What is bankruptcy? | Recommended by Fortune

We often think of debt as a bad thing—but that’s not always the case.

This can be a valuable tool in reaching some of your most important financial milestones. Maybe you’re in debt buy your dream home, finance your caror start a business. Checking the financial to-dos is often made possible through a new loan.

However, managing debt can be a challenge for many and they often don’t put it at the forefront of their minds until they find themselves in the red.

File for Chapters 11 and 13 both increased in 2022. Chapter 11, which provides for the reorganization of business debts, increased to 4,918, compared to 4,836 last year. Chapter 13 filings, the most common bankruptcy filing for individuals with regular income, increased from 120,002 to 157,087 by the end of 2022.

But what does it mean to file for bankruptcy and why should debtors use this option?

What is bankruptcy?

Bankruptcy is a legal process that individuals and businesses can rely on as a way to eliminate all or part of their debt. This may not be the most suitable option for every individual who has accumulated an unmanageable debt load because there are requirements that they must meet in order to be eligible to file for bankruptcy. It’s also important to remember that going this route has implications for your overall financial health.

“Bankruptcy is essentially a legal status, which protects debtors and helps them meet their obligations to creditors,” said Derek Jacques, a bankruptcy attorney at The Mitten Law Firm. “It can offer a fresh start to individuals or businesses that have gotten in over their heads, often through no fault of their own.”

The different types of bankruptcy filing

There are several types of bankruptcy and the type of bankruptcy that is best for your financial situation may vary. Some of the most common types include:

  • Chapter 7: Sometimes called straight or liquidation bankruptcy, this type of bankruptcy appoints a bankruptcy trustee who is responsible for collecting and selling the debtor’s unpaid assets. Those proceeds are then given to creditors as compensation. To qualify for Chapter 7, you must pass a means test to prove you need to file. If your current monthly income is more than the state median, the Bankruptcy Code requires a “means test.” You must also not have had a Chapter 7 discharge in the last eight years, or a Chapter 13 discharge in the last six years.
  • Chapter 13: As opposed to a complete elimination of your debt, a chapter 13 bankruptcy aims to make your debt more manageable. Under this chapter, borrowers propose a payment plan to make installments to creditors over three to five years. A Chapter 13 bankruptcy stays on your credit report for seven years, and you can’t file for it again until after two years.
  • Chapter 11: Chapter 11 bankruptcy is often used by businesses or corporations to create a plan to reorganize their business so that they can continue to operate while paying off their debt. In this case, the court and the creditors must sign this plan.

When to consider bankruptcy, plus some major pros and cons

If your debt has become overwhelming and you can’t find a way out of it within a reasonable amount of time, without some kind of intervention, declaring bankruptcy can be a useful option.

“Some signs that you should file for bankruptcy include: Harassment of phone calls and letters from creditors, you are at risk of eviction or foreclosure, your car is repossessed, or if your credit card will be maxed out,” said Jacques.

If you are considering filing for bankruptcy, you may want to carefully consider the benefits and drawbacks of doing so.


  • Debt collectors will pump the brakes. Once you file for bankruptcy, some debt collection methods stop. “Debt collection activity is stopped, so you can avoid some of the worst things about being in debt like foreclosure or repossession,” says Jacques.
  • Filing for bankruptcy may protect some of your assets. Once you’ve filed, any wages you earn can’t be garnished to pay creditors for any discharged debt. This will help provide peace of mind and help you focus on paying.


  • Filing for bankruptcy can seriously affect your credit. Bankruptcy can stay on your credit report for up to 10 years, which can hurt your ability to apply for a new loan, credit card, rent a home, or hit your other financial goals.
  • Filing for bankruptcy is not free. Generally, you should seek the support of an experienced attorney to guide you through this process, in addition to the filing and court fees that you are responsible for.

Alternatives to filing bankruptcy

Filing for bankruptcy may help simplify things in the short term, but the effects of a bankruptcy filing are long-lasting. That said, it’s important to consider all your options before resorting to this option. Some alternatives to consider may include:

  1. Loan repayment plans: Work directly with your lender to discuss your loan repayment options should be your first step of action. Your lender may be willing to work with you to come up with a plan that makes your debt more manageable and doesn’t require any legal action or a hit to your credit score.
  2. Debt Consolidation: Debt consolidation is another option that not only simplifies your loan repayment, but can also save you money in the long run. A debt consolidation loan allows you to convert multiple debts into one payment to simplify or streamline debt management. If you get a loan with a lower interest rate than your existing loans, you can also expect to save on interest over time.
  3. Home equity loan: Another type of loan that can help you get rid of your debt is a home equity loan. Although it can provide an additional low-interest option, this type of loan does not come with its own set of risks. A home-equity loan allows you to borrow against the market value of your home and receive a lump-sum payment in return. The catch: your home serves as collateral for the loan if you default on it.

The takeaway

Filing for bankruptcy can have serious consequences for your personal finances and should be carefully considered before you decide to file. If you are saddled with unmanageable debt, consult your lenders and possibly a legal expert to find out what your options are and decide on the best course of action.

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