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Bankruptcy

What Are the Requirements for Bankruptcy?

If you're struggling under a mountain of debt, bankruptcy could help you reduce or eliminate your debts and get back on your feet financially. Before you proceed, however, know that bankruptcy should only ever be considered as a last-resort option. Its financial and credit consequences are severe and will take years to recover from.

To file for bankruptcy, you must meet a number of requirements that can vary based on the type of bankruptcy you're pursuing. For example, bankruptcy filers need to complete credit counseling and meet certain income guidelines before being able to move forward with the process.

The two common types of individual bankruptcies are Chapter 7 and Chapter 13. Chapter 7 bankruptcy involves wiping out various unsecured debts, such as credit card bills, within several months. Chapter 13 bankruptcy has you repay your debts over a three- to five-year period. If you're looking into Chapter 7 or Chapter 13 bankruptcy, here's what you need to know about the requirements.

Why Do People File for Bankruptcy?

No one's financial circumstances are exactly the same when it comes to bankruptcy. But many bankruptcy filers head to court for similar reasons. Here are the three most common reasons for bankruptcy filings, according to the American Bankruptcy Institute:

  1. Job loss: The loss of a job can cause tremendous financial troubles, such as falling behind on your mortgage payments, auto loan payments and other debts.
  2. Medical costs: A health care issue like a catastrophic illness or injury can leave you grappling with medical debt.
  3. Divorce: Ending a marriage can heap debt on one spouse or both spouses. The change in financial situation can make it even harder to pay off these debts.

Who Qualifies for Chapter 7 Bankruptcy?

Chapter 7 bankruptcy, also called straight or liquidation bankruptcy, can wipe out many types of unsecured debt. Not just anyone can file for Chapter 7 bankruptcy, though. Here are some of the requirements to pursue Chapter 7 bankruptcy.

  • The average of your monthly income in the previous six months must be lower than the median income for the same-sized household in your state; otherwise, you must pass what's known as a means test. This test determines whether your disposable income is high enough to make partial payments to unsecured creditors. If you fail the means test, don't despair: You still might qualify for Chapter 13 bankruptcy.
  • You can't have filed for Chapter 7 bankruptcy in the previous eight years.
  • You can't have filed for Chapter 13 bankruptcy in the previous six years.
  • If you attempted to file for Chapter 7 or 13 bankruptcy but your case was tossed out, you must wait 181 days or more before refiling.
  • You typically must finish an individual or group credit counseling course offered by an approved credit counseling agency within 180 days before you file for bankruptcy.
  • Even if you're eligible to file for bankruptcy, a judge could throw out your case if it's found you're attempting to defraud creditors. An example: You run up charges on a credit card with the goal in mind of declaring bankruptcy to steer clear of paying the debt.

Who Qualifies for Chapter 13 Bankruptcy?

The requirements for Chapter 13 bankruptcy differ from the requirements for Chapter 7 bankruptcy. Here are some of them.

  • You must have sufficient income to make the monthly debt payments outlined in your bankruptcy plan.
  • Your unsecured debts (such as credit cards and medical bills) must be less than $419,275, and your secured debts (like mortgage and car payments) must be less than $1,257,850. These dollar amounts are in effect until April 2022. Debt limits change every three years.
  • If you attempted to file for Chapter 7 or 13 bankruptcy but your case was tossed out, you must wait 181 days or more before refiling.
  • You must provide proof that you filed federal and state income tax returns for the past four years.
  • You typically must finish an individual or group credit counseling course offered by an approved credit counseling agency within 180 days before you file for bankruptcy.

How Does Filing for Bankruptcy Affect Your Credit?

Filing for bankruptcy is one of the worst things you can do for your credit since it's a signal to future creditors that you were unable to meet your debt obligations. Fortunately, a bankruptcy filing doesn't leave a permanent mark on your credit reports, and you can start rebuilding your credit while you're trying to get your finances in order.

No matter whether you've filed for Chapter 7 or Chapter 13 bankruptcy, it'll show up on credit reports for card issuers and other lenders to see. Chances are, lenders will take your bankruptcy into consideration when you apply for credit. Once you've wrapped up the bankruptcy process, your credit reports will indicate that the bankruptcy and the debts covered by your filing have been discharged.

A Chapter 7 bankruptcy will stay on your credit reports and affect your credit scores for 10 years from the date your court case is filed; a Chapter 13 bankruptcy stays on your credit for seven years. As time goes by, however, a bankruptcy's effect on your scores slowly decreases.

When you apply for credit, lenders might not OK your application unless the bankruptcy has been discharged. Even then, you might find it difficult to obtain certain kinds of loans. If your application does go through, you might be confronted by high interest rates and other less-than-favorable lending terms.

It's worth noting that some lenders might view a Chapter 13 filing less negatively than a Chapter 7 filing. Why? They might consider a Chapter 13 filer less of a credit risk than a Chapter 7 filer. That's because in a Chapter 13 case, you repay all or part of your debts over a three- to five-year period, whereas debts are erased in a Chapter 7 case.

Also, keep in mind that if your FICO® Score was good before filing for bankruptcy, you'll likely see a steeper drop in your score than if your score was already low.

How to Start Rebuilding Your Credit After a Bankruptcy

One of the most important things to remember about a bankruptcy is that it won't linger on your credit reports forever. More good news: You can do a lot to start rebuilding your credit before the bankruptcy disappears from your credit reports. Here are six steps to take.

  1. Always make on-time payments. When your credit scores are calculated, your payment history plays a major role in the most commonly used credit scoring models. On-time credit card and loan payments demonstrate that you're a responsible borrower, and can help bump up your credit scores.
  2. Handle past-due accounts. If you miss payments on household bills, such as those for your utilities and cellphone service, accounts can be charged off and turned over to bill collectors. When an account goes to collections, it can harm your credit. Getting current on past-due accounts can prevent them from dragging down your scores.
  3. Boost your credit scores. On-time bill payments can also help lift your credit scores if you take advantage of Experian Boost . This free service counts your on-time monthly payments on your credit report, potentially leading to an instant rise in your Experian credit scores.
  4. Keep credit card balances low. Did you know that you don't need to maintain a balance on a credit card to preserve good credit overall? Actually, paying off your full credit card balances and consistently doing so every month can be one of the fastest routes to better credit.
  5. Start an emergency fund. Putting aside some money for emergencies, such as unexpected car repairs or medical bills, can keep you from missing bill payments or running up credit card debt. Even stashing enough money to cover just one monthly rent payment might help keep you out of financial trouble.
  6. Consider a secured credit card. Unlike unsecured credit cards, secured cards require a security deposit. This allows companies to issue credit cards to those who don't necessarily have excellent scores. If you miss payments on a secured credit card the issuer can keep your deposit. The amount of the security deposit usually dictates your credit limit. Be sure the issuer of a secured card will report your payment activity to all three credit bureaus (Experian, TransUnion and Equifax). Using a secured card responsibility could help improve your credit scores, but missing payments and defaulting could leave you worse off than before.

How to Seek Professional Advice

You don't have to go it alone when you're weighing whether to file for Chapter 7 or Chapter 13 bankruptcy and, then, if you decide to proceed. Check out these resources.

  • Bankruptcy attorney: You can file for bankruptcy without a lawyer, but you might want to visit with a lawyer if you're unsure how to move forward.
  • Credit counseling agency: A credit counseling agency might be able to work with you on a debt repayment plan so you can avoid bankruptcy. The U.S. Department of Justice maintains a list of federally approved credit counseling agencies.
  • Financial advisor: A financial advisor might be able to guide you through establishing a budget and creating a debt repayment plan.

The Bottom Line

Filing for bankruptcy is a serious step in straightening out your finances, so it's important to give it careful thought before going ahead with it. After all, it'll have long-lasting effects on your credit. However, it also can give you the fresh start you need to put you on the path toward financial peace of mind. Before, during and after bankruptcy, be sure to monitor your credit so you can track your progress.

Once the process is over, carefully monitor your credit report and scores to make sure you're building habits going forward that have the best impact on your credit health.