What might life look like after filing for personal bankruptcy?
Many consumers have heard personal bankruptcy filings called the “nuclear option” and the “option of last resort” when it comes to debt and personal finances. With such associations and with several of the best-known financial radio personalities preaching the avoidance of bankruptcy at all costs, of course, consumers fear the process. However, bankruptcy is not the end of the line and does not spell eternal financial doom for filers. Both our research and our experience with former bankruptcy filers show that recovery from bankruptcy comes in all shapes, sizes, and speeds.
Filing a personal bankruptcy, whether as an individual or as a couple, does not mean you can never purchase a home or vehicle or build wealth in the future. Many former filers can even qualify for mortgages at reasonable rates within a matter of two or three years.
If you have ever heard that you cannot keep your home or cannot ever buy a home again if you file for bankruptcy, you need to do two things. First, speak with an attorney who specializes in consumer bankruptcy. Bankruptcy can present complex financial decisions that will likely have far-reaching consequences. You want a professional in your corner. Second, keep reading below.
We do not believe bankruptcy is right for everyone. Neither do with think consumers should exert extra-human effort for decades or longer to hopefully avoid bankruptcy. Not only does bankruptcy law exist to protect consumers from losing certain assets built over decades of hard work, but because of the prospect of bankruptcy protection, many of our country’s greatest entrepreneurs feel a bit less vulnerable when taking risks to build their companies, including, ironically, some of the very so-called experts who warn against ever filing personal bankruptcy.
As you read through the following information, please keep in mind that it is intended for educational purposes only and that individuals should seek personal advice from qualified, legal professionals.
Protecting Your Assets during Bankruptcy
Many consumers hear that they will “lose everything” in bankruptcy except “the shirt on their back.” Such exaggerations create excessive fears and wildly erroneous expectations around the processes and consequences of filing personal bankruptcies in the US. Consumers should not, of course, file bankruptcy frivolously or for trivial reasons, but neither should they dismiss bankruptcy out-of-hand because of incorrect information they have heard over the years from friends, on TV shows, and in the movies.
Keeping Your Home After Bankruptcy
Yes, consumers can absolutely keep their homes even when filing for bankruptcy. Not surprisingly, it will depend upon which chapter of bankruptcy they file, whether they are current on their mortgage payments, as well as how much equity they have in the home. To keep your home in Chapter 7, you must be currently making your mortgage payments on time, and your amount of home equity can’t exceed your bankruptcy exemption. If your home equity exceeds your bankruptcy exemption, the court-appointed trustee typically sells your home and uses the proceeds (beyond your exemption) to repay your unsecured creditors.
To keep your home in a Chapter 13 bankruptcy, you can set up a payment plan and stay in your home. However, if you have so much home equity that it exceeds your state’s bankruptcy exemption, you will have to make your regular home payments plus monthly payments toward the equity that exceed your bankruptcy exemption. For example, if your home value has skyrocketed in the past five years and is worth $150,000 more than you owe, and your bankruptcy exemption is $30,000, you will have to pay off the remaining $120,000 of home equity within the repayment plan period (usually three to five years). That equates to an extra $2,000 to $3,333 per month. This payment often doubles or triples your mortgage payment, leading to the unlikely scenario of you staying current on your Chapter 13 monthly payments.
Some states like Texas (which you will see has very lenient bankruptcy laws) allow you to keep your home, regardless of its value, so long as it is on 10 acres or less in a city or 100 acres or less in the country. And that’s if you file as an individual. If you’re married or have children in the home, you can double the acreage exemptions. Theoretically, you could keep an $18 million home on 10 acres in the city of Dallas.
Keeping Your Retirement Portfolio after Bankruptcy
Under normal circumstances, your 401k, other employer-sponsored retirement plans, and Individual Retirement Accounts (including Traditional, Roth, SEP, and SIMPLE IRAs) have strong protections from creditors during bankruptcy. While Traditional and Roth IRA have a limit to their protections (currently $1M), the other accounts have unlimited protection under most normal circumstances.
Keeping Family Heirlooms
If your piece of jewelry, musical instrument, china set, or other family treasure falls within your state’s personal property exemption (or the federal exemptions), you may be able to keep it. However, state exemptions vary widely from each other and from the baseline federal list. For example, the federal exemption for jewelry is currently $1,700 while in Idaho it’s just $1,000. Texas law might exempt up to $25,000 of jewelry.
Keeping Your Car or Truck
Bankruptcy law in every state acknowledges the critical importance of allowing the filer to keep a vehicle because of its role in daily life and, more importantly, in getting to and from her or his place of employment. Where you file and the equity you have in the vehicle can matter a great deal, though, in determining whether you can keep your current vehicle.
The federal exemption for vehicles allows you to keep a vehicle with no more than $4,000 of equity (the difference between its fair market value and how much you owe). Many states allow you to keep a vehicle with $10,000 of equity while states with liberal bankruptcy laws like Texas (in keeping with its reputation of being the land of the $10,000 millionaire) allow you to keep any vehicle of any worth so long as you have a license or depend upon a licensed driver to operate the vehicle on your behalf.
These variances mean that a filer in Idaho may not be able to keep a three-year-old, two-door Chevy Spark (valued at $10,500) they own nothing on while a filer in Texas who owns a one-year-old top-of-the-line Land Rover Discovery (valued at $60,000) gets to drive home from the federal courthouse in luxurious comfort.
Growing Your Assets After Bankruptcy
Despite the extreme examples above, most filers in most states will come out of their bankruptcy filing with minimal assets. If they have kept their home, they likely have minimal equity in it. If they kept their vehicle, it’s likely worth less than $10,000. Their personal property exemptions likely covered items like appliances, furniture, household tools, silverware, dishes, and clothing that you typically wouldn’t include in any net worth model.
An interesting working paper from the National Bureau of Economic Research back in 2014 found that Chapter 13 bankruptcy filers whose petitions were approved by the courts ended up in much better financial situations than filers whose petitions were dismissed. Successful filers experienced home foreclosure rates at just one-sixth of the rates of unsuccessful filers just five years from filing the bankruptcy petition. Successful filers also experienced better health, earned higher incomes, and dealt with fewer unemployment issues.
Although complex in its analysis, one takeaway from the study can support the idea that bankruptcy can actually help many filers get a fresh financial start. Along with asset protection, that seems to be the point of bankruptcy law.
Contrary to most of what you can read online about how terrible bankruptcy is and how filers can never purchase a home or get financially caught up to their peers, the truth can offer much more hope. We have run into bankruptcy clients in our communities who were purchasing homes at very reasonable interest rates just two years after they met with us for their required credit counseling or debtor education certificates. Even though bankruptcies remain on your credit report and negatively affect your credit rating for up to ten years, you can counter its effects with some hard work and discipline.
Rebuilding Your Credit
A bankruptcy will report to the credit bureaus for seven (Chapter 13) to ten (Chapter 7) years. The further in the past it goes, the less it hurts. That means, though, that bankruptcies filed within the past 12 to 24 months exert a very strong downward push on your credit scores. Besides exercising patience and waiting while the bankruptcy filing recedes into the past and eventually off of your report, you can also work to rebuild your credit rating by engaging in positive credit activities that get reported to the credit bureaus.
As noted in our guide to building credit, you can start by paying your utility bills and making your cell phone plan payments on time. Some utility and phone companies can report your history of payments to the credit bureaus, although you would have to ask first. Additionally, Experian offers a free program called BoostTM that monitors these payments through your checking account and gives you credit for them.
Next, you might consider asking a trusted family member to add you to their credit card account(s) as an authorized user. You don’t need to use or even see the card to inherit some of your family member’s good credit. Plus, your poor credit with the recent bankruptcy will have absolutely no effect on your credit rating.
You could also consider fee-based products like using a secured credit card (some credit unions offer these products with no annual fee) and credit-builder loans.
By using these products with discipline (even just once a month and paying them off ASAP), you can add positive information that begins to counter your bankruptcy’s negative effects.
Staying Debt-Free
After bankruptcy, while you may have a home loan or even a vehicle loan (which we recommend against), you should otherwise find yourself debt-free. Do everything you can to remain so. Obviously, chronic medical conditions can make it difficult to avoid future financial emergencies, but do not let yourself slip into any scenarios and decisions that would result in credit cards, store cards, or other consumer debts. NEVER carry a credit card with you, opting instead for using cash for everyday purchases.
Managing Your Expenses
Managing your expenses will play a central role in keeping yourself out of future debt. This skill involves setting and prioritizing meaningful financial goals, understanding how to use your net income, identifying priority monthly expenses, and keeping yourself out of impulse-driven financial situations. For more ideas on planning your spending (aka budgeting), see our guide and free calculators on the topic.
Spending on Assets
Finally, look for ways to grow your assets, which have long provided a secure way to build financial stability and security. Focus particularly on assets that maintain or grow their value over time. This means the asset’s value must increase more than inflation (typically around 3% annually) and more than any associated taxes you pay on the asset. Such assets usually include a home, real estate investment properties (rentals), and securities (e.g. stocks and exchange-traded funds).
Bankruptcy may initially curtail your ability to borrow money for a home purchase, but it has no effect on your ability to invest. Max out any employer-based 401k or 403b program (TSP for military), and consider opening and contributing to an Individual Retirement Account (IRA).
With consistency, persistence, and patience, you can rebuild your finances and your credit after bankruptcy. Many of our most successful financial stories in the US involve people who have filed for personal or business bankruptcy at least once, sometimes multiple times, on their path to ultimate financial success.
“Bankruptcy is about financial death and financial rebirth. Bankruptcy is the great American story rewritten. We’re a nation of debtors.”
Elizabeth Warren – Sponsor of the Consumer Bankruptcy Reform Act of 2020
Related Questions
How long does bankruptcy take once filed?
Depending upon which bankruptcy chapter you file under for protection, your case may take as little as 75 days (rare but possible under Chapter 7 liquidation) or as long as five years (Chapter 13 repayment plans). Chapter 7 is the most common type and usually takes about 4-5 months to complete.
Why would a person file for personal bankruptcy?
While the media and some studies indicate that medical costs lead to the most personal bankruptcy filings, our own surveys of over 2,000 filers show that most file after a job loss or income reduction (40%), followed by 25% due to poor money management, then medical at 19%. Divorce is fourth at 9%.
Filing Bankruptcy in America: Four-Part Series
Money Fit by DRS Inc. is publishing a four-part series to explain the bankruptcy process in great detail. We intend to create a guide for individuals looking to understand the bankruptcy process so they can make informed decisions on whether this is an alternative to dealing with their debt that they should explore further.
Read About Bankruptcy In America
