what is bankruptcy, how does it work, how does it affect your credit, and what does it do?
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Bankruptcy is officially declaring that you cannot pay what’s being demanded of you.
You ask the court to step in, stop all your debts, and adjudicate what needs to be paid and how and from what. You basically give control of your finances and assets to someone (a bankruptcy administrator), they sell what you have, pay what they can, and then everything else is declared done. That means some people who you owe money to won’t see it all, or even anything at all.
As part of that, you basically have to declare to the court EVERYTHING you own or have in banks, etc. Every asset, penny or share you own. If you’re found to have lied – even years later – then you can go to jail for that. Your entire finances will be sacrificed and all assets (apart from those that are strictly necessary, which might mean keeping your car so you can get to work, or being made to sell it and buy a cheaper car) will be taken and sold, and all the reasonable monies that the “administrator” of the bankruptcy can possibly get from your stuff will be taken to pay off your debts, most important first.
In effect, it’s like going “All In” in Texas Hold’em. You can’t match the bet that was just placed, but you can go “all-in” and everything you own is taken as a stake against everything you owe, even if it’s not technically enough to cover the debts.
After it’s all wrapped up, you will have a severe stain on your credit record (because usually people who you owe money to, like banks, mortgage companies, etc. will severely lose money on any bankruptcy and they won’t want to be hurt again), but all those people who are chasing you for money will be ordered to stop by the court, even if you didn’t have enough to pay your debts. It wipes the slate clean, no debts, no saleable assets, no funds in your bank account, so at least you can start again, but it has a heavy effect on your future ability to get any form of credit, loan or mortgage. Most places simply won’t offer a bankrupt any of the above, not even a credit card, not even YEARS after your bankruptcy.
In some places, you’re also banned from running companies and certain jobs if you’ve ever been bankrupt.
It’s basically a method by which, rather than be in completely unsustainable debt that you can never hope to pay off and would likely become homeless, jobless, a serious suicide risk, etc. you can ask the court to wipe everything out for you and start again, but at the cost of EVERYTHING you have, and a severe stain going forward. But at least you can live again, at least you *can* earn a wage, put it into a bank and not have it just disappear into interest, fees, charges and debts. You can start over. Imagine the alternative if bankruptcy didn’t exist – working a full day, the whole cost of your debts then just taking all that money from you, and you still go home with nothing, owe more at the end of the day than you did at the start, and still can’t afford food, housing, etc.
Bankruptcy is not something to enter into lightly, and it’s not something anyone would ever want to do. Do everything in your power to avoid ever being put into that situation. It’s really very bad, but better than the alternative.
Generally speaking, most places in the world also have a less-severe alternative that is like a “partial” bankruptcy. You’re basically doing the decent thing and saying “Look, if I keep on, I’ll go bankrupt, so instead let’s combat this early”. In the UK, that’s called an IVA or similar, in the US it’s a “different type” of bankruptcy. It usually involves the same kind of process, but the administrator has the power to force the debtors to co-operate, so they are made to accept partial payment of your debts, they are banned from chasing you for any more, you are forced to give up a substantial chunk of all your income, but hopefully the maths works out that they see most of the debt paid, you still have enough at the end of the day to live in your house and buy food, and eventually you’ll pay enough back that you avoid a full bankruptcy. And things like interest and fees are generally stopped so that you don’t spiral into further debt. It still has a hit on your credit record, but less so because you were smart enough to try to combat it earlier.
And, of course, the even smarter thing is to make sure you never get into that kind of debt at all.
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