What is bankruptcy?

Bankruptcy is the process where a person legally declares himself or his company unable to pay outstanding debts. Depending on the type filed, you meet with a judge to determine a payment schedule, or you have a bankruptcy filing for most, if not all, debts. Companies can also declare bankruptcy, which means the company will go out of business or continue to operate with reduced payments to debtors. Each country has its own designations, but this explanation will focus on the most common types in the United States.

Bankruptcy for the individual or couple or domestic partner is filed in three forms, called "Chapters". Chapter 7 is the most common form filed by spouses or individuals. Chapter 12 is restricted to people who are family farmers or fishermen. Individuals or couples can also apply for Chapter 13, but this is rare.

For businesses, the two common forms of bankruptcy used are Chapter 7 and Chapter 11. Less commonly, an individual or company can file a Chapter 15 claim, which involves settling international debts. If a state agency, such as a city, needs to declare bankruptcy, it files Chapter 9, which is also called municipal bankruptcy.

Chapter 7 tends to be used by individuals or companies who want a squeaky clean slate. As a result, a company that files Chapter 7 tends to close its doors. For the individual, this type means that the courts declare that debts incurred cannot be repaid, and almost all debts are cancelled. Certain federal debts, such as student loans, are not affected by filing for bankruptcy.

In general, it must be shown that the income is not enough to cover the debts. A person filing Chapter 7 risks losing most assets with this type of bankruptcy. A vehicle or primary residence will not be lost under this form unless the person has an auto loan and cannot make payments on the vehicle, or a mortgage loan, which they cannot pay.

All assets must be reported when filing Chapter 7. Other assets such as second homes, collectibles and additional vehicles are liquidated to pay debt. Most of those who file Chapter 7 do so because they have very little to lose. Once a judge approves the request, virtually all debts, such as those owed to credit card companies and to doctors or hospitals, are erased and the person is given a clean slate.

Chapter 13 bankruptcy is filed by people who own a large amount of property or assets but find that their income cannot cover the exorbitant debt payments. In this way, debt is restructured and, in some cases, reduced so that people keep their assets but have reasonable payments they can make to debtors. In general, court-ordered payments must be made on time and regularly to avoid seizure of assets.

Companies fill out a similar form called Chapter 11. Part or part of the company's debt can be paid off and payment plans are restructured. Chapter 11 is intended to reorganize the debt so the company can continue operating.

All forms are expensive means of getting debt relief. Both individuals and businesses experience a drop in their credit scores after a bankruptcy. Individual bankruptcy stays on a person's credit report for 10 years, which can make approving new cars, houses, or credit cards expensive and difficult.