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Insights Into the World of Bankruptcy That Most People Don’t Understand

Bankruptcy is often shrouded in myths and misconceptions, most of which assume a personal is broke and faces financial hardship. Nevertheless bankruptcy is actually technical legality that does have negative impacts to your credit, but can offer a lifeline and even offer some beneficially restructuring opportunities.

Many people have heard the terms Chapters 7, 11, and 13, but don’t really understand the impact on credit scores or the differences between these details. This article will explore into the lesser-known yet significant facets of bankruptcy to equip you with the necessary knowledge to manage or avoid it.

Common Misconceptions

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Bankruptcy comes in several forms, commonly under chapters 7, 11, and 13, each catering to different financial situations.

Chapter 7 involves liquidating assets to pay off debts, whereas Chapter 13 allows individuals to keep their property and pay debts over time. Chapter 11, often misunderstood as being only for businesses, is also available to individuals, especially those with substantial debts and assets.

Automatic Stay

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An automatic stay halts all collections the moment a bankruptcy petition is filed. This legal pause provides relief from creditors, stopping everything from phone calls to wage garnishments. Misunderstandings arise when people assume it stops all legal actions, but it does not affect criminal proceedings or child support obligations.

Credit Score

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Filing for bankruptcy will negatively impact your credit score, often decreasing it by 200 points or more. Recovery starts immediately, however, and many can rebuild a fair credit score within 2 years. The fact that bankruptcy can remain on a credit report for up to 10 years does not mean bad credit persists for that long.

Student Loans

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Contrary to popular belief, student loans are not always non-dischargeable in bankruptcy. While challenging, discharge is possible if continuing to pay the debt will impose an undue hardship on the debtor and their dependents.

Tax Debts

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Many assume all tax debts are inescapable in bankruptcy, but certain back taxes can be wiped out under specific conditions. Taxes must be income-based, from a tax return filed at least two years ago, and the debt must be at least three years old. This relief does not apply to taxes withheld from an employee’s paycheck, such as payroll taxes.

Effect on Employment

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Bankruptcy can affect job prospects, especially in industries that scrutinize financial stability. However, federal law prohibits employers from discriminating against employees solely because they have filed for bankruptcy.

Marital Debt

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Filing for bankruptcy does not necessarily involve your spouse’s debts unless they are co-signed. Individual filings can protect one spouse from bankruptcy, preserving their credit score while the indebted spouse seeks relief. Couples often misunderstand this, believing that a bankruptcy filing by one spouse ruins the credit of both.

Secured vs Unsecured Debt

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Secured debts are tied to assets like homes and cars, while unsecured debts include credit card bills and medical expenses. Bankruptcy typically discharges unsecured debts, but secured debts either continue to be paid or the collateral is surrendered.

Not all assets are lost in bankruptcy. Each state has specific exemptions that may protect items like your home, car, and retirement accounts. Many people are surprised to learn that tools of their trade and even some jewelry may be exempt from liquidation.

Business Operations

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Business owners can continue operations during a Chapter 11 bankruptcy. This chapter allows restructuring of business debts and renegotiation of leases and contracts under court supervision. Misunderstandings about the cessation of business operations can deter filings that might otherwise offer a sustainable path forward.

Reaffirmation Agreements

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Debtors may choose to sign reaffirmation agreements, committing to continue paying a dischargeable debt post-bankruptcy. This decision is typically made to retain possession of collateral, like a vehicle. Such agreements must be entered into voluntarily and approved by the bankruptcy court, which ensures they do not impose an undue financial burden.

Utility Services

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Filing for bankruptcy does not lead to a shut-off in utility services. Federal law allows individuals to keep their utilities running, provided they furnish a deposit to the utility company within 20 days of filing. This deposit secures the utility company against potential non-payment post-bankruptcy.

Credit Counseling Requirement

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Before filing for bankruptcy, individuals must complete credit counseling from an approved agency. This session, which must occur within 180 days before filing, aims to educate debtors on financial management. Many are unaware of this prerequisite, which is crucial for a valid bankruptcy filing.

Multiple Filings

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Individuals can file for bankruptcy more than once, subject to certain time restrictions. For example, eight years must pass between Chapter 7 filings. This fact counters the common belief that bankruptcy is a once-in-a-lifetime option.

Luxury Purchases and Cash Advances

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Purchases over $725 made within 90 days of filing for bankruptcy or cash advances taken within 70 days are presumed non-dischargeable. This rule is designed to prevent abuse of the bankruptcy system through last-minute accumulation of debt. Debtors often overlook these specifics, leading to complications in their cases.

Pension Plans

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Most pension plans, including 401(k)s and IRAs, are protected in bankruptcy. Federal laws provide a shield for these retirement assets, contrary to the common fear that filing for bankruptcy will strip away future financial security. Understanding these protections can provide significant relief to filers worried about their retirement.

Eviction Proceedings

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An automatic stay can temporarily stop eviction proceedings, but there are exceptions. If a landlord already has a judgment for possession of the property before the bankruptcy filing, the stay might not apply. Tenants often misunderstand the scope of this protection, assuming it offers more comprehensive relief than it does.

Cosigners on Debts

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If someone cosigns a loan and the primary borrower declares bankruptcy, the cosigner may still be obligated to pay. Protection for cosigners is limited and depends on the type of bankruptcy filed. This reality can come as a shock to cosigners who mistakenly believe they are also protected by the borrower’s bankruptcy filing.

Required Creditor Meetings

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Every bankruptcy filer must attend a meeting of creditors, often called the “341 meeting.” This is a chance for creditors to question the debtor about debts and assets directly. Many debtors are intimidated by this meeting, not realizing it’s typically a straightforward process and rarely involves contentious interactions.

Life Insurance and Bankruptcy

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Certain types of life insurance policies are exempt from bankruptcy proceedings. Whole life insurance with a cash value may be protected, depending on state laws. Debtors should review these specifics before filing to understand which of their assets are vulnerable and which are safeguarded.

Bankruptcy filings are public record, which can deter some from seeking this legal remedy due to privacy concerns. However, the specifics of a bankruptcy case are rarely scrutinized by the general public.

Josh Dudick

Josh is a financial expert with over 15 years of experience on Wall Street as a senior market strategist and trader. His career has spanned from working on the New York Stock Exchange floor to investment management and portfolio trading at Citibank, Chicago Trading Company, and Flow Traders.

Josh graduated from Cornell University with a degree from the Dyson School of Applied Economics & Management at the SC Johnson College of Business. He has held multiple professional licenses during his career, including FINRA Series 3, 7, 24, 55, Nasdaq OMX, Xetra & Eurex (German), and SIX (Swiss) trading licenses. Josh served as a senior trader and strategist, business partner, and head of futures in his former roles on Wall Street.

Josh's work and authoritative advice have appeared in major publications like Nasdaq, Forbes, The Sun, Yahoo! Finance, CBS News, Fortune, The Street, MSN Money, and Go Banking Rates. Josh currently holds areas of expertise in investing, wealth management, capital markets, taxes, real estate, cryptocurrencies, and personal finance.

Josh currently runs a wealth management business and investment firm. Additionally, he is the founder and CEO of Top Dollar, where he teaches others how to build 6-figure passive income with smart money strategies that he uses professionally.