What Really Happens When You File For Bankruptcy?

When many people hear the word "bankruptcy," they usually think of Chapter 11 bankruptcy, which businesses file. That process involves financial restructuring and "reorganizing" until the company is, ideally, on more solid footing and able to pay its debtors.

By contrast, filing for personal bankruptcy is a different matter. On the absolute, most basic level, people file for bankruptcy when their debts far exceed their liquid assets. That might happen as a result of being unemployed, having incurred massive medical debt or taken on a lot of consumer debt, or in the aftermath of marital and/or custodial issues.

An individual may voluntarily file for bankruptcy in court, but getting approved isn't a simple matter. (As evidenced recently when 50 Cent, who was recently discharged from bankruptcy, was forced to clarify whether he actually owned $8 million in bitcoin.)

Going bankrupt might seem like an extreme but attractive way to wipe your financial slate clean, but it's not a decision to take lightly. Here's how it works.

The Balance has a comprehensive checklist of the level of need you need to exhibit before you might successfully be approved to file for bankruptcy. (Unless a creditor or agency petitions a court to impose bankruptcy on you.)

This include having tried to reach a feasible payment plan with creditors, having your wages garnished, facing medical bills that can be covered by insurance, or having assets that are secured by a loan, which you want to avoid losing.

Chapter 7 and Chapter 13 aren't the only two ways individuals can file for personal bankruptcy, but they are the most common. As LegalZoom explains, the former involves "[liquidating] your assets to pay off as much of your debt as possible. The cash from your assets is distributed to creditors like banks and credit card companies." (Some items, non-exempt assets, aren't eligible to be used toward this debt.)

If an individual fails a "means test" when filing for Chapter 7 bankruptcy and is unable to prove that their income is insufficient, they can file for Chapter 13 bankruptcy instead. (Courts are emphatic about this point because under Chapter 7, a person may not pay anything toward their debt other than what can be recouped from their assets.) Under Chapter 13, you must submit a three- to five-year payment plan to pay off all or most of your debt.

While filing for bankruptcy could wipe out your credit card debt and other kinds of debt, there are a number of debts that won't vanish. This shortlist generally includes student loans, alimony, child support, and tax debts.

There is only one exception when it comes to discharging student loan debt through declaring bankruptcy, which requires showing something called "undue hardship." It's not easy to prove, but if your student loan debt load is high, it might be worth a shot.

The hit to your credit scored would be severe. If your current score is solid, you have a lot farther to fall. But if your score is already on the low end, it can only sink so much. In other words, "if credit problems have already pulled your score into the 500-range, you have a little less of a credit score to protect." After the drop, you'll have nearly a decade until the filing is discharged from your record.

As Experian explains: "Chapter 13 bankruptcy is deleted seven years from the filing date because it requires at least a partial repayment of the debts you owe. Chapter 7 bankruptcy is deleted 10 years from the filing date because none of the debt is repaid." After either period of time, the bank will discharge and essentially delete that record.

Individuals in married couples may not be jointly impacted. If the person who isn't filing has the assets in their own name, they will not become part of the liquidated estate. Any joint assets, however, are fair game; and credits can go after either spouse (within legal bounds) for payment.

Unfortunately, filing for bankruptcy is not free. There are court filing fees for both Chapter 7 and Chapter 13, costing $335 and $310 respectively.

However, that's not the only cost to consider. The majority of the cost of filing for bankruptcy comes in the form of attorney fees for a bankruptcy lawyer who will handle your case with the court.

Nerdwallet has several suggestions for what to do if you — because you're filing for bankruptcy after all — can't afford these costs, from raising the money, to arranging a payment plan with your lawyer, or finding a pro bono lawyer. They stress one piece advice when it comes to filing for bankruptcy: Don't try to do it on your own.

The paperwork is very complicated and difficult to navigate without a lawyer. Even U.S. Courts website warn that both Chapter 7 and Chapter 13 takes "careful preparation and understanding of legal issues. Misunderstandings of the law or making mistakes in the process can affect your rights."

Anyone who files for bankruptcy must undergo credit counseling, so trying that option on your own will give you a head start, as The Balance suggests. If working more, getting an additional job, and selling what you can just won't make a big difference, you can also try working with creditors. If any of your accounts are in collections, you may find that some are amenable to terms that work for you.