Many people use the terms bankruptcy and insolvency interchangeably, even though they have different meanings. However, it’s crucial to understand the differences between the two when you’re in a bad financial situation. Here’s what you need to know. 

What Is Insolvency?

Technical Insolvency

When you can't pay what you owe, a creditor might cancel some or all of the debt as part of a renegotiation. To the IRS, however, the debt still plays a role in your taxable income—unless you can show you are insolvent. Technically, insolvency means that your debts outweigh your assets; in other words, you owe more than you own. In this situation, the tax code permits you to exclude canceled debts from your income tax return. 

Informal Insolvency

Informally, insolvency means you are unable to keep up with debt payments. This can happen when you lose your job, have a long hospital stay, or buy more on credit than you can afford to pay for. Insolvency is the problem, while bankruptcy is the solution.

What Is Bankruptcy?

Bankruptcy is a legal procedure that helps you achieve debt relief. When you cannot afford to pay your debts, you may file a bankruptcy petition with the court. This temporarily stays any foreclosure or repossession actions and stops creditors from harassing you with phone calls. Next, you’ll reveal your income, assets, and debts to the court and work out terms that are as fair as possible for all parties.

There are two types of personal bankruptcy: Chapter 7 and Chapter 13. Under the former, people with significant assets but little income can liquidate non-essential assets and use the proceeds to pay off some or all of their debt. The court discharges any remaining debt, and you are free to start your financial life over. It is the quickest solution, but you’ll lose assets. 

Under Chapter 13 bankruptcy, people with a regular income can renegotiate payment terms. This lets them make smaller payments—sometimes for a shorter period of time—and repay the debt without having to liquidate assets. Debt relief does not happen as quickly as with Chapter 7, but you can avoid liquidating any assets. After a prescribed number of monthly payments, the remainder of the debt is sometimes discharged.

If you need an experienced bankruptcy attorney to help you with debt relief, contact The Law Office of Christopher J. Swatosh, LLC in Ava, MO. Christopher and his team have been serving Douglas County and Central Missouri for more than 20 years. They also maintain an office in Ozark, and they specialize in bankruptcy law. Visit their website to learn more about your options, or call (417) 683-2987 to arrange a consultation.