Filing for bankruptcy is not a tabula rasa. While bankruptcy can help you deal with mounting debt and financial distress, there are certain debts and obligations it cannot erase – and long-term consequences that are inescapable.
Perhaps the most severe punishment associated with bankruptcy is not what it does to your wallet, but what it does to your credit. Depending on how you file for bankruptcy, your bankruptcy can continue to negatively impact your credit reports for the next seven to ten years. This severely impacts your ability to seek financing, secure loans, lease, and even get back on your feet.
Sadly, there are circumstances under which bankruptcy remains the only viable option for dealing with your debts. But before you proceed with the process, you must speak with a professional on credit and bankruptcy law and explore all your alternative options. In fact, the law states that consumers must seek pre-filing counseling within 180 days before filing for bankruptcy, alongside a debtor education course to be completed before their debts are discharged. Understanding how the different bankruptcy types can affect your credit report is important.
The Types of Bankruptcy
What is bankruptcy, to begin with? Bankruptcy is a legal procedure during which a court and judge determine whether the individual or business filing for bankruptcy has the capability to pay its debts.
If the court determines that the individual or business in question cannot pay their debts even after all assets and liabilities are taken into account, these debts may be forgiven, after the creditors are paid to the best of the debtor’s abilities. In other cases, bankruptcies are meant to help people restructure their finances, to pay off debt via a payment plan.
Bankruptcies can also entail either a total liquidation of an individual’s assets and finances or a major restructuring of a company to pay off a reduced debt before the slate is wiped (mostly) clean. Bankruptcy proceedings usually halt collection activities from debt collection agencies, as well as the IRS. Bankruptcy can even delay foreclosure on a property, or repossession of a vehicle.
Bankruptcy proceedings cannot eliminate all debt. Certain debts, including child support payments, alimony, and tax debt, are not forgiven through bankruptcies. While bankruptcies are intended as a second chance, they always carry long-term consequences. These depend on the type of bankruptcy in question. For most individuals and businesses, only three bankruptcy types are relevant: Chapter 7, Chapter 11, and Chapter 13.
Chapter 7 bankruptcy is the most commonly filed type of bankruptcy, and it is also what most people understand under the definition of going bankrupt: total liquidation of non-exempt assets.
For many people who have hit financial rock bottom, a chapter 7 bankruptcy can often result in a no-asset bankruptcy.
Because they may have already leveraged or sold all their property and non-exempt assets in an attempt to turn things around, over 90 percent of people who file for a Chapter 7 bankruptcy do not actually have anything left to liquidate for their creditors.
Chapter 7 bankruptcies can also be applied by partnerships, corporations, and other business entities. If you do have non-exempt assets left to liquidate, a chapter 7 bankruptcy can result in a loss of property and assets. Chapter 7 bankruptcy proceedings only grant debt discharges to individuals, not businesses or corporations.
The process for filing a chapter 7 bankruptcy begins with a petition, as well as a schedule of all assets and liabilities, income and expenses, bank statements and other financial statements, and all executory contracts and unexpired leases.
Chapter 11 bankruptcy is also known as a reorganization bankruptcy. Because it allows businesses to stay in business, and individuals to continue owning assets while they deal with their debts, it is understandably the most complicated bankruptcy process, and is typically used by businesses and individuals with more than $419,275 in unsecured debt, and $1,257,850 in secured debt.
Most individuals who opt for a chapter 11 bankruptcy do so because they are a partial owner of a corporation, one half of a partnership, a major stockholder, or own a sole proprietorship. In addition to being complicated, chapter 11 bankruptcy is also the most expensive type of bankruptcy in terms of mandatory filing fees and administrative costs.
Rather than forgive and discharge any debts, however, chapter 11 bankruptcy debtors must work with a plan their creditors have signed off on to satisfy their liabilities while keeping them afloat. If the debtor does not propose a reorganization plan, the creditors may be able to propose a plan of their own.
A company can be completely liquidated and restructured during a chapter 11 bankruptcy, allowing them to pivot and change to a different business model while paying off its debts of an agreed term.
Chapter 13 bankruptcy is another reorganization bankruptcy. Chapter 13 cases are much more common than chapter 11 cases and are both more affordable and less complex. Chapter 13 cases accounted for 28 percent of all bankruptcies in 2020.
Chapter 13 bankruptcies are exclusive to debtors with less than $419,275 in unsecured debt, and less than $1,257,850 in secured debt. As with chapter 11 bankruptcies, a repayment plan is formulated, proposed, and voted upon by creditors. Any debt left unpaid at the end of the payment plan is discharged.
The benefits of a chapter 13 bankruptcy over a chapter 7 bankruptcy include a lesser impact on their credit, as well as the ability to continue owning non-exempt assets and property. Chapter 13 bankruptcies are cheaper than chapter 11 bankruptcies but still more expensive than Chapter 7 bankruptcies.
How Long Does Chapter 7 Bankruptcy Stay on Your Credit Report?
After you have filed for a chapter 7 bankruptcy, it will remain on your credit report for up to ten years. Discharged debts will no longer have to be paid.
If your debts were declared delinquent before you filed for bankruptcy, they will be removed from your credit report seven years from the date of delinquency.
How Long Does Chapter 13 Bankruptcy Stay on Your Credit Report?
After you have filed for a chapter 13 bankruptcy, it will remain on your credit report for up to seven years. The remainder of your applicable debts is discharged at the end of your repayment period, which typically ranges from three-to-five years.
As with chapter 7 bankruptcies, any debts declared delinquent before you filed for chapter 13 bankruptcy are removed from your credit report seven years from the date of delinquency.
How Will Bankruptcy Affect Your Credit Score?
The better your credit score was, the more it will be affected by your bankruptcy. Someone with bad credit, to begin with, isn’t going to see as much of a dip in their credit as a result of going bankrupt.
Regardless of what your credit looks like now, keep in mind that you can still use the time after the bankruptcy to build up your credit score, to prepare for the day when it is removed from your credit. Good credit habits will help your credit score recover faster.