The mere thought of filing for bankruptcy is enough to make anyone nervous. But in some cases, it really can be the best option for your financial situation. Even though it stays as a negative item on your credit report for up to ten years, bankruptcy often relieves the burden of overwhelming amounts of debt.

United States Bankruptcy Courthouse

There are actually three different types of bankruptcy, and each one is designed to help people with specific needs. Read on to find out which type of bankruptcy you might be eligible for and how to determine whether it really is the best option available.

What are the different types of bankruptcy?

In general, a bankruptcy is the process of eliminating some or all of your debt, or in some cases, repaying it under different terms from your original agreements with your creditors. It’s a very serious endeavor but can help alleviate your debt if you calculate that it’s unlikely to you’ll be able to repay everything throughout the coming years.

The two most common types of bankruptcy for individuals are Chapter 7 and Chapter 13. Chapter 11 is primarily used for businesses but can apply to individuals in some instances. Take a look at the other details that set each type of bankruptcy apart from the others.

Chapter 7

Chapter 7 bankruptcy is designed for individuals meeting certain income guidelines who can’t afford to repay their creditors using a repayment plan. You must pass a means test in order to qualify. Then, instead of making payments, your personal property may be sold off to help settle your debts, including both secured and unsecured loans.

There are certain exemptions you can apply for in order to keep some things from being taken away, depending on which debts are delinquent. If your mortgage is headed towards foreclosure, you might only be able to delay the process through a Chapter 7 delinquency.

If you’re only delinquent on unsecured debt, like credit cards or personal loans, then you can file for an exemption on major items like your home and car. That way they won’t be repossessed and auctioned off.

Eligible exemptions vary by state. Usually, there is a value assigned to your assets that are eligible for exemption and you may keep them as long as they are within that maximum value. For example, if your state has a $3,000 auto exemption and your car is only valued at $2,000 then you get to keep it.

Most places also allow you to subtract any outstanding loan amount to put towards the exemption. So in the situation above, if your car is valued at $6,000 but you have $3,000 left on your car loan then you’re still within the exemption limit.

Chapter 7 bankruptcy is the fastest option to go through, lasting just between three and six months. It’s also usually the cheapest option in terms of legal fees; however, keep in mind that you’ll likely have to pay your attorney’s fees upfront if you choose this option.

Chapter 13

A chapter 13 bankruptcy is the standard option when you make too much money to qualify for a Chapter 7 bankruptcy. The benefit is that you get to keep your property but instead repay your creditors over a three to five year period. Your repayment plan depends on a number of variables.

All administrative fees, priority debts (like back taxes, alimony, and child support), and secured debts must be paid back in full over the repayment period. These must be paid back if you want to keep the property, such as your house or car.

The amount you’ll have to repay on your unsecured debts can vary drastically. It depends on the amount of disposable income you have, the value of any nonexempt property, and the length of your repayment plan.

How long your plan lasts is actually determined by the amount of money you earn and is based on income standards for your state. For example, if you make more than the median monthly income, you must repay your debts for a full five years.

If you make less than that amount, you may be able to reduce your repayment period to as little as three years. You can enter your financial information into a Chapter 13 bankruptcy calculator for an estimate of what your monthly payments might look like in this situation.

To qualify for Chapter 13, your debts must be under predetermined maximums. For unsecured debt, your total may not surpass $1,149,525 and your secured debt may not surpass $383,175. However, unlike Chapter 7 bankruptcy, you may include overdue mortgage payments in your repayment plan to avoid foreclosure.

Chapter 11

Chapter 11 bankruptcy is usually associated with companies but it can also be an option for individuals, especially if their debt levels exceed the Chapter 13 limits. A lot of the characteristics of Chapter 11 and Chapter 13 are the same, such as saving secured property from being repossessed.

Having to pay back priority debts in full and having a higher income bracket than a Chapter 7 bankruptcy are also common characteristics. However, unlike a Chapter 13, you must make repayment for the entire five years with a Chapter 11 — there is no option to pay for just three years, no matter where you live or how much you make.

Another reason to pick Chapter 11 is if you are a small business owner or own real estate properties. Rather than losing your business or your income properties, you get to restructure your debt and catch up on payments while still operating your business, whether it’s as a CEO or as a landlord.

One downside to be aware of with a Chapter 11 bankruptcy is that it’s usually the most expensive option. However, you can pay your legal fees over time as part of your repayment plan so you don’t have to worry about spiraling back into debt.

How does bankruptcy affect you in the long run?

It should come as no surprise that going through a bankruptcy causes your credit score to plummet. Depending on what else is on your report, your score could drop anywhere between 160 and 220 points.

Those effects linger: a Chapter 13 bankruptcy stays on your credit report for seven years, while a Chapter 7 remains there for as many as ten years. Their effects on your credit score do, however, begin to diminish as time goes by.

You’ll probably have trouble getting access to credit immediately following your bankruptcy. Eventually, you’ll start getting approved for loans and credit cards, but your interest rates are likely to be extremely high.

A new mortgage will probably be out of reach for at least five to seven years from the time you file for bankruptcy. Additionally, any employer performing a credit check can see all of these items on your credit report.

Government agencies can’t legally discriminate against you because of your bankruptcy, but there is no specific rule for privately-owned companies. It could be particularly damaging if the job you’re applying for deals with money or any type of financials. No matter where you work, though, you can’t be fired from a current employer because of a bankruptcy.

Is bankruptcy right for you?

There’s no correct answer to this question and it’s ultimately something you’ll need to decide on your own. However, there are a few things you can do to make sure you’re making the best decision possible. Start off by finding a licensed credit counselor to help analyze your individual situation. They’ll help you review the guidelines for each type of bankruptcy and determine if you’re even eligible.

You should also look at your expected future and compare your potential earnings to your amounts of debt. If you don’t realistically see how you’ll ever pay off that debt, then bankruptcy may be the best option. Also, understand the types of debt you owe. Tax payments, student loans, and liens on your mortgage or car will not be discharged even when you file for bankruptcy.

Once you figure out which specific options are available to you, it’s time to contact a bankruptcy attorney. You’re certainly able to represent yourself, but the process is complicated and it’s usually best to have a professional work on the case on your behalf. Just be sure to interview a few different lawyers to get multiple opinions and prices to compare.

Even when your bankruptcy is underway, it’s smart to spend some time evaluating how you got there. Was it due to a one-time financial hardship, like a long bout of unemployment? If that’s the case, then you know that you have a brighter future ahead of you with the promise of work and steady income to pay your bills.

However, if you’re on the path to bankruptcy because of reckless spending, you really need to look inward and address your overspending habits. Otherwise, it becomes too easy to put yourself in the same situation a few years down the road. Use your bankruptcy as a second chance to start fresh with a clean financial slate.