A BAD TURN in life can send someone quickly into a black hole of debt. Although bankruptcy should be looked at as a last resort, sometimes Chapter 7 or Chapter 13 protection is a debtor's best chance of recovery.
More than 1.6 million people filed for personal bankruptcy in 2003, a 5.6 percent increase from 2002 and double the number of filings a decade ago, according to the American Bankruptcy Institute.
A layoff, poor budgeting or a medical emergency are common reasons people fall into financial distress, said David Johnson at the Consumer Credit Counseling Service of Los Angeles. His average debt management client has eight credit cards.
There are two major options in bankruptcy filings. Chapter 13 reorganizes your finances and sets up a payment schedule without forcing you to use your assets, such as your house or car, to pay your bills. Chapter 7 cancels most debts, with some exceptions, including child support obligations and student loans.
But Chapter 7 doesn't necessarily mean walking away from your problems. A court-appointed bankruptcy trustee's job is to collect everything that is collectible, or non-exempt. The more your creditors get paid, the more the trustee gets paid. Trustees collected assets in about 4 percent of the Chapter 7 bankruptcy cases that closed in 2003.
What property is exempt depends on where you live. Exemptions can include equity in your home and car and public benefits like welfare and Social Security. Florida, Texas and the District of Columbia are especially lenient, as court trustees there cannot touch your house, no matter how much it's worth.
Chapter 7 may sound like a good way to start fresh if you have more debt than you can handle. But be careful. Getting yourself off the hook may put someone else on the hook, such as anyone who co-signed a loan for you. Also, a bankruptcy filing stays on your credit report for up to 10 years, which can affect your ability to take out a mortgage, rent an apartment or get a job.
You may decide Chapter 7 is right for you, but a bankruptcy judge might decide that your income is sufficiently higher than your expenses, and that discharging your debts would be "substantial abuse" of bankruptcy laws. The judge may dismiss your case or ask you to convert it to a Chapter 13 bankruptcy. In 2003, 28.5 percent of bankruptcy filings were Chapter 13 filings.
In Chapter 13, you don't lose your assets. Instead, you have three to five years to pay off your debt with your disposable income. Chapter 13, like Chapter 7, triggers what's called an automatic stay. So creditors can't seize your house or car or empty your bank account.
But just because you're broke doesn't mean you should file for bankruptcy. Doing nothing while you try to get back on your feet is another possibility. If you don't make much money and have very few assets, and you don't expect to earn more money in the future, you may be judgment-proof.
Creditors, however, can make a claim on any property you acquire in the future, said Roger Whelan, a former bankruptcy judge and now resident scholar at the American Bankruptcy Institute.
You also can try negotiating directly with your creditors to buy yourself time. Credit counselors can help you if you don't have the stomach to approach creditors directly. Just be careful to work with a counselor who is reputable. A good place to find a counselor is through the National Foundation of Credit Counselors.
If you file for bankruptcy, Whelan advises getting an attorney. Most cities have clinics where lawyers offer services free to people who qualify.
E-mail Julie Claire Diop at firstname.lastname@example.org.