Types Of Bankruptcies: Defined And Explained

If you’re struggling financially and overwhelmed with debt, you may be a good candidate for bankruptcy. Bankruptcy can help individuals and businesses address their debts through payment plans, discharging the debt or selling off assets to cover debt. However, bankruptcy is not for everyone. Discover the different types of bankruptcy and how they might impact your debt and credit score below.

What Are The Different Types Of Bankruptcies?

Bankruptcy is a legal process that relieves individuals, organizations or municipalities of their debt. The method of relieving the debt can be done by liquidating assets, setting up a payment plan or simply discharging the debt. Which process you go through depends on several factors, such as your income level, the amount of assets you own, and whether you are filing personally, as a business or as a municipality. The different bankruptcy processes are broken down into six chapters:

• Chapter 7: Used by individuals who must sell their possessions to pay as much of their debt as possible before the rest of their debt is discharged
• Chapter 9: Used by municipalities to protect themselves from creditors while they renegotiate their debt
• Chapter 11: Used by businesses to reorganize their debt while remaining in control of their assets and business operations
• Chapter 12: Used by family farmers or fishermen to create a repayment plan to pay for all or a portion of their debt over 3 to 5 years
• Chapter 13: Used by high-income individuals to set up a repayment plan for all or some of their debt
• Chapter 15: Used when dealing with parties from more than one country

Individuals and businesses typically file for bankruptcy to be freed from the burden of their debt and begin a fresh start. However, depending on the amount of your debts and the type of bankruptcy you file for, the process can be long and difficult, and will have an effect on your credit and ability to borrow money for years to come. That is why it is essential to review your finances, study the multiple types of bankruptcy, and consider alternatives before you make a final decision.

Types Of Personal Bankruptcies

Personal bankruptcies are filed by individuals to relieve debt they assumed separate from any business or corporation. There are two types of personal bankruptcy:

Chapter 7 Bankruptcy

Also known as liquidation bankruptcy, Chapter 7 bankruptcy is for anyone with a limited income who can’t pay back at least some of their debts. During Chapter 7 bankruptcy, all of your possessions will be sold (including your house) to pay off unsecured debts like credit card debt and medical bills. While Chapter 7 can help you find financial relief, it’ll stay on your credit report for up to 10 years.

Chapter 13 Bankruptcy

If you earn a sufficient income and aren’t eligible for Chapter 7, Chapter 13 (or wage earner’s bankruptcy) may be right for you. Chapter 13 involves a 3- to 5-year repayment plan where you’ll repay all or a portion of your debts. Once the repayment period comes to an end, your unsecured debts will be discharged. This means you’ll no longer be responsible for repaying them. You can expect a Chapter 13 bankruptcy to stay on your credit report for up to 7 years.

Chapter 7 Vs. Chapter 13 Bankruptcies: A Comparison

Other Types Of Bankruptcies

Chapter 9 Bankruptcy

Chapter 9 is quite different than the rest of the types of bankruptcies listed here. First, only municipalities, meaning cities, towns, villages, taxing districts, municipal utilities, or school districts, can file for Chapter 9 bankruptcy. Chapter 9 also has no system for municipalities to liquidate their assets to pay their creditors. Because of these restrictions, Chapter 9 bankruptcies are primarily used by municipalities to renegotiate the terms of their debt to extend their debt maturities, reduce their principal or interest, or entirely refinance a loan.

Chapter 11 Bankruptcy

Businesses can file for Chapter 11 bankruptcy to get a handle on their finances without having to liquidate their assets or lose control of their company. When a business files for bankruptcy under Chapter 11, they create a plan to pay off their debt and present it to their creditors. If the creditors approve of the plan, the business can submit it to a bankruptcy court for approval. Creditors can also petition the court to reorganize a business’ debt involuntarily. Individuals in some rare cases can also file for Chapter 11 bankruptcy, but it is usually reserved for businesses.

Chapter 12 Bankruptcy

Chapter 12 is a very specific type of bankruptcy designed for “family farmers” or “family fishermen” with “regular annual income.” Farmers can file as individuals or businesses but must meet certain specifications regarding the amount of their debt, the amount of their income and whether the debt arises from their farming operations. The process for Chapter 12 bankruptcy is similar to Chapter 13 in that it allows farmers to reorganize their debt obligations and create a payment plan for the debt.

Chapter 15 Bankruptcy

The U.S. government created Chapter 15 bankruptcy in 2005 in response to the United Nations' request for countries to adopt a uniform system for handling bankruptcy cases involving parties from multiple countries. Chapter 15 is designed to promote cooperation between U.S. courts and international authorities. Chapter 15 cases usually coincide with a bankruptcy proceeding started in a foreign country. If a foreign business or individual has a bankruptcy case in a foreign country that involves U.S. parties or assets, they can use Chapter 15 bankruptcy to have access to the U.S. court system.

When Should You Consider Filing For Bankruptcy?

• Your wages are being garnished. This is when creditors are taking a certain percentage of your paycheck. Bankruptcy can stop wage garnishment.
• You depend on credit cards. If you don’t have the cash to pay for your bills and everyday expenses and rely on credit cards often, bankruptcy may be a smart move.
• You’ll need at least 5 years to pay off your debt. Calculate how much debt you owe in total. If you think it’ll take a minimum of 5 years for you to become completely debt-free, bankruptcy can provide you with faster relief.
• Your debts exceed your income: If you owe more than you make and can’t keep up with your finances, bankruptcy may help.
• You’ve exhausted other options. Bankruptcy should not be the first thing you do to get out of debt. View it as a last resort and only consider it if you’ve already explored other options like debt settlement and debt consolidation with minimal to no success.

Alternative Options To Filing For Bankruptcy

Stick To A Budget

Before filing for bankruptcy, you should conduct a thorough analysis of your finances to determine whether you can contribute at all to your debt payments. The best way to go about this is to go through the budgeting process. One of the most important steps in this process is to categorize your spending. If you can adjust your spending to prioritize your debt payments while still maintaining your most basic needs, you may be able to avoid bankruptcy.

Pick Up A Side Hustle

Picking up a side hustle is a great way to increase your income so you can contribute more significantly to your debt payments before filing for bankruptcy. If you have time outside of your regular full-time job, a side hustle is an income-producing activity that you can do to make some extra cash. Gigs such as ridesharing, food delivery, dog walking and other freelance activities can help you pay down existing debts while building additional skills that can help you avoid financial insecurity in the future.

Sell Unused Items

Depending on the type of bankruptcy you are considering applying for, you may have to sell off most or all of your possessions without any say in what is sold. If you want more control over what items are sold, consider selling your unused items before filing for bankruptcy. Whether you sell them to family members, in a yard sale, or online, selling some of your unused assets could put a significant dent in your debt.

Consolidate Your Debts

If you have multiple sources of debt, like multiple credit cards and personal loans, bankruptcy may feel like the only way out from the pressure of overdue payments. However, debt consolidation can turn multiple confusing sources of debt into one easy-to-manage loan that can put you back on track financially. Debt consolidation works by merging multiple loans into one loan with one payment. Ideally, the final loan will have a lower interest rate than the separate loans, so you can manage the debt payments more easily and avoid filing for bankruptcy.

Consider Credit Counseling

If you need an outside source to help you decide the right course of action, consider seeking credit counseling. Credit counselors can help people struggling to pay their bills create a budget, manage their income and build an overall debt management plan to try to avoid bankruptcy.

The Bottom Line: Consider All Your Options Before Declaring Bankruptcy

The six types of bankruptcy offer multiple options for you to receive a fresh financial start, but they all come with a hefty price. Consider downloading the Rocket Money^SM app to take advantage of helpful tools to create a budget and manage your expenses and debt payments all in one place.