Types of Bankruptcies: Complete Guide for Individuals and Businesses

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If you’re having debt management problems, bankruptcy can help. Understanding how bankruptcies work and the types of bankruptcies available to you will help you decide whether this is a viable option for getting your finances back on track.

What Is Bankruptcy and How Does It Work?

Bankruptcy is a court proceeding that helps you get out of debt you’re unable to repay. It begins when you file a petition with the bankruptcy court, either on your own or with your spouse. You can file the petition for personal debt or for debt acquired by your business.

As the U.S. Courts website explains, a judge presides over bankruptcy cases, sometimes with the assistance of a trustee appointed by the court to handle the administrative aspects of the case.

Depending on the type of bankruptcy you file, and with the court’s approval, one of two things might happen:

• The trustee will sell your assets and pay the proceeds to the creditors. The court will then discharge the debt, meaning you’re no longer responsible for it.
• You’ll present a plan to repay the creditors over several years. After this, the court will discharge the debt.

The law doesn’t require you to use an attorney to file a bankruptcy petition, but the U.S. federal court system strongly recommends that you do.

Good To Know

The law limits the types of debt you can have discharged through bankruptcy.

Tax, child support, alimony and government-backed loans are all ineligible for discharge.

The 3 Most Common Types of Bankruptcies for Individuals

Individuals and couples with unmanageable debt generally can file for one of three types of bankruptcies.

Chapter 7 — Liquidation

Chapter 7 is where the trustee sells your or your businesses’ assets in order to reimburse your creditors for some or all of the debts you owe.

You might qualify for Chapter 7 bankruptcy if:

• Your monthly income is less than the median in your state for a family the same size as yours.
• The court agrees that your disposable income is insufficient to repay some of the debt.

Most people apply for this type of bankruptcy, according to the legal website Nolo. Chapter 7 provides a clean slate — most collection activities are stopped, and your eligible debt is discharged in its entirety even if the liquidation doesn’t cover the full amount you owe.

It’s important to note that bankruptcy laws protect certain assets from liquidation in a Chapter 7 bankruptcy. These protected assets are called exceptions, and they include Social Security benefits, certain tax-exempt retirement accounts and a portion of your equity in your home.

Chapter 13 — Repayment Plan

If you don’t qualify for Chapter 7, you can file for Chapter 13 bankruptcy instead, as long as you have earned income and your debt falls below these limits:

• $526,700 in unsecured debt, such as credit card debt
• $1,580,125 in secured debt, such as a mortgage or car loan

Chapter 13 bankruptcy differs from Chapter 7 bankruptcy in that it doesn’t wipe the slate clean. Instead, it lets you work with the courts to set up a fixed monthly payment plan so that you can resolve your debts within a three-to-five-year span.

Taking this route helps you to keep your assets rather than turn them over to the courts for liquidation. In addition, filing for Chapter 13 bankruptcy prevents creditors from moving forward with foreclosure and other collections activities as long as you make your scheduled payments.

Chapter 11 — Business and High-Asset Cases

If it’s business debt that you’re struggling with, or your personal debt exceeds the limits allowed with a Chapter 13 bankruptcy, Chapter 11 bankruptcy might be a good alternative.

Chapter 11 reorganizes your debt so you can keep your assets. It also allows you to stay in business and, with the court’s permission, borrow money while you’re in bankruptcy.

This type of filing can be much more complex than Chapter 7 or Chapter 13 and generally requires the help of an attorney to complete.

Types of Bankruptcies: At a Glance

Here’s a side-by-side look at the three most common types of bankruptcies for individuals and businesses.

Less Common Types of Bankruptcy

Several different types of bankruptcies are available for less common circumstances.

• Chapter 9 bankruptcy: Lets municipalities, including counties and school districts, reorganize or refinance debt.
• Chapter 12 bankruptcy: Allows family farmers to repay personal and farm debt.
• Chapter 15 bankruptcy: Facilitates liquidation or reorganization of debt on assets located in the U.S. but owned by a foreign debtor involved in a bankruptcy case located outside of the U.S.

How To Know Which Type of Bankruptcy Fits Your Situation

Bankruptcy can have serious financial implications. For example, you might see a major decline in your credit score after bankruptcy. With a Chapter 7 or Chapter 13 bankruptcy, you might not be able to borrow money or use credit for several years.

Knowing which type is best for your situation will help you minimize the consequences.

Here’s what to consider:

• How much debt you have: Chapter 13 bankruptcy has limits on secured and unsecured debt.
• Type of debt you have: Chapter 11 and Chapter 13 preserve your assets, so they might be better for secured debt like for a home or car.
• Whether you’re filing personally or for your business: Individuals typically file for Chapter 7 or Chapter 13 bankruptcy. Chapter 11 is more common for business planning to remain in business.
• Whether you can afford to make payments: You’ll need enough income to stick with your payment plan under Chapter 11 and Chapter 13 bankruptcies.
• Need for access to credit before your debt is discharged: Chapter 11 allows debtors to borrow with the court’s permission.

Pros and Cons of Filing for Bankruptcy

Bankruptcy has benefits and risks you should be aware of before you file.

Pros of Filing for Bankruptcy

• Provides a clean slate or affordable repayment plan
• Usually stops foreclosure and other collections activities
• Tax benefits compared to other types of discharged or forgiven debt

Cons of Filing for Bankruptcy

• Doesn’t apply to all types of debt
• Could force you to give up your home and other assets
• Can damage credit for up to 10 years

What To Try Before Declaring Bankruptcy

Bankruptcy has serious long-term consequences, and not everyone qualifies. Always consider alternatives before filing a petition.

• Payment arrangements with your creditors: Creditors might be willing to reduce your interest rate or temporarily lower or suspend your payments to give you time to catch up.
• Credit counseling: A nonprofit credit counseling agency can negotiate repayment plans with your creditors to make payments more affordable.
• Debt consolidation: If your credit is good enough to qualify, and you have high-interest debt, consider taking out a lower-interest debt consolidation loan to repay it.
• Debt settlement: Debt settlement lets you settle your debt for less than you owe. This is a risky and potentially expensive strategy that can be as or more financially damaging than bankruptcy.

Final Takeaway: Know Your Bankruptcy Options Before Filing

Bankruptcy could be the best solution to get out of overwhelming debt you can’t repay. It’s always wise to work with an attorney who can advise you about the options for your specific situation and their potential consequences, but the more you know going in, the faster you can be on your way to getting out of debt.

Stacey Bumpus contributed to the reporting for this article.

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