How Does Bankruptcy Work?

Will you really get a free pass on your debts if you declare bankruptcy?

Many people have this idea that if their debt gets too out of control, they can declare bankruptcy and start all over again financially.

The truth, though, is that bankruptcy is a little more complicated than that — and it is almost never a free pass to start all over again. In most case, bankruptcy will not, in fact, “wipe out” all of your debt.

Chapter 7 vs. Chapter 13 Bankruptcy

For individuals, there are two main choices for bankruptcy: Chapter 7 and Chapter 13. Your situation dictates which type of bankruptcy you qualify for:

• Chapter 7: This is the type of bankruptcy that most people think about when they think of bankruptcy. With this type of bankruptcy, the court determines how much you can pay your creditors, and some of your assets are liquidated to make it happen. In many cases, not all creditors are paid; the whole point is for you to pay what you can, and the rest of the debts are discharged.
• Chapter 13: If the court thinks that you have sufficient resources, you won’t be allowed to file for Chapter 7 bankruptcy. Instead, you will have to put together a payment plan for your creditors and file for Chapter 13 bankruptcy. While you can get some of your debts reduced, it doesn’t happen to the same degree as with Chapter 7.

It all depends on your financial situation, and your assets. You will need to share information about bank accounts that you may own, and other assets. There are some assets that are protected when you file for bankruptcy, and that aren’t considered as you liquidate, or make a payment plan.

Bankruptcy and Your Credit Report

You should understand that bankruptcy affects your credit report in a major way. When you file for bankruptcy, it affects your payment history. What appears in your credit report is fed into an algorithm that helps determine your credit score.

Because bankruptcy is about payment history, it makes a big impact, since that is the most important factor that contributes to your credit score. Not only can bankruptcy sink your score, but it remains on your credit report for seven to 10 years.

Even with a bankruptcy on your credit report, it is still possible to move on. However, it takes a lot of work to overcome a bankruptcy. You need to focus on making payments on time, as well as avoiding problems with your credit.  If you make a plan to get back on track, it’s possible that you will be able to get a loan — even for a home — after two or three years. In some cases, you can get a credit card or other smaller loan much sooner.

Bottom Line

Bankruptcy is rarely straightforward. You still have to discharge some of your debts, and the information goes on your credit report for several years, affecting your credit score and impacting your ability to get credit, and the best terms. In many cases, it’s a good idea to save bankruptcy as a last resort.

This has been brought to you by Lloyds TSB.