Is personal bankruptcy -- filing Chapter 7 -- the right solution for you? For millions of debt-ridden people, it's the only way out of their financial quagmire. Today's high level of unemployment is resulting in waves of desperate folks seeking shelter under Chapter 7 of the U.S. bankruptcy code.
Here's a shocking statistic to put the current financial environment in perspective: 1,512,989 people filed for bankruptcy in the 12 months ending June 30, 2010, a +21% increase from the 12 month period ending June 30, 2009. That's more people than the populations of any of these 10 states: New Hampshire, Maine, Hawaii, Rhode Island, Montana, Delaware, South Dakota, Alaska, North Dakota or Wyoming. It's also the most bankruptcies filed for any period following the Bankruptcy Prevention Act of 2005.
However, before you take the drastic step of filing under Chapter 7, you need to be fully apprised of the potential pitfalls. Here's a look at a few nasty surprises that may await you:
Bankruptcy laws vary from state to state.
Every state has its own peculiarities and exemptions; some state laws are more generous than others. Some states allow exemptions to shelter your automobile, household goods, Individual Retirement Accounts (IRAs), etc. Other states are more restrictive. Before you file for bankruptcy, do some homework to find out the laws applicable to your home state.
Mortgages and any other secured loans are not eliminated.
Bankruptcy is designed to get creditors off your back, so you can get some breathing room to right yourself. Certain types of unsecured debt (e.g., credit cards) can be wiped off the books. However, to the consternation of many who file for bankruptcy, the laws don't allow you to just walk away from your mortgage or any other secured loan (any loan in which you've pledge some kind of "collateral" -- like your car or your home -- for the loan). Bankruptcy only keeps those payments at bay until you have dealt with other creditors.
Any cosigners of any collateral are in the same boat with you.
Likewise, if any of your collateral involves consignors, your cosigners won't be able to emerge out of debt with you. They will be liable for part or all of the debt you discharge through bankruptcy.
Bankruptcy is reported on your credit report for 10 years.
Bankruptcy is like a Scarlet Letter that follows you around for a decade. The good news is that within this time frame, you can still re-establish a good credit rating, through frugality and paying off your debts in a timely fashion.
Bankruptcy does not wipe out withholding or sales taxes.
It's possible to get rid of old income taxes that are more than three years old, but this benefit has given rise to a myth that you also can eliminate withholding or sales taxes. This is not possible, no matter how old the taxes.
You can't cherry pick the debts and property to list in your bankruptcy.
Many people seem to think that they can go through their portfolio of possessions and pick and choose what they want to list in the bankruptcy. They're shocked when they discover that it's all fair game. When you file bankruptcy, the law mandates that you list all your property and debts.
Bankruptcy does not allow you to cease payment on child support or alimony. Sorry, but you still need to write those checks. Although divorce is one of the most common causes of bankruptcy (click here to see the Top Causes of Bankruptcy...And How to Avoid Them), your agreement is not affected by a Chapter 7 filing. So, if you're thinking that you can wiggle out of those responsibilities, think again.
Declaring bankruptcy does not get you off the hook on student loans.
Your student loan payments still need to be made. They can't be wiped out, as with a credit card balance.
You must still fear the repo man.
A bankruptcy discharge doesn't eliminate liens. A secured debt is a debt where the creditor has a lien on your property and can repossess it if you don't pay the debt. Bankruptcy can wipe out the debt, but it still doesn't prevent the secured creditor from repossessing your property.
Read on to get more information on what Chapter 7 is (and isn't) in our Investment Terms Dictionary. And if you want to see some advice on how you can avoid the same fate as these three bankrupt sports stars, click here.