The most widely held misconception about bankruptcy is that it's the debtor's version of the "get out of jail free" card in Monopoly. While most people know that bankruptcy affects your credit for 7 to 10 years, very few people know that it's possible that you'll have to pay back the debt anyway, even if you file a Chapter 7 "straight" bankruptcy. The formal definition of bankruptcy is "a proceeding in federal court in which an insolvent debtor's assets are liquidated and the debtor is relieved of further liability." On the other hand, the commonplace definition of bankruptcy is probably "the process of completely wiping out your debts for free." In the majority of cases, the latter definition may be appropriate, but in some scenarios, it's likely that even with bankruptcy, you'll still have to pay back at least a portion of the debt.
So when is it likely that you'll have to pay back your debts? Here are the most common scenarios when you'll get all the negatives of filing bankruptcy (severe credit impact for 7 to 10 years), but none of the benefits (you'll still have to pay back at least part of the debt):
1) You make more than the average person in your state. If this is the case, then it's likely that you'll be forced into a Chapter 13 bankruptcy plan. In a Chapter 13 bankruptcy, the court orders that you pay all your disposable income to a court appointed trustee, who in turn disburses payments to your creditors. Keep in mind that the court determines your disposable income by national and county statistics on average necessary expenses, not what you're paying. So just because you're paying a lot for a car does not mean the court will approve it. There are numerous cases when a judge ordered families to stop sending their children to private schools so they can have more money to pay back their creditors. For example, here are the latest statistics on the Illinois median income by size of household:
1-person families 41,650
2-person families 52,891
3-person families 62,176
4-person families 72,368
2) You have assets. If you own a home or car, then it's possible that the bankruptcy court will force you to sell them to generate sufficient cash to pay back your creditors. Chances are if have a good chunk of change invested (unless it's in a tax-exempt account like an IRA) then you'll also be forced to liquidate it. If you have a second home or another vehicle (assuming you own both completely), then you're really out of luck. Fortunately, there are some safeguards to protect consumers from bankruptcy hell. In Illinois, every resident is entitled to at least $ 7,500 of the value of their home, $ 1200 of the value of their vehicle, and $ 2,000 for anything that they want (known as the wild card exemption). Also, these values double if you're married (assuming the property is in both of your names).
What does this actually mean? Consider the following example.
Let's say you have a house that's worth $ 250,000, and it's in both yours and your wife's name. You still owe about $ 200,000 on your mortgage, and you decided to file Chapter 7 bankruptcy. In this example, you would be forced to sell your home, and with the proceeds you would pay back the mortgage company what you owed on the outstanding balance of the loan ($ 200,000), you'd pay yourself the Illinois real estate exemption ($ 15,000) ), and then you'd pay back your other creditors whatever was left ($ 250K-200K-15K = $ 35,000).
3) The creditors can prove that you were fraudulent and never had any intention of paying them back.
For the majority of us it means that without a) you do not have a lot of equity in any of your property, b) you do not have any investments like stocks, real estate, etc., c) you do not care about having to sell anything mentioned in points a and b or or d) you do not care about having to give up your disposable for 5 years in a Chapter 13, then bankruptcy may not be your best option.