Sometimes bills get out of control, and you don’t have enough money to pay them each month. It can happen for many reasons—job loss, divorce, and illness to name a few. Bankruptcy is a legal process that allows people to wipe out certain types of debt and get a fresh financial start.
Insolvency: When You Can’t Pay Your Bills
If you’d still owe money to your creditors after selling everything that you own and using the money to pay your debt, you’re considered insolvent—you have more liabilities than assets. Most insolvent individuals find themselves unable to pay things such as medical bills and credit card balances and still afford basic living expenses, such as rent, mortgage, utilities, food, transportation.
Some insolvency warning signs include:
- juggling expenses from month to month because you can’t afford to pay everything
- charging necessities like rent, food, and utilities
- considering debt consolidation plans
- making only minimum credit card payments
- receiving collection calls and letters from creditors, and
- losing sleep and feeling anxious about bills.
Bankruptcy helps insolvent people get back on their feet.
How Does Bankruptcy Help Insolvency?
Most filers choose between one of two types of bankruptcy: Chapter 7 bankruptcy or Chapter 13 bankruptcy. In a Chapter 7 case, the debtor can exempt (keep) a certain amount of property necessary to maintain a home and job. Any nonexempt property gets sold for the benefit of creditors.
A filer can keep all property in a Chapter 13 case; however, the debtor must pay all discretionary income into a three- to five-year repayment plan before any debt gets wiped out.
(Get more information in Choosing the Right Type of Bankruptcy: Chapter 7 or 13.)
Understanding the Bankruptcy Process
Bankruptcy usually starts when a person or business (debtor) files a package of documents called a petition. The packet includes detailed financial information regarding the debtor’s debts, income, assets, and prior financial transactions.
Most people file for bankruptcy to get qualifying debt wiped out (discharged). At the end of the case, the debtor receives a discharge order saying that the debtor doesn’t have to pay certain debts (the court lists the types of debts discharged in the order).
Many debts, but not all, get discharged in bankruptcy. For instance, nondischargeable debts include child support, student loans, alimony, criminal restitution, and some taxes. Even if some of your debts aren’t dischargeable, getting rid of others in bankruptcy can free up funds to repay these continuing debts.
After the bankruptcy court approves a discharge, creditors can’t continue to try to make you pay on the discharged debts.
(To learn more about debt that doesn't go away, see Nondischargeable Debts: Debts You Can’t Discharge in Bankruptcy.)
Stopping Creditors With the Automatic Stay
People also file for bankruptcy to get the protection of the automatic stay—a court order that stops collection action after you file your bankruptcy case. Unless a creditor asks the court to lift the stay (and the court agrees to do so), it will remain in effect until the case is over.
While the automatic stay is in place, creditors cannot continue collection actions, including:
- sending collection letters
- making collection phone calls
- continuing to pull credit reports for credit checks, or
- pursuing wage garnishments or lawsuits.
The automatic stay applies to almost all creditors—including those that you’d like to continue doing business with—so it’s important to know that the creditor isn’t allowed to ask for payment. Therefore, if you plan on keeping your house or your car, you won’t be able to rely on getting a letter from the creditor telling you when to pay. You’ll have to remember to make your payment.
Protections After Bankruptcy
Even after the bankruptcy case is complete, debtors still benefit from certain bankruptcy protections. Creditors cannot continue to pursue payment on discharged debts. Creditors who ignore the bankruptcy discharge can be assessed penalties. If you find yourself in this situation, you’ll likely want to contact an attorney.
Bankruptcy law also prevents employers from firing employees solely because they filed bankruptcy or received a bankruptcy discharge. You also cannot be evicted if you were current on your lease at the time of filing. Your landlord might require you to “assume” your lease, which means you will have to agree to the lease terms again and continue to pay on time.
Questions for Your Attorney
- Is filing bankruptcy a good idea in my situation?
- Can I discharge all of my debt?
- Which bankruptcy chapter would be best for me?