Bankruptcy is a well-known, but poorly understood financial and legal option. Most people have a tenuous grasp of bankruptcy because they’ve been exposed to it through TV shows and movies. Characters frequently discuss bankruptcy as an option to immediately relieve them of all debts in exchange for ruining their financial futures.
It’s true that bankruptcy may eliminate your debts and there may be negative consequences for pursuing bankruptcy. But the specifics are much more nuanced and complex than most people believe.
Identifying and addressing these misconceptions can lead you to a much better understanding of how bankruptcy actually works.
The Top Misconceptions About Bankruptcy
These are some of the top public misconceptions about what bankruptcy is and how it works:
1. Bankruptcy is bankruptcy.
We typically use only one word when describing bankruptcy. Bankruptcy is bankruptcy, right? The short answer is no. There are actually many different types of bankruptcy that you can file.
For example, chapter 7 bankruptcy and chapter 13 bankruptcy are very different. With chapter 7 bankruptcy, all or most of your debts will be eliminated, but the criteria is more strict, and there may be a possibility of forfeiting property. If a person meets the requirements, the debt is eliminated about four weeks after the filing and no monthly payments are required.
With chapter 13 bankruptcy, you’ll be restructuring your debt, instead of just eliminating certain debt. A chapter 13 requires monthly payments and may allow someone to save a house from foreclosure and an automobile from repossession. Additionally, a person may also be able to eliminate certain types of debts, as well. Also, a chapter 13 debtor may keep all of their property, if they can pay for the property.
There are also different bankruptcy options depending on if you’re an individual or a company. Each one has some strengths and some weaknesses, but they’re all very unique.
2. Bankruptcy is permanent and will ruin you.
It’s tempting to think that filing for bankruptcy is permanent, or that it will financially ruin you. To be fair, there are some negative repercussions associated with filing for bankruptcy.
For starters, bankruptcy is going to be included on your credit report, which typically results in initially causing difficulty qualifying for loans. But to say that bankruptcy could financially ruin you is an enormous exaggeration.
The rule of thumb is that the average debtor will be able to obtain a favorable interest rate about one year after the completion of a case, if the person takes reasonable steps to rehabilitate their credit. A favorable mortgage interest rate may require two years after the completion of a bankruptcy case.
Eventually, bankruptcy will disappear from your credit report. And even when bankruptcy is on your credit report, you’ll still have plenty of opportunities to make money and advance your personal finances. After all, bankruptcy is meant to help people out of difficult financial situations, not to permanently trap them in poverty.
3. You’ll lose everything if you file for bankruptcy.
You might imagine that after filing for bankruptcy, creditors will take everything you have. However, losing property through bankruptcy is very unusual.
Losing property in a chapter 7 case is atypical. Also a debtor that is contemplating filing for chapter 7 protection should be aware of any property that may be taken, prior to filing. Consequently, the debtor may avoid the filing. Also, if a debtor decides to file, knowing that a particular property will be taken, the debtor will receive a portion of the sale’s price.
A debtor will not be required to surrender property in a chapter 13. However, if a debtor is unable to make the required payments to keep the property, he will be unable to save the property. In the event that a debtor is unable to pay for the property, he has the option of selling property, if the sale price is less than the liens.
4. Only truly desperate people file for bankruptcy.
We tend to think of people who file for bankruptcy as totally impoverished or destitute. In reality, there are hundreds of thousands of bankruptcy filings every year. Some of these people made major mistakes. Some were confronted with an unexpected emergency. Some of them just got unlucky with their circumstances. There are many different types of people who file for bankruptcy and many different reasons to do so.
5. All debts will go away forever if you file for bankruptcy.
A chapter 7 will eliminate all unsecured debt, such as credit card debt and other loans that do not require collateral. A debtor may also eliminate secured debt if they wish to surrender property, such as a mortgage on a house.
Based on the debtor’s circumstances, a chapter 13 may or may not allow a debtor to eliminate a portion or all of their unsecured debt. Also, based on the debtor’s circumstances, a chapter 13 may or may not allow a debtor to eliminate all mortgage and/or auto financing debt, if the collateral is surrendered.
However, certain types of debts may not be eliminated in a chapter 13 or chapter 7. For example, student loans, child support, alimony, certain types of tax debts and certain debts owed to a governmental unit may not be eliminated.
Any debt that may not be eliminated in a chapter 7 is still owed after the case is complete. In a chapter 13 case, certain debt that may not be eliminated must be paid, in its entirety, through a monthly plan. Other debt that may not be eliminated need not be paid in full through a plan. However, the balance due is still owed after the case is complete.
6. After filing for bankruptcy, you’ll never qualify for a loan again.
It’s true that having a bankruptcy on your credit report will make it more difficult to qualify for a loan or future credit card. But eventually, all references to your bankruptcy will disappear, and in the meantime, there are plenty of options available to people who have recently filed for bankruptcy. You might pay a higher interest rate, or face stricter terms and conditions, but you will have financial options.
7. Bankruptcy makes you a failure.
When you imagine someone who filed for bankruptcy, what do you picture? It’s important to realize that filing for bankruptcy doesn’t make you a failure. Many successful, intelligent people have filed for bankruptcy, and many people who filed for bankruptcy in the past have gone on to live amazing, fulfilling lives.
Your neighbor, relative or friend may have filed without your knowledge.