When your income drops, the paychecks may stop coming, but the bills don’t. You’re legally obligated to pay all debt, but when you don’t have enough money to cover your monthly expenses and pay your creditors the minimum amount due, you face some tough decisions. If you owe a large amount of money and your creditors will not accept reduced payments, you may have to consider your option of last resort – personal bankruptcy.

It is an unfortunate reality that some homeowners will fall behind on their payments. Learning more about your options may help prevent getting to that point. And if you do get behind on your mortgage, find out more about working with your lender.

When creditor calls become overwhelming, people often begin to consider personal bankruptcy as an option.

“Bankruptcy is generally considered the debt management option of last resort because the results are long-lasting and far-reaching,” says J. Michael Collins, family and consumer economics specialist with the University of Wisconsin-Extension and assistant professor of consumer finance at the UW-Madison School of Human Ecology.

“A bankruptcy stays on your credit report for ten years, making it difficult to acquire credit, buy a home, get life insurance, or sometimes even get a job. However, it is a legal procedure that can offer a fresh start for people who can’t satisfy all their debts,” says Collins. “Individuals who follow the bankruptcy rules receive a discharge-a court order that says they do not have to repay certain debts.”

There are two primary types of personal bankruptcy: Chapter 13 and Chapter 7. Each must be filed in federal bankruptcy court. A debt can typically be discharged in a Chapter 7 bankruptcy if it is unsecured, meaning that there is no collateral backing it up. This includes debts such as credit card debt, medical bills and most personal loans. A Chapter 13 bankruptcy case involves a three- to five-year repayment plan. To qualify for Chapter 13, you must have a regular source of income, have enough disposable income, and your debts may not be too high.

A Chapter 7 bankruptcy can be filed by individuals on their personal consumer debts or by individuals or businesses on debts they incurred while operating a business. The debtor files a petition with the Bankruptcy Court, listing all debts and all property. Consumer debtors keep property that is exempt under state or federal bankruptcy laws.

Most people filing for bankruptcy don’t possess any non-exempt assets, so the debtor generally keeps all her/his property. If a debtor has assets worth more than the law allows them to keep, the court may sell some of them to pay creditors. A discharge occurs about three months after the case is filed.

People with incomes over the state “median” income for the household may be denied a Chapter 7 discharge if their “net monthly income” after deducting specified expenses is over a certain amount ($39,157 for one person; $49,918 for two; $60,106 for three; $6,300 for each additional person over three). This median income amount increases annually.

Under Chapter 13, the debtor arranges to pay all or part of their debts over a period of time under the court’s protection. The debtor’s plan must last at least three years (five years if the debtor(s) fails the “means test”), unless the plan proposes to pay debts in full. Payments must be sufficient to pay certain claims in full (secured car loan, mortgage arrears, taxes and support owed to parent or child) in a reasonable time (three to five years) with interest on secured claims.

Debtors are allowed to keep:

• Equity in their home up to $18,450 (debtor must live there); state exemption is $40,000
• Disability benefits and retirement or 401K benefits and plans necessary for future support
• Personal property, including clothing, appliances, and furnishings up to a total of $9,850
• Jewelry up to $1,225
• One motor vehicle up to $2,950 in value (minus any loans)
• Tools of the trade up to $1,850
• A wild card exemption of $975 to cover any property not listed above; as well as an additional wild-card exemption of up to $9,250 of unused homestead exemption.

You can only file a Chapter 7 once every eight years. You can file Chapter 13 more often, even if you’ve filed a Chapter 7 within the past eight years. Generally, you should not consider filing unless you are several thousand dollars in debt. A Chapter 7 bankruptcy can be listed on your credit report for ten years from the date of filing, as can judgments against you. A Chapter 13 bankruptcy and most other information will be removed after seven years.

All chapter 7 and 13 debtors must certify that they have had a credit counseling briefing before filing and complete a financial education course prior to getting a discharge. A certificate will be issued as proof of completion for both the briefing and the education course.

“Attorneys who specialize in bankruptcy are available and you should compare their charges,” says Collins. “There are also ‘bankruptcy form preparers’-non-lawyers who prepare forms for a fee. These should be cheaper than using a lawyer, but proceed at your own risk.”

Some debts are not part of bankruptcy. Student loans are able to be discharged only if you can demonstrate that repayment would be an undue hardship through an adversary proceeding. Filing bankruptcy has no effect on child support or alimony obligations. You must pay those obligations in full. You will also have to continue making mortgage payments-bankruptcy cannot stop foreclosure permanently. In general, tax debts are not able to be discharged under bankruptcy and you will continue to be obligated to pay them.

Additional Resources

Understanding Default and Foreclosure

Money Matters Website – When You Can’t Pay Your Bills

Dealing with a Drop in Income

Find a non-profit credit counselor near you on the Debt Advice website.

Legal assistance for low-income households:

• • www.legalaction.org (southern Wisconsin);
  • www.judicare.org (northern Wisconsin)

Learn more about options to keep up with mortgage payments on the Making Home Affordable website.