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Effect of Bankruptcy on Individuals

Bankruptcy can have both positive and negative effects on an individual.  The positive effect is that the bankruptcy proceeding will prioritize debts and pay creditors in order of priority using the debtor’s nonexempt assets.  After those assets are used, any remaining debt is discharged.  After the debt is discharged, the debtor is no longer personally liable for those debts and creditors may not take any further action to pursue collection of those debts.  Discharge is not automatic in all cases and some debts cannot be discharged at all.  Also, if debt is secured with a piece of property, the creditor may still foreclose on the property.  Any debtor guilty of misconduct during the course of the bankruptcy will be denied discharge.

Some of the debts that cannot be discharged include certain taxes and fines, debts arising out of fraudulent acts, debts not mentioned by the debtor, alimony, maintenance and support payments, educational loans, debts arising from a willful and malicious injury, debts owed as a result of driving while intoxicated, debts that were not discharged in prior bankruptcy proceedings, and certain debts arising from obligations to banks and similar institutions.

In addition to liquidation, bankruptcy allows an individual to reorganize his or her debts in order to make those debts more manageable.  This may include a combination of reorganization and discharge.  Reorganization may include a reduction of interest owed, reduction of the principal balance owed, or both while the remainder of the debt is discharged.  Again, the above listed debts are not dischargeable under any chapter of bankruptcy.

Bankruptcy gives a debtor an opportunity to rebuild his or her credit.  However, bankruptcy does not provide a clean slate.  A bankruptcy will have an adverse effect on an individual’s credit report.  This will make it difficult to establish, or reestablish, good credit, but it is not impossible.  A Chapter 7 or Chapter 11 bankruptcy will remain on an individual’s credit report for ten years.  A Chapter 13 will remain on an individual’s credit report for seven years.  This information might affect an individual’s ability to receive credit in the future.  Although it will not be impossible to receive credit, it is common that credit will include a higher interest rate, and may require security.

A bankruptcy will appear on an individual’s credit report for seven to ten years, but most people will be able to obtain a mortgage after two years following the bankruptcy.  Although a bankruptcy will have an adverse effect on an individual’s credit report, debtors are likely to be rewarded for staying current on all debts following a bankruptcy.

Bankruptcy may also have an effect on an individual’s ability to lease property and find employment.  Rental property owners are allowed to check credit history.  Many rental property owners are reluctant to lease property to individuals with a bankruptcy on their records.  Employers are also allowed to ask individuals if they have ever filed for bankruptcy.

Also, filing for bankruptcy may affect an individual’s ability to file for bankruptcy in the future.  Finally, bankruptcy can be a stressful and emotional process and may take a psychological toll on an individual.

When should an individual file for bankruptcy?

Generally speaking, bankruptcy might be a good option when an individual finds him or herself in a hole that he or she just cannot climb out of.  Bankruptcy might be a good option when a person’s liabilities exceed that person’s assets.  This might happen for a number of different reasons, such as illness or an unexpected loss of employment.  In this situation, an individual simply might not be able to pay his or her debts.  This especially might be the case if the individual has few or no assets and the individual’s monthly income is not enough to cover the monthly debt payments.

Another circumstance where it might be beneficial to file for bankruptcy is when a debtor has already tried to negotiate with creditors unsuccessfully.  An individual might have tried to work out a different repayment plan other than the one already in place and the creditor might not be willing to change the agreement.  If the debtor does not have the means with which to make the payment, bankruptcy might be the best, or only, option.

Some individuals might be concerned that bankruptcy will result in a liquidation of their individual retirement accounts.  This will not happen.  Most retirement accounts are included in the federal exemptions that states cannot opt out of.  In addition, the Supreme Court has held that individual retirement accounts are protected by federal bankruptcy law.

It is important to remember that although bankruptcy provides financial relief, it does not provide a clean slate.  A bankruptcy will remain on a debtor’s credit report for up to ten years.  This will make it difficult for an individual to receive loans or a mortgage in the future as well as low-interest credit and property leases.  A bankruptcy could also have an effect on future employment because employers are allowed to ask individuals if they have ever filed for bankruptcy.

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