Can You Get Rid Of All Your Loans By Filing Bankruptcy?

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No, you cannot get rid of all your loans by filing bankruptcy.

It is said that the world is in a state of bankruptcy, that the world owes the world more than the world can pay.   

– Ralph Waldo Emerson

When the Lehman Brothers filed for Bankruptcy in 2008, most of the world, including their own investors and the people working for them (a 25,000-person workforce), had no clue of what was going to happen.

Bankruptcy is a common term, and we’re used to hearing it in our day-to-day life, but seldom do we take the time to review its consequences and implications. Due to relaxation in some federal and state laws, filing for bankruptcy is relatively easier today than it was a decade ago; as a result, there were about 780,000 cases of bankruptcy filed in the United States alone in the financial year 2018.

US constitution has separate laws governing bankruptcy. (Photo Credit: create jobs 51/Shutterstock)

Whether it’s an individual with a few mortgages or multinationals driven into debt, bankruptcies are brutal for everyone surrounding the entity filing for it; hence, one should be adequately informed regarding its rules and regulations.

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What Is Bankruptcy?

Bankruptcy is nothing but a legal term used when a person’s debts or a business corporation’s debts exceed its assets, meaning that it is no longer able to repay its loans.

To understand bankruptcy clearly, one needs to understand the terms involved with it.

Debt is the amount of money that you borrow from someone and have a legal obligation to repay. The debtor is the body that loans the money. Assets are items that have some kind of value (monetary, in most cases) and can help in the generation of money. They can be used to repay debts. Credit is the money loaned out to someone that generates interest. Hence, it is an asset, because when it is received back, it can be used to repay loans.

Bankruptcy is therefore a legal scenario in which the assets of an organization are not sufficient to meet all of its debt obligations. To protect itself from the legal actions of the creditors, the firm (or individual) files for bankruptcy.

Also Read: If All Large Countries Are In Debt, Who Do They Borrow Money From?

What Happens When You Go Bankrupt?

If you think that the feds are going to raid your house, take every possession you own, then perhaps misunderstand the concept of going bankrupt.

In the United States, there are three major types of bankruptcies, and different sets of laws mentioned under different Chapters of the United States Constitution govern each one of them. Henceforth, these bankruptcies are referred to as chapter 7, 11 etc. and have various implications.

Chapter 7 bankruptcy involves the liquidation of assets of an individual or business to repay all or part of their debts.

What happens is that the court divides the assets of the debtor into different types—‘exempt’ and ‘non-exempt’ assets. A court-appointed trustee may sell the non-exempt assets and distribute the net proceeds to creditors according to the priority’s preferences established in the Bankruptcy Code of the US Constitution.

Exempt items include cash, bank accounts, stocks and bonds, second vehicle or house, family heirlooms, valuable collectibles, expensive musical instruments (unless the debtor is a professional musician) and various other items. You can also purchase items necessary for your survival, provided you receive approval from the court.

you are telling me meme

The non-exempt property includes–tools of the debtor’s trade or profession (up to a specific value), pensions, reasonably necessary clothing and household appliances, a portion of unpaid but earned wages, and some public benefits, including social security and unemployment compensation.

Chapter 13  allows people with enough income to repay all or part of their debts over a fixed period as an alternative to liquidating their assets. This is bankruptcy for those whose most significant problem is not a lack of income, but the inability to meet the immediate payment demands of certain creditors. Only individuals can reorganize under Chapter 13. This option is not available to corporations or LLCs.

Under this option, a person generally has between 3 and 5 years to resolve his debts by applying all his disposable income to debt reduction, once the court has approved a repayment plan. However, the terms are subject to certain conditions, and if the debtor fails to meet certain obligations under the reorganization plan, the entire setup will fall apart.

Chapter 11 bankruptcy helps corporations restructure their debts, just as Chapter 13 functions for individuals. After filing for Chapter 11, the debtor may continue to run the corporation, but will do so under the jurisdiction of the court. The creditors are put into different classes, and their claims are handled accordingly.

Chapter 11 is the most flexible and thus the most sophisticated form of bankruptcy. Its success rate is very low, and one must be very careful before filing for it.

Help businessman falls - Image(By alphaspirit)s
Bankruptcy is the last resort to many (Photo Credit: alphaspirit/Shutterstock)

In January 2019, Gymboree Group Inc, a popular children’s clothing store, announced that it had filed for Chapter 11 and was closing all its Gymboree, Gymboree Outlet and Crazy 8 stores in the United States and Canada.

Also Read: What Is A Recession And What Causes One?

How To File For Bankruptcy?

Bankruptcy is not a magic word. You can’t just shout, “I’m bankrupt” and throw yourself at the mercy of the court, expecting all your problems to disappear.

bankruptcy meme

This is not how you declare bankruptcy.

Rather, it is a complicated procedure that requires hours of legal formality and a lot of paperwork.

First of all, one must have a record of all assets, debts, income and expenses compiled in the form of a list to be submitted to the court and a counselor. After this, it is compulsory to receive credit counseling 180 days before filing for bankruptcy in a US court. Once the counseling is over and all other possibilities have been exhausted, you will receive a  certificate from your counselor.

The next step is to file for a petition, along with the certificate and various other documents, to the court and decide which type of bankruptcy you want to file for. This is the step where the bankruptcy lawyers step in. Once your case is accepted, you are assigned a court trustee who takes over the proceedings from that point.

Is There An Alternative To Filing Bankruptcy?

One can always directly negotiate with creditors and settle on a payment plan that would be beneficial to both parties.

If you don’t have a knack for negotiations, don’t worry… there are companies who will handle that end of the proceedings for you. This process is called Debt Consolidation and requires a certain amount of fees to be paid to the firm representing you.

Refinancing your debt can be another option. This involves shifting your mortgage from one lender who is proving to be difficult to someone who gives you some extra breathing room. However, this would also include certain costs.

Bankruptcy: Should One ‘Go For It’?

Bankruptcies provide a great mental and emotional lift to an individual, as all debts are eliminated, and a person is given a fresh start.

However, it’s very important to understand that although bankruptcy gives you a chance to start over, it affects your credit and the ability to use money in the future. It can possibly stop or delay the foreclosure of your home or repossession of your car. It might also prevent the garnishment of your salary and other legal methods that creditors use to reclaim their debt. However, there’s always a price to pay.

Bankruptcy carries some significant long-term penalties because it will remain on your credit report for 7-10 years. Hence, a bankruptcy should be undertaken only after exploring all other options and consulting a lawyer. After all, who wants to go bankrupt!?

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References (click to expand)
  1. June 2018 Bankruptcy Filings Fall 2.6 Percent - U.S. Courts. The Administrative Office of the United States Courts
  2. State and Federal Bankruptcy Exemptions.
  3. Chapter 13 Bankruptcy - What It Is & How It Works -
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About the Author

Rajat is an undergraduate student of BTech at BITS Pilani (India). He likes all kinds of sports and has represented his college for Athletics several times. He also loves to sing and play the guitar. He enjoys watching movies and likes to read about financial management and the stock market.