Since 2005 it has been a legal requirement for anyone filing for bankruptcy protection to first receive credit counselling from a government approved credit counselling agency. While this reform has been very unpopular since it requires the debtor to pay extra money before they even have the option of filing it is also quite helpful. Since most of the credit counselling agencies that are able to issue the requisite ticket are non-profit organizations, they are fairly unbiased and will review the individual’s current financial situation in close detail to determine whether or not bankruptcy is the right way to go. Therefore, since this counselling is required anyway, it serves as a good way to help an individual determine if bankruptcy is the best option under the circumstances.

People considering bankruptcy should also keep in mind that there are two different types of bankruptcy that apply to most individuals as well: Chapter 7 and Chapter 13. Chapter 7 bankruptcy is the type of bankruptcy that most people think of first, where their non-exempt property is liquidated to pay some of the creditors and the rest of the debt is discharged. This may or may not be the best course of action, but is usually most applicable to people with fairly simple financial situations, extremely limited income, and few solid assets. 

Chapter 13 bankruptcy is more complicated and essentially results in a court ordered restructuring of the debtor’s liabilities, which are all paid off over the span of the three to five year Chapter 13 repayment plan. In many cases, Chapter 13 makes much more sense, especially if the debtor has significant assets and a regular income. Although Chapter 13 bankruptcy remains on the debtor’s credit report for a full ten years like Chapter 7 bankruptcy, it also tends to look better to most lenders since most of the actual debt should be paid in full through the Chapter 13 process.  

There are definitely times when bankruptcy is by far the best option for a debtor, but there are others when this might not be the case. Further, since few things look worse than a bankruptcy on someone’s credit report, it is a decision that should not be taken lightly. The mandatory credit counselling that has to be taken before filing should serve as a helpful measure to see if the bankruptcy is a proper fit or not.

While anyone has the right to file for bankruptcy by themselves without legal representation, in general this is a terrible idea. Bankruptcy law is extremely complex and extremely technical, involving very specific steps that have to be done in a very specific sequence. Any mistake, from an accidental omission to a simple oversight of a document submission can result in very serious consequences. Failure to list an item for example may result in that item not being exempted though it qualified for exemption; or just as easily may be viewed as a deliberate effort to “hide” the asset from the court opening the filer up to sanctions from the court and/or having their case dismissed out of hand. Bankruptcy law is a specialized legal field which represents its own specialist niche in the legal field and this specialization is justified in view of the complexity of the process.

Further, the Bankruptcy Abuse Prevention and Consumer Protection Act, which was completely written by the commercial lending industry and implemented as law in 2005, mandates a number of even tighter restrictions on leeway afforded the bankruptcy judges. Many small mistakes that might have been forgiven by a sympathetic judge in the past now result in an immediate dismissal of the case. On top of this, depending on how far the case had proceeded before it was dismissed, the debtor may lose the right to re-file, leaving them with no recourse to the bankruptcy courts at all. Therefore, even a small accidental oversight can result in a calamity if the person filing pro se does not know what they are doing.

Obviously anyone considering filing for bankruptcy is already hard pressed financially, so hiring an attorney may not seem like a good investment, but this is only true in the most basic of cases. If the debtor has an extremely simple situation – no cash, no assets – then they may be able to file on their own without too many problems. However, for anyone that owns a home, has items to exempt from liquidation, has an income, or even considering a Chapter 13 bankruptcy; getting legal representation is well worth the effort. Depending on how dire the borrower’s situation is, they may qualify for free legal counsel from a number of charitable legal aid organizations. The bankruptcy courts themselves strongly advise that all filers have legal representation and provide resources on where to look for free legal assistance on their website (www.uscourts.gov > FederalCourts > Bankruptcy > BankruptcyResources > FilingBankruptcyWithoutAttorney).

The first thing to consider is the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA). Many people have some old fashioned ideas about what bankruptcy means, what can be exempted, what kinds of debts can be discharged and what you have to do to file. The fact is that the BAPCPA radically altered personal bankruptcy in the United States, making it generally harder to do, less likely to succeed, reducing the kinds of debt that can be discharged and otherwise making it more troublesome for most people. This bill was written directly by the lending industry, transferred to Congress by the lending industry’s lobbyists, and passed on their account. The entire idea is to make it harder to file for bankruptcy and reduce the benefits of doing so.

Examples of important changes introduced by BAPCPA included introducing the requirement to receive credit counseling from an approved agency sometime within six month of filing, adding a means test to determine if you are truly poor enough – by the credit card industry’s standards – to file for bankruptcy, mandating that certain technicalities in the filing process result in automatic dismissal of the case, and adding a number of kinds of debts to the list of those that cannot be discharged by the courts. Therefore, the first thing to look into before filing bankruptcy is to see if your debt can be discharged through the process or not and see if you meet all the new standards and requirements.

Also keep in mind that if you do file for bankruptcy and the case is accepted and debt is discharged, then this will be reported on your credit history for the next ten years. Contrary to some of the claims made by fraudsters online, there is no legal way to have a bankruptcy removed from your personal credit history once the process has been completed. This means that the consequences, as well as a very obviously red flag to almost all potential lenders, will follow you consistently for the next decade.

However, do not let that make you think that you will no longer be able to get credit. One of the things that the BAPCPA did was make it longer – eight years now – before you can file for bankruptcy a second time. This means that once your bankruptcy goes through you will become a prime target to all kinds of predatory lenders that will offer you credit the day you leave bankruptcy court. The idea is that most people that go bankrupt will make the same mistakes again if given the opportunity (credit), except this time they cannot file for bankruptcy for the next eight years. So these people are prime targets for predatory lenders since once they get caught a second time, they have no recourse but to lose everything.

Chapter 7 bankruptcy is what most people think of when they think of bankruptcy. The basic process entails liquidating the debtors non-exempt property and using the proceeds to pay as much of the outstanding debt as possible. Once this phase is complete, the rest of the debt is either discharged (or written off and invalidated) or restructured into a court ordered payment plan. Before 2005, most debts were discharged, more or less giving the debtor a second chance, but since the passing of the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) of 2005, many more debts have simply been restructured, reducing the value of the whole process in many cases.

Historically speaking Chapter 7 bankruptcy was a valuable tool to help people get a second chance, but the Bankruptcy Abuse Prevention and Consumer Protection Act has changed much of this. This bill was specifically written by the lending industry and completely serves their interests to the detriment of the debtor. This law instituted a means test, mandatory credit counseling, added a wide range of mandatory dismissal provisions to the instructions used by the judges for minor technicalities, and mandated that much less debt is to be discharged, in favor of court order restructuring. Basically the only people that Chapter 7 bankruptcy makes sense for today are people who are literally destitute except for their exempted property. Chapter 7 generally exempts property necessary for life (like your home and clothes) and property necessary for livelihood (like a primary vehicle and tools) from liquidation and collection efforts.

Chapter 13 bankruptcy is very different from Chapter 7 and does not result in any property being liquidated or any debt being discharged. Instead it basically amounts to a court order debt restructuring plan. Chapter 13 bankruptcy is known as “wage earner bankruptcy” because it only really applies to people with a significant regular income. This is the option usually chosen by professionals, who can rely of a decent regular income and who frequently own properties that would not be exempted from liquidation under Chapter 7 bankruptcy. Further, since the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 implemented a means test to Chapter 7 bankruptcy, in some cases Chapter 13 may be the only bankruptcy option open to the debtor.

Essentially the Chapter 13 process takes into account all of the debtor’s income and holdings and all of their debt and liabilities and develops a carefully structured repayment plan that usually lasts from three to five years. Virtually every aspect of the debtor’s spending is spelled out in and governed by the repayment plan; making it a very intrusive process. Further, any mistake – like a late payment – can result in the whole Chapter 13 repayment plan being scrapped, leaving the debtor in a much worse situation than they were in before.

Chapter 13 bankruptcy is the option chosen by people that have a lot of assets that would not be exempt under Chapter 7 bankruptcy and are earning a reasonable regular income. Unlike Chapter 7 bankruptcy, no debt is actually discharged or erased, but instead it is all restructured according to a detailed plan.  In effect, it is like court ordered loan modification and as long as the debtor follows the restructuring agreement perfectly, they get to pay off their debt over a three to five year period while preventing their creditors from taking any actions against their property or other measures. Further, Chapter 13 frequently involved the creditors stopping any additional interest or assessing additional fees, so at least in this respect some money is saved. The catch is that the debtor has to follow the restructuring plan to the letter, as any little mistake – like a single late payment – is enough to throw out the entire Chapter 13 repayment plan, leaving the debtor at the mercy of the creditors.

Chapter 7 bankruptcy is more what most people think of when they think of bankruptcy in general. In this process, the debtor loses his or her non-exempt property, which is put up for auction and the proceeds are paid out to the creditors. The remaining debt is discharged, or written off, by the court and no longer remains outstanding against the debtor. Chapter 7 bankruptcy allows most things that are required for living (home, furniture, clothing, etc.) as well as most things required to make a living (vehicle, tools, word-related equipment, etc.) exemption from being liquidated. So Chapter 7 bankruptcy automatically protects your most valuable assets – like your home – from your creditors and may (or may not) result in a significant amount of your outstanding debt being discharged.

Chapter 7 bankruptcy used to be much more beneficial to the debtor, but the passing of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) – a bill that was practically written by professional lending institutions and their lobbyists – changed much of this. Today a debtor has to pass a means test in order to qualify for bankruptcy, has to obtain the approval of a recognized credit counseling agency, can not exempt as much property as used to be the case, and fewer debts can be discharged. Nevertheless, Chapter 7 bankruptcy still offers a range advantages, the most important being the protection of your home and primary vehicle from your creditors.