If you file for Chapter 7 bankruptcy, your assets are combined into a “bankruptcy estate.” Some assets are protected, or “exempt,” which means they can’t be sold off to satisfy creditors. Under federal law, assets such as pensions, 401(k) plans, IRAs, Social Security benefits, alimony payments and child support payments are exempt. Most states allow you to protect all or some of the equity in your home, and most allow you to protect the equity in your cars. You can also protect up to a certain amount in household goods. “Non-exempt” assets are liquidated. You get a fresh start, but a bankruptcy can affect your ability to obtain credit for a while going forward. Chapter 7 is a relatively quick process, generally taking just a few months, but you can file for Chapter 7 only if your income is below a certain threshold.
Another option is Chapter 13. If you have a regular income, the bankruptcy court under Chapter 13 will create a plan to pay back creditors for up to five years. Meanwhile, creditors will have to stop collection and foreclosure. It is a longer process than Chapter 7.
If you’re dealing with crushing debt and a failing marriage simultaneously, it makes sense in many cases to file for bankruptcy first. Once you’ve filed for bankruptcy, no matter what type, an “automatic stay” is put into place, stopping creditors from contacting you, freezing your assets and property and temporarily halting all legal proceedings against you. The automatic stay applies to divorce proceedings, too, making it tough for a family court judge to divide up your property, and dragging out the divorce process even longer that it otherwise might be.
If you and your spouse are on fairly civil terms, you might consider filing jointly for bankruptcy before filing for divorce; in some states that would enable you to increase your exemptions. And it might simplify a subsequent divorce proceeding. If you file for Chapter 7, the process is usually complete within six months, allowing you to then move quickly to a divorce.
On the other hand, you might consider filing for divorce first if you and your spouse have a combined income too high to qualify for Chapter 7. Once divorced, you may be able to file for Chapter 7 protection individually instead of having to go through a Chapter 13 payment plan. Additionally, by going through a divorce first, you can resolve support issues prior to bankruptcy. Owing a significant amount in child support or alimony can affect how a bankruptcy will proceed.
Your best bet is to talk to a family lawyer who understands the interplay between bankruptcy and divorce.