It is more and more common to encounter a bankruptcy filing when screening new applicants for your vacancy. It’s important to know and understand the different types of bankruptcy filings and how they can affect your decision. Bankruptcy essentially wipes out the debts amassed by an individual or business by offering creditors partial payment through the transfer of assets. There are three types of bankruptcy filings.
Chapter 7 – A widely used form of bankruptcy among business and real estate owners, Chapter 7 deals with the liquidation of assets. For example, if a business files for chapter 7, they must cease operations, sell off their assets (e.g. inventory, land, etc) to pay for part of the debt, and go out of business. If an individual files for Chapter 7, they must also liquidate assets they own such as real estate, automobiles, or recreational merchandise (boats, ATVs, etc). It is common for landlords to come across chapter 7 filings because individuals who had to sell their home will be looking for a place to rent.
Chapter 11 – Usually only seen in the corporate world, Chapter 11 gives a business the opportunity to restructure their debts and reorganize their assets. The business can then start anew as long as it honors the obligations set forth as part of the new structure.
Chapter 13 – Another form common among prospective tenants is Chapter 13. This is when an individual must reorganize their finances under direct supervision of the court. The debtor must submit for approval a plan to repay all debts to creditors within three to five years. This can be problematic for landlords because up to %100 of the individual’s income can be used to repay the debts. However, an individual is likely to declare Chapter 13 over Chapter 7 in order to maintain control of their assets such as real estate. Since Chapter 13 offers a court approved time frame to pay back all debts, liquidation of assets is not mandated.
A bankruptcy will affect an individual’s credit report. All debts charged off in the bankruptcy will no longer negatively affect the credit score of the individual. In fact, they will now have an opportunity to build a higher credit score. When reviewing a tenant credit check containing a bankruptcy, it is helpful to look at other pertinent information. For example, how is their financial behavior post bankruptcy? Have they established a better payment record? Are they amassing another number of debts? Knowing as much as you can about bankruptcy and its different forms will help you to be an effective landlord and make well-informed decisions.