First of all, a big fat disclaimer: I'm not a lawyer. Not even sort of a lawyer. What follows is based on some conversations I've had with bankruptcy lawyers, and it's limited by my memory. I asked the questions because there seemed to be some interest from my faithful readers in hearing more about the "get out of debt . . . or else" topic that came up a while back. Some had wondered what happens when you go bankrupt. Why is it so bad? After talking to several people, I discovered there seems to be some wildly differing ideas on the process, so I thought it might be useful to go over what I learned. Ready? Here we go.
Let's set the stage first. You're in debt up to your eyeballs, although maybe you've been doing a fair job of hiding it. You've got several credit cards--all maxed out--you've got student debt, two mortgages, a car loan or two, you're behind on your utilities payments, and you're basically at the point where you have to decide which bills to pay each month, based on how overdue they all are. That said, your actual life hasn't changed all that much yet. You're still buying things when you can, still living in your home, still driving your car. You're on the edge, but you haven't gone under.
Then, it happens. You have an unforeseen debt pop up. Maybe the car engine goes, or you have damage to your home, or some unexpected dental bills--but in any case, you're no longer on the edge. You're now getting phone calls from creditors, and since you were already on the edge to begin with, you start sliding into real crisis.
What can happen? For one thing, your creditors will be in a rush to garnish your bank accounts and your salary. What does that mean? It means that if you owe people money, they can contact your employer or bank and tell them, "Hey--we know you owe this person some money, but he owes us money. From now on, we want you to pay us X% of whatever he makes, or give us X% of his bank account funds." Yes, they can do this to you. Yes, they will do this to you. At this point, everyone you owe money to is realizing you're likely going to go under, and it turns into a big game of Hungry Hungry Hippos to see who can gobble up what they can while it's still there for gobbling.
Up until now, you've been able to make sure that what money you make goes to things you actually really care about: your car, or your house, or your XBox Live subscription. But once your wages start getting garnished, that freedom goes out the window. You now are forced to pay some bills, and your other creditors start gathering the torches and pitchforks to come after you, as well. You are now in real danger of losing things you really value.
It gets to the point where you really are in trouble, and there's just no way you're going to stay afloat anymore. So you start looking into filing for bankruptcy. As an individual, there are two "chapters" you can file under. Chapter 13 is where you work with a central figure to pay off a certain amount of your debt over the next three or five years, with clearly established monthly payments. At the end of that time, then you're back in the clear. It's the preferable Chapter, for the most part. Once you file, all those nasty creditor phone calls go away, and you get some protection.
Of course, if you've made it far enough to need to file for Chapter 13, chances are you really haven't learned your budgeting lessons. You make the payments required for a month or two--maybe even a year. But old habits are hard to break, and sooner or later, you start getting behind again. You miss your bankruptcy payments, and your "protection" goes away. Creditors start clamoring again, and it's time for the final step: Chapter 7.
Chapter 7 essentially consists of liquidating your assets. In order to have your debts discharged, you need You're allowed by law to keep a certain amount of money for your assets, depending on state exemptions. For example, if your state has an exemption for cars of $3000, and you have a car that's worth $10,000, then your car will likely be sold, and you will get $3000 for it, with the other $7000 going to the people you owe money to. This same principle usually applies to home equity, as well--your house can be sold, but you're entitled to a portion of that equity, depending on the state exemptions. Non-exempt property will be sold to pay back your debts. It all depends on how much you owe, how much you own, and how it will be handled. Many Chapter 7 filings end up not selling off any property, because it's all under the exemption threshold.
In Maine, $5000 of a single car is exempt; $47,500 of a home if you have no dependents; $95,000 of a home if you do. You can find all this information online.
Anyway, it's more complicated than I'm making it, but hey--I'm not a lawyer. I'm just trying to illustrate what can happen. Basically, if you're forced to file for Chapter 7, then you'll emerge from it with some money for basic house and car, and most other debts wiped clean. (Student debt, tax debt, and some other debt isn't wiped--you have to pay those back eventually) Of course, getting any credit for the next while will be difficult, and you'll pay a lot for the credit you do get. So don't expect credit cards in your near future.
What it boils down to from my perspective is that you can either choose to start living within your means now, or you will be forced to live within your means later. And for a good year or two of your life--maybe more--you will not have a very pleasant experience. Then again, this is just from what I've read. I've never gone through bankruptcy--I suppose I might be painting it as being worse than it is. Heck--maybe I'm portraying it as too lenient.
Anyone have anything to add? Any questions? Discuss away!