What is Bankruptcy?

A Birdseye View

When a person’s debt becomes so overwhelming that they are not able to pay or even maintain the debt, the word “Bankruptcy” starts popping up in our mind. But many of us have only a vague idea of what bankruptcy is. Today I wanted to share some basic information about what bankruptcy is.

A bankruptcy is an application of a set of state and federal laws that work together. By using these laws, a person may eliminate many of their debts. This may give them time to either refinance and pay their debts, or, discharge their debts altogether.

There are different kinds of bankruptcies that apply to people.

  1. Chapter 7 Bankruptcy – also known as a “liquidation bankruptcy”
  2. Chapter 13 Bankruptcy—also known as a “reorganization bankruptcy”

Here are some examples:

Chapter 7

With a liquidation bankruptcy, the individual turns over the non-exempt assets to the trustee to be sold and used to pay off the debt. Examples of non-exempt assets might be luxury items such as a bass boat, a yacht, or a vacation home.

If a person does not have any assets like that, then there is nothing to be sold. The debts may still be discharged. Whatever doesn’t get paid by the sale of non-exempt assets may get wiped out.

Chapter 13

With a reorganization bankruptcy, typically a person wants to refinance things like a mortgage on a house or they might want to refinance on a car. The payments may be spread out over a period of time. The debtor would pay for those important debts, and whatever they cannot afford may be wiped out.

For a Chapter 13 bankruptcy, there are various ways where a person may reduce or find a way to afford the debts that are important.

  • A person may surrender unwanted items such as a broken-down car, and surrender them to the bank or car dealership, thereby relieving themselves of having to pay for those things.
  • A person may refinance something. Suppose you had a truck that you’ve been paying for years, but that note is really high because trucks are expensive. If you can spread that note out for up to a 5-year period, many times that can reduce the monthly payment for the truck.
  • A person may cram down the debt. In other words, pay for what the value is for the vehicle/collateral, not necessarily what you owe on the vehicle.
  • A person may change interest rates. Credit cards carry a stiff interest rate (between 18-29%.) But some debts are extremely expensive. Title loans charge horrendous interest rates. (300-400%). Even worse are payday loans. Interest rates on these can sometimes reach up to 400-500% interest. The monthly payment alone on those notes is about as much as the amount that they originally borrowed.

We will discuss Chapter 7 and Chapter 13 bankruptcies more in-depth in later posts. I hope this was a helpful first look at these kinds of bankruptcies.