How to File for Bankruptcy 

Being in debt sucks. Owing money to creditors, banks, and other institutions can truly break your spirit, and letting your financial issues turn into a genuine credit crisis can destroy your credit score.

Fortunately, for individuals who want to take action to resolve their debt troubles and get on with a new approach to financial health, there are several options. It might sound strange, but filing for Chapter 7 bankruptcy can sometimes be the best thing to do.

"Being in debt today doesn't mean you're a bad person, and it doesn't mean you have to have debt slavery forever," says local bankruptcy attorney Wendi M. Freeman. "Bankruptcy is a solution to a certain type of financial problem."

Freeman mainly works with non-wealthy individuals and families on a variety of debt issues. For those with a lot of unsecured debt, which includes credit card fees and interest charges, it's a solid option.

There's a common misconception that those who consider bankruptcy are at the end of their financial rope — utter failures condemned to suffer forever with a bankruptcy cloud hanging over them. But it's usually not bad spending habits that leads someone to consider bankruptcy. Oftentimes, situations involve those who've been living conservatively and frugally, and whose debts come either over a long period of time or appear suddenly due to an unexpected life experience.

"I think the major causes for bankruptcy are job loss, illness, divorce, medical expenses, a major move — things like that," Freeman says. "My rule of thumb is if you can't pay off your debt in five years and don't see a reason why your income will shoot up dramatically in the near future, you really need to think about solving the problem."

Bankruptcy doesn't make sense for those who can repay their debts or those who have secured debts, which include student loans, back taxes, and child support payments.

"I typically don't file a Chapter 7 when an individual has extra assets," Freeman says. "I want the debt to be discharged and forgiven. I want to get rid of all of the unsecured debts."

Those who file for Chapter 7 bankruptcy these days face fairly new legal requirements. The Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) became effective in Oct. 2005. It made changes to the U.S. Bankruptcy Code and created a system that's more aggressive in pursuing repeat filers — offenders who consistently act irresponsibly and abuse the system.

"After BAPCPA, things became more complicated," Freeman says. "With Chapter 7, you have to pass this means test. If you have income in the top 50 percent of your household size, we look at your current monthly income, which is based on all of your income in the last six months. If you're over the median income, you go to the second part of the means test and it starts deducting expenses, according to the IRS guidelines."

Filers also have to attend credit counseling by an approved agency of the U.S. Trustee's Office. If a Chapter 7 debtor doesn't complete the course, it constitutes grounds for denial of discharge. "It's usually just a review of your income and expenses by an outside agency," Freeman says.

They also have to produce 60 days worth of pay stubs and take a required means test, which needs six months worth of taxable and non-taxable income information. "Then there's a mandatory attendance at a financial management course after you file," Freeman says. "It covers budget and management, which I think is useful and helps people avoid the same mistakes."

Filing for Chapter 7 can be expensive. According to Freeman, the credit counseling can run between $25 and $50. The recently updated filing fee is now $306. The cost for an attorney to complete the petition is generally around $2,000.

"Because it's so much more complicated now, that leads to increased costs," Freeman says. "The attorneys have more duty to doublecheck and certify things than before. The concept is the same. There's just more paperwork to get there. You have to jump through more hoops, but in the end, the result is still just as rewarding. "

While a Chapter 7 bankruptcy can severely damage one's credit report, it's not a life sentence. Once a filer's debt is discharged, the bankruptcy stays on their credit report for seven to 10 years. The three major credit score bureaus — Equifax, Experian, and TransUnion — calculate an individual's scores based more on their most recent financial activities than on old delinquencies. Within a year of a bankruptcy discharge, one can very easily start rebuilding their credit score by paying bills on time, using limited credit (secured credit cards, small installment loans) wisely, keeping balances low, and pacing themselves. Within two years of diligent and consistently responsible behavior, one can create a favorable payment history and push a bad credit score of 500 or so up to a score in the upper 600s, which is above the cut-off point for many lenders.

Most filers come away from the experience with more confidence and knowledge on how to spend, borrow, and manage their financial situations. They better understand how to live within their means. In that way, a bankruptcy can clean the slate and offer a fresh start.

"I believe that in certain situations, bankruptcy really does help people go on with their lives," Freeman says. "In so much of our legal system, you don't get a solution. Cases like divorces and lawsuits come to a conclusion, and you can win or lose, but it's still hard. In bankruptcy, you're solving a problem. And that's really nice."

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