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Course: Financial Literacy > Unit 5
Lesson 5: BankruptcyBankruptcy
Bankruptcy is a legal process designed to help people or businesses who can't pay their bills. It's a way of getting a fresh start financially. In the United States, there are two main types of bankruptcy: Chapter 7 and Chapter 13. Each type of bankruptcy has different rules and requirements.
What is bankruptcy?
Have you ever heard the term "bankruptcy" and wondered what it means? Bankruptcy is a situation where a person or a company is unable to pay back the money they owe to others, so they ask the court for help in finding a solution. This can involve making a plan to pay off their debts over time, or selling their belongings to get money to pay back those they owe. There are different reasons why someone might go bankrupt, and it can have a big impact on their life.
In this article, we will explore some common causes of bankruptcy and the two main types, Chapter 7 and Chapter 13.
What causes bankruptcy?
There are many reasons why people end up filing for bankruptcy. For some, it is due to overspending or money mismanagement. They may have taken on too much credit card debt or have too many loans. In this case, a long period of poor credit management ultimately results in bankruptcy.
But for others, bankruptcy may be the result of things they can't control.
Medical expenses
Medical expenses are often the most common reason people file for bankruptcy. If you don't have medical insurance, a serious health issue or emergency could leave you with thousands of dollars in medical bills. It can be tough to pay off these bills, especially if you don't have a high-paying job or if you have other debts.
Job loss
Job loss is another common reason for bankruptcy. If you lose your job and don't have any savings, you may not be able to pay your bills, including your rent or mortgage. This can quickly lead to debt and, eventually, bankruptcy.
Divorce
Divorce can also be a major factor in bankruptcy. When a couple files for a divorce, their income is often divided in half, but their expenses usually stay the same or even increase. This can be a financial shock for some people, and they might not be able to keep up with their bills.
Failed business
Finally, a failed business can lead to bankruptcy. If you start a business and it doesn't go as planned, you could end up with a lot of debt. Many small business owners invest all of their own money into their business, so if it fails, they may not have any other option but to file for bankruptcy.
What are bankruptcy chapters?
In the United States, there are two main types of bankruptcy that people use: Chapter 7 and Chapter 13. Let's look at these two chapters to see how they work.
Chapter 7: A clean slate
Chapter 7 bankruptcy is also called "liquidation" because it involves selling some of your belongings to pay off your debt. When you file for Chapter 7, a court will look at your income, your expenses, and your assets (the things you own). If you qualify, the court will appoint a trustee who will sell your non-exempt assets (like jewelry or a second home) to pay back your creditors (the people you owe money to).
After this process is done, most of your remaining debt will be wiped away, and you'll have a fresh start. There are some debts that cannot be erased, like student loans, child support, and taxes. Chapter 7 can be a good option if you don't have a lot of assets or if your income is low.
Chapter 13: A repayment plan
Chapter 13 bankruptcy is also known as a reorganization, or a "wage earner's plan" because it's designed for people who have a regular income but are struggling to pay their debts. Instead of wiping away your debt like Chapter 7, Chapter 13 helps you create a plan to repay some or all of your debt over a period of to years.
To qualify for Chapter 13, you must have a regular income and your total debt must be below certain limits for unsecured debts (like credit cards) and secured debts (like a mortgage).
When you file for Chapter 13, you'll work with the court to create a repayment plan that fits your budget. This plan will help you pay off your debt in smaller, more manageable amounts. At the end of the repayment period, any remaining debt may be forgiven.
Comparing Chapter 7 and Chapter 13
There are some key differences between Chapter 7 and Chapter 13 bankruptcy.
1. Time
Chapter 7 bankruptcy is typically faster, taking about three to six months to complete. Chapter 13 bankruptcy requires a three- to five-year repayment plan.
2. Property
In Chapter 7, you may have to sell some of your assets to repay your debts. In Chapter 13, you can keep your property as long as you stick to the repayment plan.
3. Eligibility
Not everyone is eligible for Chapter 7 bankruptcy. You must pass a "means test" that looks at your income and expenses. Chapter 13 bankruptcy is available to those with a regular income who can afford to repay some of their debts.
4. Credit report
Chapter 7 bankruptcy remains on your credit report for ten years, while Chapter 13 remains for seven years.
Conclusion
In conclusion, bankruptcy is a serious decision that should only be considered as a last resort. Filing for bankruptcy can have long-lasting consequences for your financial future, especially your credit score and credit report. Your credit score will plummet and your credit report will list a bankruptcy filing, both of which will make it harder to get loans or credit cards for a long period of time.
It is important to weigh all your options carefully and seek professional advice before choosing this path. Remember, there may be other ways to manage your debt and get back on track without having to declare bankruptcy.
Want to join the conversation?
- It is not clear to me how beneficial it is to declare bankruptcy and go to Chapter 13. If I do this, it means that if I have a debt of $100 dollars and I cannot pay it, the state will allow me to pay less of that debt over the course of 3-5 years? Will I be paying less than the initial debt (for example $75)?(6 votes)
- Chapter 13 is well described in the lesson before this one. Look at the part that begins at7:58and listen on to the end.
Chapter 13 allows you time, it allows you some room for negotiation, and it is not a guarantee that you will pay only $75 out of $100 (as you suggest), but it is a way for you and your creditors to work things out so that you don't go completely broke (as is the case with chapter 7). I encourage you to re-do that lesson.(4 votes)
- Do Chapter 7 and Chapter 13 bankruptcy exist only in the United States, or do other countries have different systems for handling bankruptcy?(3 votes)
- These chapter titles refer to the laws as they exist in the USA. For the practices as used in other nations, you'll need to search out something like: "Bankruptcy in Benin" or something like that related to the particular nation in which this is an issue for you. Each nation makes its own laws on these things.(6 votes)
- I want to make sure I understand why Chapter 7 bankruptcy would be preferable for low incomes and few assets. Does the preferability derive from the court's inability to access more assets and resources to devote to the repayment? If that's the case, wouldn't that only mean that the client has less to pay towards the principal, and that the debt still stands? Or does the court-overseen act of selling off everything possible, regardless of their value, result in the "clean slate"?(3 votes)
- Chapter 7 is for persons, Chapter 11 is for businesses. Here's the comparison, from a law firm I found through a search: "Chapter 7 is a “liquidation” bankruptcy that doesn't require a repayment plan but does require you to sell some assets to pay creditors. Chapter 11 is a “reorganization” bankruptcy for businesses that allows them to maintain day-to-day operations while creating a plan to repay creditors."(3 votes)
- What happens if you aren't eligible for either chapters? Is there a Chapter 19 or something?(3 votes)
- Even if you ARE eligible for a chapter, don't go bankrupt. It messes you up for the rest of your life.(2 votes)
- this cool and good explantion(3 votes)
- Does this article only apply in the United States?(2 votes)
- Yes. But most countries have something similar. Check it out wherever you live.(1 vote)
- Also does chapter 7 only exist in the united states or does it exist in every country because im a little confused.(1 vote)
- This is relevant to the United States. Bankruptcy happens in every country around the world, and each has its own way of dealing with the phenomenon. Check locally for what applies to you.(1 vote)
- This is cool and good explantion(0 votes)