A Consumer's Guide to Bankruptcy

An individual, or couple, can find debt forgiveness under the bankruptcy laws of the United States. This legal proceeding begins when the debtor files a petition with the courts. A trustee is appointed to evaluate and measure the debtor’s assets, which will be sold to repay the outstanding debts. Once the bankruptcy is discharged, the debtor is no longer under the debt obligations that were incurred prior to the bankruptcy proceedings.

The Two Primary Versions of Bankruptcy

Various “chapters” under the bankruptcy code apply to the different entities that can incur debt. Businesses and municipalities fall under different portions of the bankruptcy law than private consumers. Certain qualifying characteristics will apply to each case since the financial situation of the debtor determines which type of bankruptcy can be filed.

Chapter 7 – Liquidation

As the most common form of individual bankruptcy, certain characteristics must apply to the debtor, the debts and the assets.

  • Trustee – This court-appointed person will take control of the assets in the debtor’s possession, sell them for cash and distribute the money to creditors.
  • Non-exempt assets – Under this chapter of the bankruptcy code, there is little property that does not qualify for sale. A specific list of non-exempt assets must be acquired from the state of residence.
  • Exempt assets – The court puts forth guidelines that allow the debtor to certain assets, such as one vehicle, that will allow the debtor to recover from the bankruptcy.
  • Debts – Various categories of debt cannot be discharged in a Chapter 7 bankruptcy.
  • Means test – The debtor must participate in a test that will reveal whether there is sufficient cause to file bankruptcy. A debtor’s income can disqualify him from filing if the income exceeds certain thresholds.

Chapter 13 – Adjustment of Debts of an Individual with Regular Income

Anyone with a steady monthly income and too many debts, must apply for bankruptcy protection under this chapter of the bankruptcy code. Specific criteria must be met for the debtor to qualify to file bankruptcy.

  • Assets – A valuable asset, such as a primary residence, can be protected under Chapter 13.
  • Repayment – Debtors with a steady income are required to embrace a repayment plan for some portion of the outstanding debts. The Bankruptcy Abuse Prevention and consumer Protection Act of 2005 was implemented to reduce the tendency to file bankruptcy without consideration for the creditors.
  • Failed the “Means Test” – Anyone who does not qualify under Chapter 7 might find that Chapter 13 will meet their needs.
  • Trustee – This court-appointed individual will receive the payments from the debtor and pay the creditors.
  • Discharge – Only after all of the payments under the repayment plan will the court discharge the bankruptcy.
  • Protection – The debtor is protected from wage garnishments, lawsuits and all other creditor actions while the repayment plan is underway.
  • Debts – A broader array of debts can be discharged under Chapter 13.

What Are the Leading Causes of Bankruptcy?

Many different life events can cause a family to incur an overwhelming amount of personal debt. Statistics reveal that economic fluctuations cause the percentage in each category shift. Overall, the most common causes of bankruptcy remain unchanged.

  • Medical bills – 42% - High costs of healthcare services have become the primary reason for someone to file for bankruptcy protection. Recent studies revealed that 78% of these people had health insurance.
  • Job loss – 22% - Without a steady income, debt will accrue every month. Paying bills from any possible means can be devastating if a job is not found quickly.
  • Uncontrolled spending – 15% - Living a lifestyle far above one’s means is another common cause of bankruptcy. Expensive cars and homes can require significant payments each month. Loss of income results in bankruptcy because the consumer was unable to sustain the lifestyle of the long-term.
  • Divorce – 8% - Costs associated with divorce include legal fees, child support payments and alimony. Existing debts can cause the consumer to file for bankruptcy to eliminate all eligible debts. Child support payments cannot be discharged under the bankruptcy code.
  • Natural disasters – 7% - Wild fires, floods, tornadoes, hurricanes and earthquakes cause substantial property loss for businesses and individuals. Insufficient insurance coverage is the primary reason that families must file for bankruptcy to eliminate mortgage debts. In some cases, the jobs are lost because the employers were unable to rebuild.
  • Avoiding foreclosure – 1.5% - A home mortgage lender can begin foreclosure proceedings when the borrower falls 90 days behind on payments. In an effort to slow the process, the borrower can file for bankruptcy to re-organize personal debts. The bankruptcy court will include the house payment in the repayment plan.
  • Poor financial planning – 1.5% - Anyone living paycheck-to-paycheck is a prime candidate for bankruptcy. Any number of events can cause the consumer to fall behind on debt payments. This situation is common since few people were taught to manage money effectively.
  • Avoid loss of utilities – 1% - In rare cases, the consumer must file bankruptcy to avoid losing the utility services to the primary residence.
  • Student loans – 1% - A bankruptcy will not eliminate student loans. Anyone with large amounts of debt incurred through student loans can request a restructuring of the debt through the bankruptcy court.
  • Prevent repossession – 1% - A vehicle repossession can be avoided if the consumer qualifies for repayment plans under the bankruptcy code. After a vehicle is repossessed, the credit can be forced to return the vehicle.


Individual consumers must fall within certain criteria to file for bankruptcy protection in the United States. Attempts to appear qualified will be considered fraud, which carries stiff penalties that are imposed on the debtor not the attorney.

  • Means test – Financial information is entered in a webform to determine if the debtor falls within appropriate income and indebtedness levels. This test is required to determine if the debtor should file a repayment plan instead of asking for the debts to be discharged. Results of the means test are filed with the bankruptcy paperwork sent to the court.
  • Solvent or insolvent – A debtor can be considered “solvent” and still qualify for bankruptcy protection. The law lists which assets are considered non-exempt or exempt. A trustee will be assigned to turn the assets into cash for payment to the creditors.
  • No previous dismissal – Within the past 180 days, the debtor cannot have had a bankruptcy case dismissed for non-compliance with court requests. Dismissed bankruptcy cases require the debtor to file a new case after waiting six full months.
  • Credit counseling – The debtor must complete credit counseling within 180 days of filing for bankruptcy protection. Approved agencies are the only entities that can provide acceptable credit counseling for the debtor. Pre-filing and post-filing credit counseling classes are required before the discharge will be awarded to the debtor.
  • Existing liens – The discharge of the bankruptcy will not extinguish a lien on property. Additional legal proceedings will be required to free the property from liens that were attached to the property prior to the bankruptcy filing.
  • Discharge – A bankruptcy case is said to be complete once the debtor receives the official “discharge” from the courts. All debts listed in the proceedings are forgiven, and the creditors cannot pursue the debtor for repayment at a later date. The timing of the discharge will vary depending on the bankruptcy chapter filed.


Few people realize the number of real consequences that are associated with filing for bankruptcy protection. Financial transactions are based on the borrower’s ability to repay the loan. A bankruptcy is an obvious admission that the potential borrower has defaulted on previous obligations. All of these consequences must be considered before filing for bankruptcy protection.

  • Credit denied – Traditional sources of credit will deny credit cards and loans to the consumer with a bankruptcy listed on the credit history. There are exceptions to this rule, but the consumer must realize how difficult acquiring credit will be until the bankruptcy entry rolls off the credit history.
  • Home loans denied – For the first two years following a chapter 7 bankruptcy, the consumer will be unable to qualify for a home loan. Until all of the debts are repaid under a chapter 13 bankruptcy, the two-year clock does not start counting.
  • Career opportunities impacted – Employers have adopted the practice of checking each applicant’s credit history. Anyone with a bankruptcy can be disqualified because of the perception of irresponsibility in handling financial matters. An applicant for a director, or principal, position would be disqualified from consideration since handling money would be part of the job.
  • Inability to rent property – Landlords will disqualify a potential renter if a bankruptcy is on the credit history. Risk of nonpayment is considered unacceptable in the rental markets.
  • Personal assets lost – Expensive collections, extra vehicles and vacation properties are prime candidates for repaying debts. A consumer must list every asset on the bankruptcy paperwork. The court trustee decides which assets are eligible for sale.
  • Credit history impacted – A bankruptcy will appear on the personal credit history for up to 10 full years. The presence of this entry indicates to potential creditors that the consumer presents a significant risk of default in credit transactions.
  • High interest rates – A creditor can agree to offer a credit card to a consumer with a bankruptcy on the credit history. Risks associated with nonpayment are offset through higher interest rates. As time passes, the same creditor can lower the interest rate after the consumer demonstrates the willingness to make timely payments.


Consumers believe that bankruptcy can be filed whenever a sense of overwhelming debt is felt. The court system in the United States follows strict guidelines to prevent abuse of the bankruptcy guidelines. Full debt relief is not obtained easily since the credit system depends on the high percentage of consumers repaying every loan and credit card balance. The consumer must consider other options prior to embarking on the quest to file for bankruptcy protection.

  • Sale of assets - Non-exempt assets will be claimed by the trustee during the bankruptcy investigation. These assets have market value, which can be converted into cash to pay the creditors. Jewelry, art, home equity and recreational vehicles can be seized during the proceedings to create cash for the creditors.
  • Restructuring – Instead of Chapter 7, the court can convert a bankruptcy filing into a Chapter 13 because the consumer failed the means test. A repayment plan would be developed to allow the consumer to repay the debts over time.
  • Debt consolidation – Filing bankruptcy should be the last resort after investigating other methods for dealing with creditors. Consolidation of all outstanding debts can be achieved through a single loan that repays all debts. One payment is easier to afford for the consumer. This option is common when a steady income exists.
  • Out of court agreements - Direct contact with each creditor can result in lower interest rates and affordable payment plans for each debt. The courts encourage consumers to negotiate debt restructuring to avoid bankruptcy.

Debts Not Forgiven Under Bankruptcy

Prior to filing for bankruptcy protection, the consumer should evaluate the types of outstanding debts. Certain categories of debt are considered “excepted from discharge” under each chapter of the bankruptcy code. The consumer must list all outstanding debts in the bankruptcy forms. The courts determine which debts can be discharged and what must be paid.

These debts will not be discharged:

  • Certain tax claims
  • Debts omitted from the bankruptcy forms
  • Spousal support
  • Child support
  • Alimony payments
  • Debts associated with liability settlements
  • Government-funded student loans
  • Benefit overpayments received
  • Personal injury settlements awarded when the debtor was intoxicated
  • Condominium or cooperative housing fees
  • Debts incurred because of fraud or maliciousness

Under Chapter 13, the court can change the debts that can be discharged if circumstances outside the debtor’s control have occurred. Hardship discharges of the bankruptcy are possible in certain cases.

Discharge of the Bankruptcy

The court will award the debtor a discharge when the requirements of the bankruptcy case have been met. A bankruptcy discharge released the debtor from all personal financial liability for the debts that were listed in the bankruptcy papers. Debts that are discharged are no longer obligations associated with the debtor. As a permanent court order, the discharge prohibits the listed creditors from taking any form of legal collection action against the discharged debts.

The debtor must be aware that a valid lien against personal property will remain following the bankruptcy discharge. A secured creditor can take steps to enforce the lien to recover the property.

Timing of the Discharge

Bankruptcy proceedings follow specific guidelines that ensure the creditors have sufficient time to oppose the bankruptcy. The debtor must wait until the court completes its work before receiving the notification of discharge. Each chapter of the bankruptcy code requires the debtor to fulfill specific obligations prior to receiving the discharge.

  • Chapter 7 – The court will grant the discharge following the expiration of the time limit allows a creditor to file a complaint. A motion to dismiss the case for substantial abuse must be filed within 60 days for consideration by the court. Without opposition to the discharge, the debtor will receive formal notification 60 days after the 341 meeting date. The entire process, from filing through discharge, requires four months, or 160 days.
  • Chapter 13 – A repayment plan can span five years. The discharge for the bankruptcy will be issued following the final payment to the last creditor. The average amount of time between filing a Chapter 13 case and the discharge declaration is four years.

Debtors must realize that a bankruptcy discharge will be withheld by the court if the educational requirement is not completed. All of the expense and work associated with the case must be repeated if the debtor fails to attend the financial management training from an approved provider.

How the Discharge Arrives

Cases move through the bankruptcy courts according to a closely managed schedule. Each case meets the milestones and is approved to move to the next phase. Following the 341 meeting of the creditors, the court waits for objections to the discharge. In most cases, the 60 days will pass without incident. The discharge notice is prepared and mailed to the debtor’s address on provided to the court on the bankruptcy filing papers.

Each creditor will receive a copy of the discharge notice that specifically lists the debt that was discharged. The creditor is cautioned to not take any further action to collect against the debt. Attempts to do so will result in a contempt of court charge against the creditor. Court mistakes that cause the discharge to not be sent will not exempt the creditor from contempt charges if they pursue a discharged debt.

When Courts Dismiss Cases

A notice of “dismissal” is not a good notice to receive from the bankruptcy court. Debtor should never assume that the bankruptcy case has been dismissed by the court in the same way that a criminal case is dismissed. The dismissal of a bankruptcy case ends the case before the factors in the case are decided in a judgment from the courts. The status quo with every creditor is restored if the court dismisses the bankruptcy case. Each creditor can begin collection proceedings once the bankruptcy case is dismiss. The creditors are notified of dismissed bankruptcy cases.

Situations in which the court can dismiss the case:

  • Involuntary dismissal reasons include:
    • Failure to complete the credit counseling requirement
    • Hiding property owned by the debtor to prevent sale or liquidation
    • Misrepresenting information on the official bankruptcy forms
    • Non-payment of the filing fee
    • Failure to file the required forms for the particular bankruptcy chapter
    • Failure to attend the meeting of creditors
    • Failure to make on-time payments listed in the Chapter 13 repayment plan

Credit Counseling – Prior to filing a bankruptcy case, the debtor must complete an online, or classroom-based, credit counseling course. The provider must be approved by the court to qualify. This action must be completed with 180 days prior to the filing date.

Bankruptcy fraud – The debtor will be held responsible for the information on the bankruptcy forms. An attorney who files the forms will require proof of the information provided on the forms. The court will hold the attorney responsible in a different way. Fraud charges are serious for the person who attempts to lie about existing assets. Prison time and large fines are part of this federal crime.

Bankruptcy forms – A voluntary petition must be filed with the court to initiate the bankruptcy case. All other required forms must be filed with the debtor’s financial information, including debts and creditors.

Filing fees – Court fees must be paid at the time the case is opened. Failure to pay these fees causes the court to issue a dismissal.

Attend the 341 meeting of creditors – The court-appointed trustee conducts this meeting. A busy court can take anywhere from 20 to 50 days to schedule this meeting after the case is filed. Failure to attend this meeting can result in dismissal.

Failure to make Chapter 13 payments – All payments on the repayment schedule must be made. Anticipated issues with the payment schedule must be addressed quickly to avoid dismissal. These cases span a number of years, so dismissal is more common.

  • Voluntary dismissal of the bankruptcy case:
    • Filing was not the best choice for the situation
    • Discovery that property exemptions do not apply
    • Inheritance that is received after the filing date
    • Certain debts will not be discharged
    • Unable to sustain Chapter 13 repayment plan

A debtor will be asked to attend a hearing if a voluntary dismissal is filed. Changes in the financial situation will be discussed.

Events Following Dismissal

The debtor will be given the reason for dismissal on the form sent from the court. An honest mistake is grounds for appealing the court’s decision to dismiss the case. Fraud can cause the court to bar the debtor from filing for bankruptcy protection for a certain period of time.

Debtors must be aware that a bankruptcy filing will appear on the credit report. Multiple filings will be listed separately, which can cause a negative effect on the credit score.

Credit Training is Required

Every jurisdiction requires a debtor to attend credit training to avoid the same mistakes that led to bankruptcy. Two phases of the bankruptcy training must be completed within the proper intervals.

Pre-Bankruptcy Training

Within 180 days prior to filing for bankruptcy, the debtor must complete an approved course in credit counseling. A list of approved agencies is available on the state website. The certificate of completion must be filed with the court no later than 15 days after the bankruptcy filing date. In Chapter 13 cases, the repayment plan will be written during this training.

Purpose of Pre-bankruptcy credit counseling – The debtor will be given sufficient information to determine if bankruptcy is the only option. Insufficient income with a significant debt load is grounds for most debtors to file for bankruptcy. The agency will devise a plan for repayment of debts if the income is available. In addition, the debtor will devise a monthly budget for the months after the bankruptcy discharge.

  • The debtor is not obligated to follow the recommendations offered during the training.
  • Bankruptcy law requires that the debtor participates in the counseling.
  • A repayment plan that is written does not obligate the debtor to embrace that specific plan.
  • The recommended repayment plan must be filed with the bankruptcy documents.

Post-Bankruptcy Training

All debtors must complete a training course after filing before the debts will be discharged by the court. This course can be completed online, or in a classroom. An approved financial education course must be completed, and the certificate must be filed with the court.

Purpose of post-bankruptcy training – Financial literacy is believed to be lacking for most households in the United States. Financial problems can be avoided when these important topics are embraced:

  • Rebuilding the financial resources and credit history after bankruptcy
  • Develop and follow a budget
  • Understand the best practices associated with using credit
  • How to recognize “predatory lending” practices
  • Ways to avoid identity theft

Avoid Predatory Services

Debtors should be aware that fraudulent activities are common. Any deal that appears to be too good to be true probably is. Some known scams include:

  • Home mortgage scams – Someone contacts the mortgagee and claims that filing bankruptcy will stop all foreclosure proceedings. Claims that the government will forgive the entire debt if a certain amount of money is sent. This practice has surfaced because of recent government programs to help “upside down” homeowners.
  • Retirement draining schemes – Some retirement funds may be protected from bankruptcy proceedings. If a consultant starts by suggesting draining your retirement as a first step then they likely do not have your best interests in mind.
  • Inexperienced attorneys – Extremely low legal fees should indicate a problem for the debtor. An attorney with little experience can fail to file the proper bankruptcy forms with the court. Incidents have been reported where the debtor was charged with fraud because of the attorney’s actions.
  • Immigrants and minorities – These two special groups of people are especially susceptible to fraudulent bankruptcy schemes. Credit availability in the United States can cause the new citizen or resident to misuse credit instruments. An experienced attorney can assist the individual with good financial decisions to avoid bankruptcy.

Final Evaluation

Filing bankruptcy is a life-changing decision that can have long-lasting effects. Financial goals can be eliminated if the bankruptcy occurs at the wrong time in life. The consumer should consider other avenues prior to filing for bankruptcy because of personal debts. Consequences will reach into areas of life that were never considered. Many resources are available to assist the person who is willing to repay debts. Reputable attorneys are invaluable in the attempt to negotiate with other parties to avoid filing for bankruptcy protection.

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