There are many reasons why an individual can experience serious financial issues. You can eventually come to a point at which your personal debt is beyond your ability to repay. Creditors may be threatening or in the process of filing judgments in civil court or repossessing your property.

You can put an immediate stop to all debt collection activities by filing for bankruptcy protection in your local Federal court. However, there are two types of bankruptcy available for the average debtor. 

The type you choose will be based both on your personal goals and your ability to repay your debts.

Chapter 13 bankruptcy

Known as the "wage earner's plan", Chapter 13 bankruptcy allows a debtor to keep many of their assets while repaying debtors according to their disposable income. Obviously, the debtor cannot keep substantial assets, but that is not usually a problem, because if they owned sufficient assets, they could be liquidated to repay debtors and avoid the problem.

The debtor must show that they have sufficient income to at least meet their monthly living expenses, aside from their debts. Any income that exceeds their living expenses will be used to repay unsecured debt, such as debt accrued by credit cards and personal loans.

The length of the repayment plan is also based on income. Individuals with lower incomes must repay their debts for three years, while those with higher incomes must pay for five years. Any remaining unsecured debt is forgiven after the mandated repayment period.

Secured debts under Chapter 13 bankruptcy

Payments on secured debts, such as home and car loans, must be paid in full during the Chapter 13 repayment period and beyond, until the lien is satisfied. If the debtor is behind on payments, the court can devise a repayment plan for any missed payments. However, these payments must be made concurrently with their regular monthly payments and the mandated payments toward unsecured debts.

What can you do if you don't qualify for Chapter 13 or if you just want a completely fresh start, free of debt?

If you don't have sufficient income to qualify for Chapter 13 bankruptcy and are hopelessly underwater (owe much more than the current value of your property) in your secured debts, you can choose Chapter 7 bankruptcy, which involves the liquidation of your assets in return for forgiveness for all debts. 

This doesn't mean that you must surrender all of your property. You may choose to keep certain secured debts, like a home or car, as long as the amount of equity in the items doesn't exceed allowable exemptions and the creditor agrees to keep the loan intact.

There are both federal and individual state guidelines that mandate specific amounts of equity in property that cannot be seized in either type of bankruptcy.

Exemptions include a specified amount of equity in a home, a vehicle, personal items, and other assets, so you are not left completely destitute after bankruptcy. If possible, it is best to seek legal advice from a bankruptcy attorney in order to take advantage of all possible exemptions. 

Will filing for bankruptcy ruin your credit rating?

If you are at the point that filing for bankruptcy is your best or only option, your credit rating will likely be very low already, due to late or missed payments. Like all negative information on your credit reports, Chapter 13 bankruptcy stays there for seven years, while Chapter 7 bankruptcy stays on the reports for ten years.

However, if you regain control of your finances and are freed of all or most of your debt through bankruptcy, creditors are often willing to take a chance and extend credit, albeit in less-favorable terms and interest rates, until you can prove yourself and show that the bankruptcy was a moment in a particularly bad time in your life.