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How Bankruptcy Exemptions Work


Before the change in bankruptcy laws in 2005, some homeowners tried to protect themselves by moving to a state with a generous homestead exemption (like Florida), then buying a very expensive house.
Before the change in bankruptcy laws in 2005, some homeowners tried to protect themselves by moving to a state with a generous homestead exemption (like Florida), then buying a very expensive house.
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Unpaid bills pile up in a corner. Creditors hound you daily. You're working hard, but it's just not enough. Or maybe you have a spending problem. Or enormous medical bills. Whatever the reason, you simply can't pay your debts. You have to declare bankruptcy.

Sweat beads on your forehead. Visions of a foreclosure sign on your front lawn flash into your mind, followed by images of your car being towed away. What will happen? How will you live? Take a deep breath and relax. State and federal governments don't want to see you wind up in the poorhouse, either, so they offer bankruptcy exemptions to help get you back on your feet.

Before explaining exemptions, here's a quick bankruptcy primer. When you file for bankruptcy, you have a choice of filing for Chapter 7 or 13 bankruptcy. (Chapter 11, a well-known filing, is mainly for businesses.) Once you file, most of your property (home, vehicles, jewelry and furniture) becomes part of your bankruptcy estate, meaning it can be sold to pay off your debt -- unless it can be exempted, or protected from sale.

Under Chapter 7 bankruptcy, a quicker, easier process, your assigned bankruptcy trustee sells off your unprotected, or nonexempt, assets to pay back your creditors. It's generally the best option if most of your debts can be paid off by filing Chapter 7, and if most of your property can be exempted, or protected [source: Lazun].

Under Chapter 13 bankruptcy, you can keep your property, but you must create a three- to five-year payment plan to reimburse your creditors. The amount you have to pay back equals the value of your unprotected, or nonexempt, assets. This plan works best if you have enough income to afford the payment plan [source: Lazun].

So under Chapter 7, bankruptcy exemptions protect your property. Under Chapter 13, they lower the amount you have to pay back. Now the question is whether to use your state's bankruptcy exemptions or those created by the federal government.


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