There are two types of personal bankruptcy, Chapter 13 and 7. Chapter 13 does not require the person declaring bankruptcy -- referred to as the debtor -- to get rid of any of his assets. Instead, the debtor proposes a repayment plan and makes payments to his creditors over a period of three to five years. With Chapter 7 bankruptcy, the trustee may sell some of the debtor's assets, but not all of them. Certain assets are exempt from the bankruptcy process to ensure that the debtor can provide for himself after bankruptcy.
Chapter 7 Basics
To initiate Chapter 7 proceedings, a debtor must petition a federal bankruptcy court. The debtor must list all of his creditors, debts, income and monthly expenses. Then a trustee is appointed to oversee the process. When the debtor files for a bankruptcy, an estate is created that temporarily holds all the debtor's property. The trustee evaluates the estate’s property, transferring some of the assets back to the debtor based on statutory exemptions and other considerations. The trustee then sells what remains and transfers the proceeds to the debtor’s creditors. In most Chapter 7 cases, the trustee will find no nonexempt property worth selling, so there will be no proceeds to distribute.
What property is included in a bankruptcy estate is determined by state law. Some states exclusively define what property is exempt while others allow the debtor to choose between state and federal exemptions. While each state has a different list of exemptions, a debtor generally can exclude most of his wages, most of his personal property, any tools required for him to pursue your trade, and all federal and state benefits that are owed to him, like Social Security and unemployment payments.
Home and Car Exemptions
Generally a person’s home and car are exempt under state law, but only to an extent based on his equity in the asset. Assume a debtor lived in a state that allowed him to keep his home if he has up to $15,000 in equity in it. If he has $14,000 of equity, the home is exempt and will not be sold so long as he can make the mortgage payments. But if he has $150,000 of equity in the home, that leaves $135,000 of nonexempt equity, which makes it worthwhile for the trustee to sell the house to pay the debtor's obligations.
What federal exemptions are available for your use depend on where you live and whether you want to take advantage of your state’s exemptions. Generally, the federal bankruptcy exemption excludes alimony, federal benefits, personal property and personal injury judgments. Some of the exclusions are limited by category. For example, only $1,000 worth of jewelry is exempt under federal standards.
The trustee may decide to abandon, or not sell, some nonexempt assets. A trustee may decide to abandon because the debtor has little equity in the asset or because the cost of maintaining and selling the asset would minimize any return from the sale. When the trustee abandons property, it is either returned to the debtor or to a creditor that has a lien or mortgage on the property.
Redemption of Property
If a debtor has the necessary funds and the current value of the item is less than its lien, he can “redeem” personal property that he intends to keep for personal use. For example, if a car worth $5,000 has a $10,000 lien on it, a debtor can redeem the car by paying the creditor $5,000. The asset must be exempt or abandoned, and the bankruptcy court must approve the transaction.
Reaffirmation of Debt
A debtor can agree to pay a loan and exclude it from being discharged in bankruptcy. Generally considered a bad idea, both the debtor and creditor must agree to it, the debtor must sign a reaffirmation agreement signifying he understands his responsibilities and the debtor’s attorney must sign a document stating he explained the repercussions to his client. These documents must be filed with the court withing 60 days of the required meeting with creditors.