The ins and outs of filing for personal bankruptcy

If mounting credit card bills are threatening to pull you under, you may be considering bankruptcy as a way to hit the restart button.

The American Bankruptcy Institute expects worsening economic conditions to drive up the number of consumer filings this year to their highest level since stricter bankruptcy terms went into effect in 2005.

The more than 880,000 filings through October have already eclipsed the 823,000 filings for all of 2007. It's no wonder, with government figures showing Americans are lumbering under some $900 billion in credit card debt.

Bankruptcy comes with serious consequences for your credit profile, however. So if you're considering bankruptcy as a way out, here are six questions to ask yourself.

1. What type of bankruptcies are there?

There are two bankruptcy options for individuals.

Most people file for chapter 7 bankruptcy, which wipes clean unsecured debt such as credit card or medical bills. What won't disappear are fixed debts including mortgages, student loans, taxes and child support.

Under the second option, chapter 13 bankruptcy, filers agree to repay creditors over three to five years. Chapter 13 is typically for people who think they will be able to repay lenders and hold onto their home and other belongings.

There is no debt limit to file for chapter 7. For chapter 13, however, people can only have about $1 million in secured debt and some $350,000 in unsecured debt. This is to prevent businesses or wealthy individuals with business debts from applying.

2. Who can apply?

Eligibility for chapter 7 is determined by a formula known as the means test, which weighs your income against your ability to pay creditors. Your attorney calculates the test and it is vetted by a trustee.

A family earning $100,000 or less generally won't have problems filing for chapter 7 because the means test factors in living expenses. People who received a chapter 7 discharge in the past eight years are not eligible for another discharge.

A similar means test is used to determine a payment plan for chapter 13. People who filed for a chapter 7 bankrupcty resulting in discharge in the past four years or a chapter 13 case resulting in a discharge in the past two years are not eligible for another discharge.

3. How do I get started and what are the costs?

Depending on the complexity of a chapter 7 case, you'll need to pay a lawyer an upfront fee of about $1,000 to $2,000, said Henry Sommer, president of the National Association of Consumer Bankruptcy Attorneys. Chapter 13 cases usually cost about $2,000 to $3,000 since they require developing a payment plan over several years.

In both cases, there is a court filing fee of about $300. You'll also need to pay roughly $100 for a mandatory credit counseling session and budgeting class.

Both sessions typically last about 45 minutes and may be in person, via phone or online.

If these costs seem out of reach, there are nonprofit groups that provide pro bono legal services. Court fees may also be waived for those who can't afford them.

4. What can I keep?

Pensions and 401(k) retirement accounts are usually safe under bankruptcy proceedings.

Depending on where you live, you may also be allowed to keep a limited amount of property under chapter 7.

In Massachusetts, for instance, people can keep up to $500,000 in home equity as long as there are no liens on the house, said Jack Williams, resident scholar of the American Bankruptcy Institute and a professor of bankruptcy law at Georgia State University. In South Carolina, the home-equity limit is $50,000 for an individual and $100,000 for married couple under changes that took effect in 2006.

By comparison, Maryland doesn't let people hold onto any home equity while Texas puts no cap on how much home equity people can keep. Some states also have capped exemptions for motor vehicles.

"Wild card" exemptions in several states let people keep as much as $20,000 in cash or other assets. The court typically won't go after property worth less than $1,000, because it might take more to administer the liquidation than it's worth.

You may also claim exemptions under chapter 13, but filers often hold onto their belongings by repaying creditors.

5. How does the process work?

Once you file for bankruptcy, an automatic stay immediately requires creditors to stop collection efforts. That means no more phone calls, letters or lawsuits.

Under chapter 7, you still need to pay mortgages and other secured debt.

Within 20 to 40 days after you file for bankruptcy, a trustee will schedule a meeting with you to go over your financial records. Creditors then have up to 60 days to object before debts are discharged.

Only the debts you list when you file for bankruptcy are erased. Any debt you incur or money you earn after filing for chapter 7 is not subject to proceedings. The process should take about four months from filing to approval.

For chapter 13 bankruptcy, repayments start within 30 days after the case is filed, Sommer said.

Interest rates on mortgages, credit cards and other debts will likely drop substantially and the principal may also be reduced. During the repayment process, applications for new loans need to be approved by the trustee.

6. What are the repercussions?

Filing for bankruptcy comes with serious consequences.

To start, a chapter 7 bankruptcy stays on your credit report for 10 years while a completed chapter 13 sticks around for seven years.

Those with decent to good credit can also expect to see their scores drop by at least 100 points, said Barry Paperno, a spokesman for Fair Isaac Corp. Someone who doesn't have many credit card bills but suddenly incurs major medical expenses may fall into this category.

The exact impact on your score depends on how much debt was discharged and how many different accounts were involved. For instance, bankruptcy may have very little impact on someone who already has bad credit - which is often the case for filers. This might apply to people with scores of 500 or lower.

Of course a bankruptcy filing will hamper your ability to get credit going forward, so if you're in habit of living above your means that's an issue bankruptcy can't address.