What’s the Downside of Filing for Bankruptcy?

If you’ve already tried everything to get out of debt and you’re still drowning, it’s normal to think that bankruptcy sounds almost too good to be true. After all, a Chapter 7 bankruptcy can eliminate your debts in as little as 4 months. Not to mention that the vast majority of personal bankruptcy filings actually allow the filer to keep all of their belongings. As with everything in life, there are some downsides to filing bankruptcy. Let’s take a look at what they are so you can decide whether filing bankruptcy is the right debt relief solution for you.

Some problems can’t be solved using bankruptcy

Filing any type of bankruptcy can be the solution to a number of problems, but whether you should file really only depends on whether it would solve your problems. Let’s take a look at some of the limitations of Chapter 7 bankruptcy. 

Some debts can’t be erased

Filing bankruptcy can provide you with a fresh start, but it’s not for everyone. Depending on the situation, there could be disadvantages to filing a Chapter 7 bankruptcy especially since not all debts can be eliminated with bankruptcy. The following list includes some of the most common non-dischargeable debts:

• debts related to certain taxes such as tax debt from the last 3 years;

• alimony and child support payments;

• debts related to fraud or criminal matters such as court fines and penalties;

• secured debt that is reaffirmed.

Student loans are very hard to eliminate through bankruptcy

To erase student loan debt, a bankruptcy filer has to prove an “undue hardship.” A federal court case interpreted “undue hardship” to mean that a bankruptcy filer’s financial situation will remain the same during the student loan repayment period, that a good faith effort was made to pay back the student loans, and that a minimal standard of living can’t be maintained. This became known as the Brunner Rule. While there’s always exceptions to the rules, when Congress passed the Bankruptcy Abuse Prevention and Consumer Protection Act  known as BAPCPA in 2005, student loans became even more difficult to erase by filing for bankruptcy. 

Since not all debts can be wiped out with bankruptcy, make a list of your dischargeable and non-dischargeable debts. If a large portion of your debt is non-dischargeable, then consider other forms of debt relief such as debt consolidation,or a debt management plan, and consider speaking to a bankruptcy attorney about whether a Chapter 13 bankruptcy makes more sense for your situation.

Some goals can’t be accomplished

Now that your list separates your dischargeable debts from non-dischargeable debts, the next step is to compare your expenses to your net income (after taxes). Include domestic support obligations such as alimony and child support in your calculations. If you still have little to no money left over, or even worse, are negative, bankruptcy isn’t going to change that. It may even make your situation worse because if your house gets foreclosed on or the car you reaffirmed gets repossessed after you filed for bankruptcy, you will have to wait 8 years before you can file Chapter 7 bankruptcy again. During this period, creditors can file lawsuits against you, place liens on your personal property and real estate, and garnish your wages. Therefore, if you can’t keep up with your financial obligations even after filing bankruptcy, then consider other options that reduce your expenses.

Another situation when bankruptcy may not be the solution is with the automatic stay. When a bankruptcy is filed, the automatic stay prevents lawsuits from moving forward, stopping a foreclosure, car repossession, or wage garnishment. However, it’s only a temporary solution. A creditor can always file a motion with the bankruptcy court requesting to lift the automatic stay so the foreclosure or repossession can move forward. A dismissal of your case or receiving the discharge also ends the automatic stay. Also, the automatic stay won’t stop a garnishment because of alimony and/or child support.

Your credit score will take a hit

By the time you file for bankruptcy, most likely your credit score has already been negatively impacted and the interest rate on your credit cards is high. Even other forms of debt relief such as a debt settlement will negatively impact your credit score. Filing for bankruptcy also reduces your credit score, however, the good news is that you can start rebuilding your credit immediately after receiving your discharge. 

You’ll be paying higher interest rates for a while

If you have bad credit, chances are you were already paying a higher interest rate on your debts. After receiving the bankruptcy discharge, you will be able to get new credit cards or personal loans, but you will also be charged a higher interest rate than normal. However, as you continue to rebuild your credit and make timely monthly payments, you will qualify for lower interest rates, saving you money. That’s why it’s important to rebuild your credit to improve your credit score.

You may lose items of value

When filing for bankruptcy, the bankruptcy forms are divided into sections known as schedules where certain information is listed. For example, unsecured debts are listed in Schedule E/F, income on Schedule I and the Statement of Current Monthly Income, and expenses on Schedule J. On Schedule A/B is where all your personal and real property is listed. 

Depending on the laws in your state, a Chapter 7 bankruptcy may result in losing some of your assets, unless protected by a bankruptcy exemption. For example, in Florida, the available exemption for a car is limited to $1,000. That means any equity in your car above $1,000 may not be protected. Equity is determined by the value of the asset minus what you owe. Say your car is worth $10,000 and you owe $6,000 to the bank. Your equity is $4,000. However, when you include the $1,000 exemption, $3,000 is not protected by an exemption (non-exempt). That’s the amount the bankruptcy trustee is entitled to collect to pay to your creditors. If you can’t afford to pay back the trustee the non-exempt amount, the trustee can force the sale of your car and use the net proceeds to distribute the money to your creditors. In that case, you’ll get your $1,000 exemption to buy another car.

Chapter 7 bankruptcy will not protect your co-signers

Do you have co-signers on any of your debt? Sometimes there may be a co-signer because it was required by the lender or to get a lower interest rate, but regardless of the reason, a co-debtor is just as responsible for the debt as you are. Therefore, even though you received your discharge and are no longer responsible for that debt, your co-signer is. The only way to protect the co-signer is with a Chapter 13 bankruptcy, so long as the case remains pending.

Possible unintended consequences

Did you owe money to a friend or family member and paid them back? Did your son or daughter just get their driver’s license and as a gift, you transferred your car to them? While you did the admirable thing by keeping your word with your friend and you will earn praises from your son/daughter, in bankruptcy court this could be a problem.

Paying back a friend for an outstanding debt could be considered preferential treatment and transferring the car to your son/daughter could be considered a fraudulent transfer. As a result, the trustee could sue your friend to get the money back or your son/daughter for the car.

Filing for bankruptcy too soon is another common mistake. For example, having to file bankruptcy because of medical bills and health related costs is common, but if you have future treatments and surgeries pending, there will be additional medical bills. If you didn’t include those debts in your Chapter 7 bankruptcy by filing too early, you will have to wait several years before you can file bankruptcy again.

It’s also important to understand the 180 day rule, and how it affects your bankruptcy case if you receive an inheritance after filing your case. For example, if you received an unexpected inheritance within 180 days of filing for bankruptcy, you are required to disclose that in your bankruptcy forms. It doesn’t even matter if you aren’t expected to receive the money for months or even years from the date you filed your Chapter 7 bankruptcy. The same applies to a personal injury case that happened before your case was filed. That money becomes part of the bankruptcy estate and, unless protected by an exemption, the trustee could be entitled to it.

Chapter 7 is not an option for everyone

To qualify for bankruptcy, you have to pass what is known as the Means Test. The Means Test was one of the changes in BAPCPA. Passing the Means Test means the average of your last 6 months of income is below the required state limits, or the extended analysis shows that you’re unable to pay at least a portion of your debts despite being over the limit. If you don’t pass the Means Test, you may be able to proceed with a Chapter 13 which is another type of personal bankruptcy.

Filing a Chapter 13 bankruptcy is a long-term commitment

If you didn’t qualify for a Chapter 7 bankruptcy because of the Means Test, you still have the option of proceeding with a Chapter 13 bankruptcy. A Chapter 13 is different from a Chapter 7 in several ways. For example, with a Chapter 7, you can complete your bankruptcy and receive a discharge within 3 to 4 months after filing. With a Chapter 13, there is a monthly payment plan with the court that lasts 36 to 60 months. Your payment is then used to pay back a portion of your debts. Because of the lengthy payment plan, the success rate for Chapter 13 bankruptcies is low, approximately 33% versus 96% for Chapter 7 cases. Since Chapter 13 cases are more complicated than a Chapter 7, attorney fees are also much higher. Nationwide, the average fee for a bankruptcy lawyer is $1,500, compared to $3,000 plus for a Chapter 13, and that doesn’t include filing fees or fees for additional motions. Because Chapter 13 bankruptcies are more complicated than Chapter 7 cases and have a much lower success rate, you shouldn’t consider filing a Chapter 13 on your own. Chapter 13 bankruptcies that are filed pro se which is another way of saying they were filed without the help of a lawyer, have less than a one-half of one percent (.5%) chance of getting approved by the bankruptcy court. If your case gets dismissed, you may have to wait six months before you can file again. Upon dismissal, you lose the protection of the automatic stay and creditors can pursue collection actions against you and lawsuits can proceed. This may put you in a worse position than when you started. It’s best to  consult with a qualified bankruptcy lawyer experienced in handling Chapter 13 bankruptcies, instead. 

Filing bankruptcy can be confusing and a lot of work

Even with the help of a bankruptcy law firm, bankruptcy can be time consuming. Before you file for bankruptcy, you have to review your credit report and any collection notices you’ve received in the mail to make sure all of your debts are included in the bankruptcy petition. You will need the last 6 months of pay stubs and with each pay period, you must provide your new pay stub to your bankruptcy attorney. You also need to complete the credit counseling class. 

After filing for bankruptcy, there are additional documents that must be provided to the bankruptcy trustee such as tax returns and bank statements. You also have to complete the second credit counseling class. If you fail to comply, your case will be dismissed. But with Upsolve, we are here to help guide you through the bankruptcy process free of charge. If you can’t afford a bankruptcy lawyer, try our free web tool to prepare your forms and file Chapter 7 bankruptcy on your own.