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Five Benefits of Bankruptcy

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Admitting you're under water is the first step toward recovery.

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Bankruptcy is a choice most of us hope to avoid. But with the unemployment rate north of 10%, layoffs and pay cuts are now the norm and many Americans are actually finding relief by recognizing their inability to pay off their debts.

The number of bankruptcy filings has skyrocketed in the past year.

In the 12-month period ending September 30, 2009, 1.3 million non-business bankruptcy petitions were filed, up 30% from one million non-business filings over the previous 12 months, according to the latest data from the administrative office of the US Courts.

Business bankruptcies are on the rise, too. Lehman Brothers, Circuit City, and some 59,000 other businesses filed for bankruptcy protection in the 12-month period ending September 30, 2009, up a whopping 52% year-over-year. Some, such as Lear Corp. (LEA), General Motors, and Charter Communications, managed to emerge from it.

Of course, even when the collection agent is pounding at your door and you can't pay the mortgage, electricity, cable, and credit card bills all in the same month, bankruptcy should still be your last option.

Before meeting with a lawyer to determine whether you even quality for bankruptcy, Mathew Paulose, a Manhattan-based bankruptcy attorney, suggests exhausting all other options before turning to the court.

Ask your friends and family to loan you money; try to negotiate with your creditors; determine whether a legitimate debt consolidation firm can help; work as many hours as you can, even if that means picking up another job.

If and when all those efforts fail, the bankruptcy court will be your last standing friend.

Non-business bankruptcies are generally filed under either Chapter 7 or Chapter 13.

In a Chapter 7 filing, the individual debtor (or couple) turns over all their assets -- save for a few exemptions like your home, clothing, furniture, and a small amount cash on hand as designated by your state -- to a bankruptcy trustee who then liquidates the assets and distributes the proceeds to your unsecured creditors. Chapter 7 debtors generally get their debt release within 90 days of filing their petition.

In the less commonly used Chapter 13 procedure, a debtor with a steady income agrees to contribute a portion of future earnings to repaying creditors a fraction of the total amount owed over the next three to five years. The debtor maintains control of their assets, but doesn't get discharged of any debt until the repayment plan is completed.

To determine whether you qualify for bankruptcy, your attorney will conduct a detailed evaluation of your total assets, liabilities, income, and expenses. The attorney will file a series of forms known as a "means test" that measure your income and the number of people in your household against the median income for the same size household in your state.

If your income falls below the median, your petition is likely to get accepted and you'll be discharged of your debt, assuming it's great enough to qualify.

However, there are other qualifiers that a trustee will evaluate, too. For instance, if you're filing for a Chapter 13 bankruptcy, you'll only qualify if you have enough excess income to cover a reasonable payment plan.

A trustee will also factor in any prior bankruptcy filings. Chances are you won't be granted a Chapter 7 debt release if you've filed successfully in the past eight years; Chapter 13 can be repeated after just two years.

If you qualify for bankruptcy, you probably don't have a great FICO score. Expect it to get even worse. After your debt release, it will take several years to build it back to a healthy level. You can improve your credit score by taking out a new credit card and using it responsibly, which means only buying what you can afford to pay off without racking up interest.

Big lenders like Bank of America (BAC), Citigroup (C), and Capital One (COF) will view you as a high-risk individual, so your credit card rates could be as high 21% to 24%. Some may even ask for a deposit to cover an initial credit limit.

After you spend a number of months proving that you can pay your bills on time, you'll become a more attractive candidate to banks for mortgages and auto loans. Carrying a manageable amount of debt will help improve your credit score over time.

For those who qualify, bankruptcy is truly a way out of trouble. Here are five benefits to filing for bankruptcy protection:

1. You Can Keep Your Home

Under most states' bankruptcy laws, the home you live in is exempt from liquidation if your equity stake is within the designated amount. For instance, in New York, if an individual's equity in their home is less than $50,000 (or $100,000 for a couple), the trustee will deem the home exempt. However, if the individual or couple owns more equity in the home than their state's threshold, it's subject to liquidation.

2. Your Creditors Will Stop Hounding You

For those who are drowning in debt, calls and surprise visits from creditors and collections agents are a clear and present buzzkill. One of the perks of bankruptcy is that from the moment you and your lawyer file your petition, you'll enter an automatic stay period meaning that your creditors can't contact you. If they do, the court can penalize them.

3. You'll Be Discharged Of Your Debt

In either Chapter 7 or Chapter 13, the debtor is discharged of their unsecured debt including medical bills, credit cards, and car payments. In a Chapter 7 filing, the debtor is usually discharged within 90 days. In a Chapter 13, the debtor is discharged once the payment plan is completed.

4. No One Has To Know

Your friends, family, and co-workers don't ever have to know you filed for bankruptcy. Even though public humiliation and stigma are technically in the past, you have the right to keep your financial information private. The only time your filing would come out is if you're asked for a credit history report when applying for a new loan or credit card.

5. You'll Get A Financial Fresh Start

After your debt is discharged, your slate has been wiped clean. You can now apply for new loans and credit cards. The interest rates won't be stellar right away, but the best way to rebuild your credit is to operate under those terms and prove that you're a responsible debtor. While your bankruptcy filing will remain on your credit history report for 10 years, you can get credit again well within that time period, says Paulose.


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