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Personal bankruptcy is a legal protection offered by the U.S. government for people struggling with various types of debt. In essence, bankruptcy provides consumers with a chance to eliminate debt and start over financially.
Individuals seeking personal bankruptcy generally choose between two types, Chapter 7 bankruptcy and Chapter 13 bankruptcy.
Chapter 7 Bankruptcy
Chapter 7 bankruptcy gets its name from the U.S. Bankruptcy Code.
Chapter 7 of this code outlines the rules and requirements for this type of bankruptcy. Generally, Chapter 7 tends to work well for filers who have a relatively low income, little property and primarily unsecured debts (that is, debts not connected to property).
Here’s an overview of how Chapter 7 works.
- Chapter 7 means test: This is an eligibility test that was introduced by the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) of 2005. In order to file under Chapter 7, a person must demonstrate that he or she does not have the “means” (that is, income) to make payments under Chapter 13.
- Liquidation: In some cases, a Chapter 7 filer’s non-exempt assets are liquidated (that is, sold to raise cash) and the proceeds are used to partially repay creditors. It’s important to note, though, that every state offers exemptions that protect a filer’s property from liquidation. Many Chapter 7 filers find they have little or no non-exempt property.
- Debt discharge: Chapter 7 has the power to completely eliminate a filer’s eligible unsecured debt. Debts from credit cards, medical bills and payday loans are all usually eligible for discharge in Chapter 7 bankruptcy. Once a debt has been discharged, a creditor has no legal right to collect it.
Chapter 13 Bankruptcy
Like Chapter 7, Chapter 13 bankruptcy is so named because of its place in the U.S. Bankruptcy Code. Chapter 13 is designed to grant filers with steady income and/or significant secured debt a chance to catch up on past-due payments.
Chapter 13 bankruptcy works like this.
- Repayment plan: When submitting a Chapter 13 case to the court, filers must present a plan for repaying their major debts over a period of three to five years. Filers make monthly payments to a bankruptcy trustee who distributes the money according to the repayment plan.
- Reorganization: Chapter 13 prioritizes certain debts over others so that filers can repay the most important debts first. Because of this strategy, Chapter 13 bankruptcy is often referred to as "reorganization."
- Debt discharge: At the end of a Chapter 13 repayment plan, the court may discharge any remaining unsecured debts for filers who have adhered to their repayment plans throughout.
Bankruptcy’s “Magical” Protection: The Automatic Stay
One thing that distinguishes bankruptcy from other types of debt relief is the legal protection called the automatic stay. It works like this:
- Immediate effect: As soon as a person files his or her bankruptcy case with the court, the automatic stay takes effect. It typically remains effective for the duration of the bankruptcy case, though it will depend on the case.
- Sweeping protection: When the automatic stay is active, most creditorsare prevented from taking collection action against the bankruptcy filer. This includes foreclosure, repossession, wage garnishment, mail and phone contact, and debt lawsuits. Creditors who attempt to collect while the automatic stay is active can face legal repercussions.
- Breathing room: Thanks to the automatic stay, many bankruptcy filers find they have the breathing room necessary to face their debts in a less stressful environment.
Bankruptcy Filing Requirements
In order to be eligible for the type of protection personal bankruptcy provides, filers must meet a few requirements. These include the following.
- Credit counseling session: Since 2005, all filers have had to complete a credit counseling session with an approved credit counseling service before submitting their bankruptcy petition with the court. Filers who do not meet this requirement risk having their cases dismissed.
- Debt limits: In order to qualify for Chapter 13 bankruptcy, a filer’s debt must fall within certain limits. Currently, the limit for unsecured debt is $360,475 and the limit for secured debt is $1,081,400. Chapter 7 filers do not face debt limits.
- Income: Personal income greatly affects what type of bankruptcy a person can file. In order to file under Chapter 13, a person must have a reliable source of income sufficient to cover the basics (rent, food, utilities, etc.) and payments in the repayment plan. To file under Chapter 7, a person must pass the means test, which demonstrates that his or her income is insufficient to make Chapter 13 repayments.
- Previous bankruptcy discharges: While it is legal to file for bankruptcy more than once, filers must wait a certain number of years between filings. A bankruptcy lawyer can help determine whether a person is currently eligible to file.
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