What Does Bankruptcy Mean?

Bankruptcy means that you have been granted legal protection from your creditors. A successful bankruptcy proceeding either wipes the slate clean or provides you with an extended repayment plan.

Bankruptcy is a term that’s often used but that has a specific legal meaning. The U.S. Constitution authorizes Congress to create bankruptcy laws, and Congress has done so through U.S. Code Title 11. Congress amended the U.S. Bankruptcy Code by passing the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), which was signed into law by President George W. Bush.

What Does it Mean to File for Bankruptcy?

Filing for bankruptcy means that you have debts that you aren’t able to repay and that you wish to ask the court to relieve your debt burden. There are five different types of bankruptcy, but only two are applicable to personal debt:

  • Chapter 7 strips the consumer of most assets and wipes out most types of debt.
  • Chapter 13 enables the consumer to retain certain assets and sets up a repayment plan.

Typically, Chapter 7 bankruptcy is available to consumers who have little income and few assets, while Chapter 13 bankruptcy often works best for consumers who have higher income and significant assets.

The Role of BAPCPA

When Congress amended the Bankruptcy Code in 2005, it dramatically restricted Americans’ ability to access the bankruptcy process. Since that change, consumers can only file for Chapter 7 bankruptcy if their monthly income falls below the median income of those in their state or if they are able to pass a “means test.”

The means test takes into account a variety of monthly income deductions that are defined by the Internal Revenue Service. The deductions that are part of the means test include pre-defined living expenses, actual health insurance expenses, allocations for each minor child, contributions to charity, and a small percentage of secured and priority debt.

If a consumer is ineligible to file for Chapter 7 bankruptcy and does so anyway, then there is a presumption of abuse and the case will either be dismissed or converted to Chapter 13.

Other Implications of Filing Bankruptcy

If you decide to move forward in filing bankruptcy, you are first required to receive credit counseling. Prior to your debts being discharged at the conclusion of your bankruptcy proceeding, you are required to complete a class in personal financial management.

Bankruptcy also has implications for your ability to borrow money. A completed Chapter 7 bankruptcy will remain on your credit report for ten years, while a Chapter 13 bankruptcy will remain on your credit report for seven years. However, the impact of the bankruptcy on your credit score will lessen over time.

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