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Fans of NBC’s “The Office” may remember an episode in which Michael Scott yells to his office, “I. DECLARE. BANKRUPTCY!” Unfortunately, there’s a lot more to fixing a heap of debt than making a loud proclamation. Filing for bankruptcy is a complex legal process that might save you money, but it also comes with serious consequences you’ll want to consider.
The first step in determining whether a bankruptcy is right for you is defining what it is. Here are a couple important terms to know:
- Bankruptcy is a legal means by which someone with a large burden of debt can get out from under it. In a 1934 case (Local Loan Co. v. Hunt), the U.S. Supreme Court defined the purpose of bankruptcy as giving “a new opportunity in life and a clear field for future effort, unhampered by the pressure and discouragement of preexisting debt.” In other words, it’s an opportunity for a financial do-over.
- If bankruptcy is the end goal, a bankruptcy discharge is a tool used to accomplish it. A bankruptcy discharge is a court order that releases a debtor from personal liability for specific debts. It legally prohibits a lender or creditor from taking any action to collect the debt in question.
Sound too good to be true? In several important ways, it is. For one, the bankruptcy shows up on your credit reports for seven to 10 years, depending on the type of bankruptcy you file, and will almost surely harm your credit scores. It also only applies to certain specific types of debts, so it’s not a catch-all remedy.
Follow along to learn more about discharged debt and whether a Chapter 7 or Chapter 13 bankruptcy might make sense for you. If in doubt, work with a qualified credit counselor or bankruptcy lawyer to ensure you make the best decision for your needs.
What is a bankruptcy discharge?
The goal of a bankruptcy is to get your creditor(s) to forgive outstanding debt, or at least put you in a position to pay off that debt according to a court-specified plan. Discharge is the legal term meaning you’re not legally required to pay the debt, and collectors can’t take any further action to collect it.
Following a bankruptcy discharge, debt collectors and lenders can no longer attempt to collect the discharged debts. That means no more calls from collectors and no more letters in the mail, as you are no longer personally liable for the debt.
A bankruptcy discharge doesn’t necessarily apply to all of the debt you owe. For example, if you owed $100,000 and get half of your debt discharged, you now owe $50,000. The type of bankruptcy you choose will determine what is discharged and what happens to other property during and after the bankruptcy process.
What's the most common type of bankruptcy?
In 2016, there were 770,846 non-business bankruptcies in the United States. Nearly 62% percent were Chapter 7, 38% were Chapter 13 and less than 1% were Chapter 11. This makes Chapter 7 the most common type of bankruptcy in the U.S. But just because it’s popular doesn’t necessarily make it right for you.
The question of “What happens to my property?” looms large in many bankruptcy cases. Although you’re not personally liable for discharged debts, a valid lien (in other words, a charge upon specific property to secure payment of a debt) can remain in place even after debt is discharged. That means a secured creditor may still enforce the lien to recover any property that is rightfully owed.
What gets discharged in a bankruptcy?
If you feel the crushing weight of credit card debt and a car loan on your shoulders, a bankruptcy might be a viable solution — assuming you understand the consequences. But if all of your debts are student loans, think twice before moving forward with bankruptcy.
These types of debts are not dischargeable according to U.S. law:
- Tax-related debts
- Most federal student loans
- Debts not included in court filings
- Spousal or child support or alimony
- Debts related to willful and malicious injuries to people or property
- Government fines and penalties
- Debts related to damages or injuries caused when driving while intoxicated
- Some retirement plan loans
- Some condo or cooperative housing fees
If you have any doubt of a specific debt, contact a qualified bankruptcy expert for personal guidance. It’s likely not a good idea to declare bankruptcy if your debts can’t be discharged.
What are some negative consequences of a bankruptcy discharge?
When you clean your financial slate with a bankruptcy, you’ll have to deal with some credit-related consequences.
A bankruptcy will remain on your credit reports for up to either seven or 10 years from the date you file, depending on the type of bankruptcy. Since your credit scores are calculated based on the information in your credit reports, a bankruptcy will affect your credit scores as well. This can make it more difficult to buy a home or a car with a loan, or even get a new apartment rental. For more information, check out our article on what happens to your credit when you file for bankruptcy.
A discharged Chapter 7 bankruptcy and a discharged Chapter 13 bankruptcy have the same impact on your credit scores, though it’s possible a lender might look more favorably on one or the other.
In some cases, bankruptcy is the right path to a clean financial slate, so you can start fresh and get rid of financial stress. Getting rid of debt collectors is a great benefit, but you may spend the better part of 10 years repairing your credit.
A bankruptcy discharge may be the right way for you to get out of debt. Consider other paths to debt freedom and financial stability, such as a debt settlement or a debt payment plan, before deciding on bankruptcy as the best way forward.