that you should be able to exempt your automobile if you have $3500 or less in equity. In case you’re wondering, equity in an automobile is the difference between what it’s worth and how much you owe on it.
Secured debts
Not even a chapter 7 bankruptcy will discharge your secured debts as well as some of your unsecured ones. Your secured debts include mortgages and car loans. The unsecured debts that won’t be discharged are student loan debts, alimony and child support, taxes owed, and debts obtained through fraud.
You may not qualify
Another important thing to understand about a chapter 7 bankruptcy is that you might not qualify for one. The way the process works is that after you file for bankruptcy, the bankruptcy judge reviews your finances and decides whether or not you should be allowed to discharge your debts. If not, you will be automatically moved to a chapter 13 and required to pay back most of your debts.
The consequences of a chapter 7 bankruptcy
While a chapter 7 bankruptcy will give you a “fresh start,” it does have serious consequences. For example, a chapter 7 bankruptcy will stay in your credit report for either seven or 10 years (depending on the credit reporting bureau). This is seven or 10 years during which time you will have a hard time getting new credit. In fact, you may not be able to get any credit at all for the first two or three years after your bankruptcy.
It could cost you 200 points
Also, it is estimated a bankruptcy will lower your credit score by 200 points. If you had a reasonably good score of, say, 650 before your bankruptcy, you would have a bad score of 450 after the bankruptcy. A score this low could keep you from getting a mortgage or auto loan and might even affect the cost of your auto insurance.
Think before you file
A bankruptcy can either be a blessing or a curse – depending on your financial circumstances. You need to really weigh the plusses and minuses before you file to make sure you’re making the right decision.
