Transition Guidance

Chapter 7. Chapter 11. Chapter 13. Whatever the legal avenue used, bankruptcy is a critical chapter in anyone's financial life. The cost and stigma of bankruptcy make it a painful solution.

Filing for personal bankruptcy can be an opportunity for a fresh start, but it also has a big price tag, financially, professionally and emotionally. That is why relatively few people in financial trouble use bankruptcy as a solution.

Bankruptcies have finally been on the decline recently, but the numbers are still very high. Non-Business bankruptcy filings averaged about 113,500 per month in 2011, according to the Administrative Office of the U.S. Courts.

Bankruptcy is a daunting prospect, yet for some it may seem like financial salvation. No one should enter into it without understanding the highly technical ins and outs, the truths and the myths.

Public Exposure is Part of the Price:

Bankruptcy is a legal action. It protects you in court against loss of assets by declaring that you are unable to pay financial obligations. The moment you file for bankruptcy, all attempts by creditors to collect money or property - by phone calls, repossessions or letters - must stop.

Your bankruptcy also becomes part of the public record, which means anyone looking into your financial background - employers or landlords, for example - can easily learn of your situation.

Filing for bankruptcy costs money. Not only does filing the petition itself incur fees, most of which must be paid up front, but in most cases it also requires attorneys' help, which costs money.

You can file for bankruptcy without a lawyer, but it means a lot of extra work. Lawyers not only handle all the necessary correspondence to creditors but also defend you against creditors' legal challenges. "The petition itself costs $300, while legal fees can accumulate into the 1,000's, depending on the type of bankruptcy and geographic location," says paralegal Eileen Williams-Jackson, who volunteers at the Fort Bragg, N.C., legal office.

One reason a lawyer is needed to file bankruptcy is that there is more than one way to go about it.

For individuals, there are Chapter 7 and Chapter 11, the primary difference being the amount of assets to protect and the means by which financial obligations can be met.

In Chapter 7, known as liquidation of assets, many of your assets are pooled together and sold by an officer of the court, known as a trustee. The money raised is used to pay creditors. Usually, this option works better for those with few assets to protect than someone with a lot of property to lose.

Chapter 11 is a plan for financial reorganization of businesses that allows them to continue operating while they repay creditors following a court-approved plan.

Chapter 13, also involving financial reorganization, is for people who have a regular income that can be used to repay debts. It allows you to keep all your assets, but a court-approved portion of your income must be used to bring down your debts.

Filing for bankruptcy affects co-signers to loans and credit cards you have received. When you file for bankruptcy, your co-signers must make regular payments as before; they are not protected by your bankruptcy.

If the co-signers make the payments, they automatically become a creditor to you and are entitled to receive money from the sale of your property. If they do not pay your bills, creditors may go after them for the money. If they fail to pay it will then affect their credit rating.

People don't usually talk about their inability to pay bills. By the time they make a public admission by declaring bankruptcy, their financial difficulties usually are way out of control.

For that reason, filing for bankruptcy can cause emotional difficulties. Most people therefore see it as a personal failure.

Don't Listen to Myths:

In the depths of desperation over a mountain of debt, bankruptcy often seems too good - or ghastly - to be true.

In reality, bankruptcy is neither a cure-all nor the end of the world. But a number of myths have arisen on both counts, including:

1. Bankruptcy will erase all of your debts.

   In fact, some debts are not excusable, even after a bankruptcy filing. These include alimony, child support, taxes, school loans and court fines. However, some of the people or agencies that are owed that money may be willing to negotiate directly with you to reduce your debt to them.

2. Bankruptcy is the simplest way to get out from under a mountain of debt.

   You declare bankruptcy, and your debts are taken care of. In reality, it entails mountains of paper work to establish expenses, liabilities and assets, which must be verified.

   Chapter 7 usually takes about four to six months from the time of filing until it's complete. Once your assets are sold, the money is disbursed according to a hierarchy of creditors.

   Secured creditors, who have a legal right to take back property that was pledged to secure credit, get all the money they're owed if there is enough; if not, they split the money. Then, if there is any money left, court and attorneys' fees incurred since the filing are paid. Unsecured creditors are last in the money line.

   And it gets even more complicated. Within the ranks of secured creditors, for instance, there is a separate hierarchy of who gets paid first, determined by the order in which they filed liens against you.

   It can take three to five years to complete a repayment agreement under Chapter 13. If all payments are made on time, the court will approve the financial reorganization plan as completed, thereby erasing all remaining debts.

3. Bankruptcy happens only to people who overspend or have high incomes.

   Unforeseeable things can happen that cause people to become overburdened with debt. Consider the person who unexpectedly lost a job, is having difficulty finding another and has exhausted all unemployment compensation benefits. Even when that person finds work, he or she may be unable to catch up with past-due bills. An unexpected illness or accident can be equally devastating financially. Unable to work, a person can suffer a huge drop in income even as medical bills keep piling up.

4. Bankruptcy does not affect anyone but the person who files.

   Creditors cannot be expected to absorb their entire loss when they can't collect everything owed to them because of a bankruptcy. They pass on those costs to consumers through increased prices for goods and services. Uncollected medical bills, for example, drive up insurance premiums. Credit card companies that don't get their money raise finance charges. In the end, everyone pays for bankruptcies.

5. It is impossible to recover financially from a bankruptcy.

   Depending on what form it takes, a bankruptcy can appear on your credit report for seven to 10 years. However, you can rebuild your credit - at a price. Creditors may agree to give you credit, but at a higher interest rate or with greater fees than they would charge a consumer who had not been through bankruptcy.

   It is indeed difficult to recover. You may be refused credit, employment or housing based on your bankruptcy even though that is illegal. The reality is that you will have to prove the bankruptcy was used as the reason for rejection.

6. I will lose everything I have in a bankruptcy filing.

   Depending on the state and federal laws that apply to your situation, you may be able to keep some of your assets, such as your house, car, clothes and tools of your trade, in a Chapter 7 bankruptcy. Under Chapter 13, whether to sell property to repay creditors is your choice; the court allows you to propose your own repayment plan.

Find Other Means of Escape:

"The final decision is yours, but filing for bankruptcy should be the last resort," says Bettye Banks, vice president for education at for Consumer Credit Counseling Services in Dallas.

A better, and generally easier, step out of debt is to work out a payment plan with creditors.

Another option is to visit a professional credit counselor for help in working out a budget that will enable you to make payments, help you recognize and stop bad spending habits, and educate you about finances.

The Consumer Credit Counseling Service provides such advice. It also acts as an intermediary between you and your creditors, taking a check from you every month and dividing it up proportionally among the people to whom you owe money.

The service is widely accepted among financial institutions, Banks says. "CCCS does not carry a stigma because the creditor knows that the person is trying to pay back the debt, not get out of it."

Another option short of bankruptcy is to take out a debt consolidation loan, but not without thorough consideration.

Some lending institutions offer to add the cost of other products or services, such as home improvements or vacations, into the loan, which can get you into further trouble.

"Debt consolidation loans with a low interest rate and manageable payments may allow a person to function better psychologically, simply because they will only have to pay one monthly bill," says paralegal Williams-Jackson.

"The bottom line is to take precautionary measures to protect yourself from having to file for bankruptcy in the first place," she says.