Filing for bankruptcy can feel like the end of the road, but in many cases, it is a much-needed fresh start. However, not all debts are treated equally in the bankruptcy process. If you’re considering bankruptcy or want to better understand its effects, this article dives into how different types of debt are impacted and what relief, if any, may be available.
Types of Bankruptcy
Before exploring how bankruptcy affects various debts, it's important to understand that there are different types of bankruptcy filings. The two most common for individuals are:
Chapter 7 Bankruptcy (Liquidation Bankruptcy) - This involves selling off non-exempt assets to pay creditors. Once the assets are distributed, most remaining unsecured debts are discharged.
Chapter 13 Bankruptcy (Reorganization Bankruptcy) - This allows debtors to keep their assets and repay their debts over three to five years based on a court-approved repayment plan.
The type of bankruptcy you file can significantly impact the way your debts are handled.
Secured vs. Unsecured Debt
A critical distinction in how debt is treated during bankruptcy is whether it is secured or unsecured:
Secured Debt: Backed by collateral, such as a home mortgage or car loan. If you fail to make payments, the lender can seize the collateral.
Unsecured Debt: Not tied to any specific collateral. Credit card debts and medical bills are common examples.
How Bankruptcy Affects Different Types of Debt
1. Credit Card Debt
For most individuals, credit card debt makes up a substantial portion of unsecured debt. Under Chapter 7, this debt is generally discharged, meaning you are no longer legally required to pay it. In Chapter 13, you may repay a portion of this debt through your repayment plan, with any remaining balance discharged at the end of the repayment term.
Important Note: Charges made on credit cards shortly before filing for bankruptcy, especially luxury purchases or cash advances, may not be dischargeable.
2. Medical Debt
Medical debt, another common unsecured debt, is treated similarly to credit card debt. In a Chapter 7 filing, it is typically discharged. In a Chapter 13 filing, it will be included in the repayment plan. Given the unpredictable nature and potential for high balances of medical debt, bankruptcy can provide significant relief for individuals facing overwhelming healthcare expenses.
3. Personal Loans
Personal loans without collateral are unsecured and are treated much like credit card debt. These debts can be discharged through Chapter 7 bankruptcy or partially repaid via a Chapter 13 plan. However, if a personal loan is secured—such as a car loan secured by the vehicle—it will be treated as secured debt.
4. Mortgage Debt
Mortgages are a type of secured debt. If you file for Chapter 7 bankruptcy and are behind on your mortgage, the lender can proceed with foreclosure despite the bankruptcy filing unless you reaffirm the debt (a legal agreement to continue paying). Chapter 13 bankruptcy, however, offers a chance to catch up on missed payments over the life of the repayment plan, potentially saving your home from foreclosure.
5. Car Loans
Car loans are another type of secured debt. In Chapter 7 bankruptcy, if you wish to keep your vehicle, you must continue making payments and may need to reaffirm the loan. In Chapter 13 bankruptcy, you can include your missed payments in the repayment plan, and sometimes, you may be able to reduce the principal balance owed (a process called “cramdown”) if your loan meets specific criteria.
6. Student Loans
Student loans are notoriously difficult to discharge through bankruptcy. In most cases, they are considered non-dischargeable unless the debtor can prove that repaying the debt would impose an “undue hardship.” This standard is challenging to meet and often requires extensive documentation and legal proceedings.
7. Tax Debt
Most tax debts are non-dischargeable, meaning you cannot eliminate them in bankruptcy. However, certain older tax debts may be eligible for discharge under strict conditions, such as being more than three years old, filed on time, and assessed at least 240 days before filing.
Chapter 13 bankruptcy can offer relief by structuring a repayment plan for tax debt, potentially reducing penalties and interest.
8. Child Support and Alimony
Obligations for child support and alimony are considered priority debts and are not dischargeable through bankruptcy. You must continue making these payments as agreed, regardless of the type of bankruptcy you file.
9. Court Fines and Criminal Restitution
Debts incurred through court fines or criminal restitution cannot be discharged in bankruptcy. These debts must be paid as directed by the court, regardless of the outcome of the bankruptcy process.
What About Cosigners?
If a debt has a cosigner, filing for Chapter 7 bankruptcy may leave the cosigner responsible for the remaining balance. In Chapter 13, however, cosigners receive some protection as long as the repayment plan remains active and in good standing.
Making the Right Decision
Bankruptcy is a complex and challenging process that can provide relief, but it is not a one-size-fits-all solution. It’s crucial to understand how your specific debts will be affected to determine the best course of action.
Need Help Navigating Bankruptcy?
At The Law Office of MaryBeth Schroeder, our experienced bankruptcy attorneys are here to guide you every step of the way. From understanding which debts, you can eliminate to developing a tailored plan for financial recovery, we provide compassionate and expert legal support. Give us a call at 732-228-7400 for a free consultation to see how we can help you find a fresh financial start.
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