Personal bankruptcy is a debt relief tool to let people to discharge debt in order to restart and rebuild financially for the future. However, over the years a number of myths have surfaced regarding the consequences of filing for bankruptcy, and some of these myths may even be stopping a person from filing when it really is needed.
To start, there are two different types of personal bankruptcy: a Chapter 7 and a Chapter 13. Under a Chapter 7 bankruptcy a person’s assets are sold off in order to pay creditors. However, in order to file for Chapter 7 a person must prove eligibility through a bankruptcy means test that looks at income and deductions. Often times those who do not qualify for Chapter 7 – or those who just in general have a lot in assets – will file for a Chapter 13 bankruptcy, which is when a person can hold on to their assets and set up a repayment plan with creditors.
The differences in these types of filings is important because it shows that a person with significant assets – like a house – will not lose their home because he or she will most likely file for Chapter 13, which is when the payment plan is set up.
It’s also important to realize that in the case of a Chapter 7 not all assets are sold and that there are certain assets that are exempt from being sold, like 401(k) plans and IRAs. However, it should be noted that if a person takes the money out of these retirement accounts before filing, the money that was taken out must then be included in a bankruptcy filing. This means that if a person is struggling financially, taking out retirement funds to avoid bankruptcy is not always the best option if there is a chance that a personal bankruptcy may still happen in the future.
Overall the bottom line is that filing for a personal bankruptcy is a way to help people, not hurt them. However – like any debt relief solution – there are different outcomes between filing for a Chapter 7 or Chapter 13, and deciding which option is the best will vary depending on a person’s current financial situation.
Source: Investopedia, “5 Myths About Personal Bankruptcy,” Angie Mohr, 5 May 2011