- Financial Term Glossary
- Bankruptcy
Bankruptcy
Bankruptcy summary:
Bankruptcy is a legal process for dealing with debt. It temporarily stops collections.
Chapter 7 bankruptcy can be completed in a few months, but you might have to give up some of the things you own.
Chapter 13 bankruptcy takes three to five years. It’s a payment plan, but you get to keep the things you own.
Bankruptcy definition and meaning
Bankruptcy is a formal legal procedure for dealing with debt that happens in a special court system. Bankruptcy law covers debt that can't be paid as agreed. A bankruptcy judge decides how much the debtor (the person who owes money) will pay and how much debt will be forgiven (wiped out). The judge applies bankruptcy law and settles any disagreements that may come up between debtors and creditors (the person or institution who is owed money).
A bankruptcy trustee makes sure that everyone involved pays what the law says they must pay and collects what they're entitled to receive.
The court also works to prevent fraud and ensure that everything takes place aboveboard.
More about bankruptcy
Bankruptcy is how the legal system helps debtors and creditors sort out tricky financial situations. The debtor (the person who owes money) is the one who asks for bankruptcy protection. When it's not possible for debtors to pay what they owe, they might ask a bankruptcy court for help.
The creditor is the person or institution (such as a bank) who loaned the money and wants to be repaid.
Bankruptcy law determines which creditors' claims are most important and must be satisfied first. For example, child support payments take priority over credit card balances.
Bankruptcy protection temporarily stops all collection processes and helps maintain order. The debtor might be allowed to sell assets, reorganize their finances, and structure more affordable repayment schedules.
Bankruptcy is designed to balance the need for creditors to be repaid with the need for debtors to get back on their feet.
The two main types of bankruptcy for individuals are Chapter 7 and Chapter 13.
Chapter 7 bankruptcy clears unsecured debts in months
Chapter 7 bankruptcy could involve giving up assets (things that you own). Most people have assets that they get to keep, like clothing, household goods, and a modest car. Things you get to keep are called bankruptcy exemptions. Every state has its own rules about exemptions.
Assets that are considered nonexempt must be surrendered to the court. For example, if you own multiple vehicles, you might have to let go of all but one. A bankruptcy trustee sells your nonexempt assets and distributes the money to your creditors. If there’s money left over, you get it back. When all accounts have been reviewed and monies paid, the judge can issue a bankruptcy discharge and wipe out any unpaid balances.
Chapter 7 bankruptcy generally takes three to six months. It's also called a clean slate, fresh start, or liquidation bankruptcy.
Chapter 7 can’t wipe out every type of debt. It works for unsecured debts like credit cards, personal loans, and medical debt. Also, not everyone is allowed to file Chapter 7. To qualify, you have to pass the bankruptcy means test. This test is designed to encourage those who can afford to repay at least some of what they owe to file Chapter 13 instead.
Chapter 13 bankruptcy is a payment plan
Chapter 13 bankruptcy involves using future income to repay what you owe. Debtors get to keep their assets, but must commit to a monthly repayment plan. Chapter 13 is also called the wage earner's bankruptcy, because you repay creditors from income rather than from selling the things you own.
A bankruptcy trustee analyzes your finances and decides how much you’ll pay and for how long. Every year, you’ll have to submit tax returns and other paperwork to the trustee so the monthly payment can be adjusted if needed. You can’t take on new debt without the trustee's permission.
Chapter 13 bankruptcy plans run for three years if you’re low-income for the area where you live, or five years if you’re not. Any remaining balances are discharged (forgiven) once you’ve made all of the payments in your plan.
Steps in bankruptcy:
Complete pre-bankruptcy credit counseling. This is required to file.
File a petition with the bankruptcy court, listing your debts, assets, income, and expenses.
The automatic stay goes into effect, which means your creditors must stop trying to collect.
You, the bankruptcy trustee, and your creditors meet and discuss the situation.
If you file Chapter 7, you may have to give up some of the things you own. If you file Chapter 13, you’ll begin making payments.
Money is distributed to creditors.
The judge issues a bankruptcy discharge if debt remains when your case ends.
The information provided in this article is intended for general informational purposes only and should not be taken as legal advice. For personalized legal advice, consult with a qualified attorney licensed to practice law in your state.
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