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what is bankruptcy

What Is Bankruptcy? - All Things That You Should Know

Updated on December 8, 2022


Bankruptcy is not just another financial process. It is a serious decision and can affect your economic life. However, you shouldn't consider it a failure if you're willing to give yourself a fresh financial start.

From professionals to business owners, bankruptcy can happen to anyone for many reasons. According to data provided by the Administrative Office of the U.S. Courts, 413,616 bankruptcies were filed in 2021, out of which 14,347 were business filings, and 399,269 were non-business bankruptcy filings. Though there's a sharp 24% drop in the total number of bankruptcy cases filed in 2021 compared to 2020, it wouldn't be wrong to say that filing for bankruptcy is quite common in the U.S.

While it's possible to bounce back from bankruptcy, it's crucial to understand the repercussions of doing so before you travel down that difficult path. Essentially you should never rush into the decision to file for bankruptcy. It's vital to examine the benefits and drawbacks of bankruptcy, its alternatives, the cost of filing, and a lot more.

This article will outline everything you need to know about bankruptcy to ensure it's the best option for your financial situation.

What Is Bankruptcy?

Bankruptcy is a legal process for individuals and organizations who are no longer in a position to pay their outstanding debts or obligations. Most often, the process is initiated with a petition filed by the debtor, but a creditor can also file for bankruptcy of a debtor, which is an infrequent occurrence. As a debtor, you can file a petition in U.S. Bankruptcy Court to release you from debt and allow you to start your financial life with a clean slate.

What Are Contributing Causes Of Bankruptcy?

Many people can have different stories to tell about how they became bankrupt. A few former U.S. presidents have also considered filing for bankruptcies in the past. Therefore, it's said that defaulting can happen to anyone and can result from unforeseen events or as a consequence of bad financial decisions you may have made.

Here are the common reasons people consider bankruptcy filing:

Causes of bankruptcy: Job loss

Job Loss

The loss of money from a job can be distressing, whether it's caused due to a layoff, termination, or resignation. In such a situation, not having an emergency reserve to draw from only makes things worse. Those who cannot obtain a similar job for an extended period and make up for their lost income may not afford to pay their debts.

Causes of bankruptcy: Medical expenses

Major Medical Expenses

Medical bankruptcies are the most common in America. They occur when consumers are forced to declare bankruptcy due to the unbearable cost of medical treatments. Medical expenses from uncommon or severe illnesses or accidents can rapidly run into thousands of dollars, wiping out all the savings in months and leaving bankruptcy as the only remaining viable option.

Causes of bankruptcy: Spending too much

Living Beyond Means

Overspending or living beyond your means can potentially contribute to bankruptcy. Regularly maxing out your credit cards on shopping trips or going overboard on the family food budget can mean you're overspending. Contrary to situations like losing a job or medical emergencies, which you may not be able to prevent, how to spend money is something you can control.

Causes of bankruptcy: Expensive mortgage

Expensive Mortgage

A foreclosure commonly occurs due to an inability to make mortgage payments. To avoid the risk of losing their house, people file for bankruptcy when they realize paying for a mortgage is not possible. Such a situation may arise if you buy a more expensive home or take out a high-interest mortgage loan than you can handle. A job loss could also be an underlying cause of the inability to manage your household debt.

Apart from the above four reasons, other causes like divorce and student loan debt can force people to file for bankruptcy. Knowing how to consolidate debt can help you avoid bankruptcy costs if you have too many debt payments to make at once. On the other hand, if bankruptcy is the only option you are left with, let's learn how the process of bankruptcy works.

How Does Bankruptcy Work?

To file for bankruptcy, you must complete credit counseling from an approved agency 180 days before your filing date. After completing the counseling, you can submit a petition to the bankruptcy court in your judicial district. You have two options when filing for bankruptcy: you may do it yourself, or you can hire a lawyer, which most experts believe is the wisest option to take.

Federal courts in the United States handle all bankruptcy cases. The court can decide whether to accept and proceed with your claim or reject it. When a bankruptcy case is filed, a trustee is typically appointed. The trustee is an officer appointed by the United States Trustee Program of the Department of Justice who represents the debtor during the proceedings. This is because there's usually very little to no direct contact between the debtor and the judge. All of the debtor's documents are reviewed by the trustee. Based on the type of bankruptcy applicable, the trustee is legally obligated to the creditors and repay as much outstanding debt as possible from the debtor. If the court finds that the person or company has enough assets or is capable of paying its obligations, the court can dismiss the bankruptcy case.

Once the court decides to discharge a debtor's debts, the person is no longer legally bound to pay any outstanding financial obligation listed in the order. Additionally, once the discharge order is in effect, no creditor listed on the discharge order is permitted to carry out any collection activity from the debtor.

It is important to note that not all debts qualify to be discharged, like tax claims, child support or alimony payments, obligations to the government, personal injury debts, and anything that was not shown in the records by the debtor. Any secured creditor may continue to enforce a lien on the debtor's property as long as the lien is still legal.

Steps For Filing Bankruptcy

Causes of bankruptcy: Complete credit counciling

Complete credit counseling within 180 days before filing

Causes of bankruptcy: get records

Compile all your financial records

Causes of bankruptcy: Meet your trustee

Select and meet your Bankruptcy trustee

Causes of bankruptcy: File with the court

File for bankruptcy

Causes of bankruptcy: Fulfill obligations

Fulfill your obligations based on the type of bankruptcy

Causes of bankruptcy: Be debt free

Your eligible debts are discharged, and you are debt free

What Are the Types of Bankruptcy?

In the United States, filings for bankruptcy usually fall under one of the six common chapters of the Bankruptcy Code. A brief description of the six types of bankruptcy is given below:

Chapter 7: This type of bankruptcy allows individuals and, in some cases, businesses to get rid of their unsecured debts, such as credit card balances and medical bills. A court-appointed trustee may sell your nonexempt assets like family heirlooms, stocks, or bonds and use the net proceeds to repay some or all of your unsecured debts.

Chapter 9: This chapter applies to municipalities and other political subdivisions such as airports, hospitals, school districts, etc. It helps create a plan to settle the debt between the city and its creditors.

Chapter 11: Businesses aim to reorganize their complex debt structures when they file bankruptcy under Chapter 11. Some companies have also filed for Chapter 11 bankruptcy and continued to stay open and become once again profitable.

Chapter 12: This type of bankruptcy safeguards the interest of family-run farms or fishing businesses in financial distress. It enables them to discharge their debts by proposing and carrying out a plan to repay their debts over three or five years.

Chapter 13: Also referred to as wage-earner's bankruptcy, this type of bankruptcy enables individuals with regular paychecks to restructure their debt and repay a portion or all of the money they owe to their creditors.

Chapter 15: Added to the code in 2005, if international bankruptcy filings impact financial interests in the United States, Chapter 15 bankruptcy facilitates cooperation between U.S. courts and foreign courts.

Pros and Cons of Filing for Bankruptcy

Pros of Bankruptcy

Cons of Bankruptcy

It helps eliminate or decrease debt for persons struggling to make ends meet, depending on the type of bankruptcy filed.Bankruptcy affects your credit score for up to 10 years, making it difficult for you to qualify for a loan, any lines of credit, and even jobs.
Creditors are prohibited from taking legal action against you until your bankruptcy is discharged because of the automatic stay clause of bankruptcy law.Depending on the type you file, there's a risk of your home and automobile, among other vital possessions, being forfeited in bankruptcy.
Bankruptcy can be considered a second chance to manage your finances better.Getting a mortgage after bankruptcy can be difficult; even if you get one, the interest rates will be higher.
You can prevent creditors from temporarily repossessing a car or foreclosure.If friends and family members co-signed loans, they might be held responsible for paying back creditors in the event of bankruptcy.

How Much Does It Cost To File for Bankruptcy?

Though bankruptcies are essentially for people or businesses drowning in debt, filing for bankruptcy can cost you a lot of money. If you don't qualify for legal aid, the cost of filing for bankruptcy ranges generally between $1,000 and $2,000. According to the National Bankruptcy Forum, a Chapter 7 bankruptcy costs $1,250.

Bankruptcy costs mainly include attorney fees and filing fees. You can check the American Bar Association for information if you need assistance finding a reasonably priced bankruptcy attorney or free legal services. You can save money on attorney fees if you file on your own. However, your prospects of success might significantly decrease if you prepare and submit your bankruptcy case while paying filing fees that are usually substantially high.

Although declaring bankruptcy may be the most incredible way to escape crippling financial obligations, you may want to consider some of the alternatives to bankruptcy before making your final decision:

  • Without entering the courts, you can negotiate and reach an agreement with your creditors that benefits both parties. Some creditors may agree to a repayment plan that lowers your debt rather than taking the chance of obtaining nothing.
  • In case of an inability to make mortgage payments, you can speak with your loan servicer and ask about a forbearance or loan modification as an alternative to filing for bankruptcy.
  • You can use a debt consolidation loan with a lower interest rate to help you combine multiple debt payments into one monthly payment and save money.
  • A debt management plan often provided by non-profit credit counseling groups can be an alternative to bankruptcy if you want to pay off high-interest credit card debt and get your debt under control through financial planning and budgeting.

Getting a Loan After Bankruptcy

Getting loan approval with favorable terms may be challenging soon after the debtor receives a discharge order from the court. However, your options aren't entirely gone. Some lenders are ready to work with individuals or businesses who have had bankruptcy or other challenging credit occurrences in the past. Getting a personal loan after bankruptcy can help you pay any urgent bills.

Additionally, new information is valued over outdated information by credit scoring models. Therefore, even though the bankruptcy is still listed on your credit report, with good credit practices after filing for bankruptcy, your credit score will gradually improve.

Is Bankruptcy Right for You?

It's always beneficial to educate yourself on the consequences of a procedure before you begin, and the same applies to bankruptcy. This is why the first step before you file for bankruptcy is to seek credit counseling. Bankruptcy might seem the right way to restart your financial journey, but not everyone is eligible.

Considering bankruptcy costs and all the other alternatives to bankruptcy, if bankruptcy seems like the only option, then go for it. Over the years, bankruptcy is losing some of the stigmas it formerly had. Getting a second opportunity with bankruptcy is not bad if you treat the process respectfully and take advantage of it by making better financial decisions.

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Harita Solanki

Harita Solanki is a passionate advocate for personal finance and believes in empowering individuals to take control of their financial lives.

Her expertise covers a wide range of personal finance topics, including budgeting, saving, credit, debt management, and retirement planning.

With over six years of dedicated experience in the finance industry, Harita has helped countless readers of CASH 1 Loans make informed decisions and achieve their financial goals.

As a dedicated writer, Harita has contributed to numerous financial publications, sharing her knowledge and insights to help readers navigate the complexities of personal finance.

Her writing style is approachable, concise, and tailored to the needs of everyday individuals looking to improve their financial well-being.