When to Declare Bankruptcy
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You have many options for debt relief. There are debt settlements, debt management plans, debt consolidations, and bankruptcy. Each option has pros and cons. The best choice for you will depend on your particular situation. Whether you should file bankruptcy and what type of bankruptcy to file is unique to your situation. Everyone's financial situation is different.
Written by Attorney John Coble.
Updated July 22, 2020
You have many options for debt relief. There are debt settlements, debt management plans, debt consolidations, and bankruptcy. Each option has pros and cons. The best choice for you will depend on your particular situation. Whether you should file bankruptcy and what type of bankruptcy to file is unique to your situation. Everyone's financial situation is different. A Chapter 7 bankruptcy may have been the perfect solution for your next-door neighbor, but that doesn’t make it the best option for you. There are many factors to consider when deciding which debt solution is best for you. Consider the following scenarios.
Scenario 1: You are a twenty-five year old with no money in your retirement account. You are in good health. You have $30,000 in unsecured debt in the form of credit cards and medical bills. You have a $20,000 car loan and you’re behind on this loan by three months. You rent your home. You have a spouse and one child. Your total household income is $40,000 which is lower than the median income for a household of three in your state. In this case, a Chapter 13 bankruptcy may be an excellent choice since it would help you save the car.
Scenario 2: Everything is the same as the first scenario, except you are fifty-five years old. In this second scenario, it makes a lot of sense to let the car go back and file a Chapter 7 bankruptcy to eliminate the unsecured debt sooner and start putting money into your retirement account. If you choose to pay creditors with this money, you may have insufficient money to live on when you retire. Filing allows you to surrender the car to the creditor and buy a cheaper car. In this second scenario, the filer has only a few years until retirement and this makes all the difference.
These two scenarios are examples of the careful consideration necessary when determining which chapter of bankruptcy you should file. If you think you need to file a Chapter 13 bankruptcy, you need to discuss the issue with a bankruptcy lawyer. Most bankruptcy attorneys provide free consultations.
What Are the Alternatives to Filing Bankruptcy?
Bankruptcy isn't your only option. You have a few debt relief choices. You could take out a loan to consolidate all your debts into one monthly payment. Debt consolidations only make sense if your credit score is high enough for a low-interest rate loan. Debt consolidations will not harm your credit report if you use the loan as intended. Alternatively, you could hire a non-profit credit counseling agency to negotiate a debt management plan for you. These debt management plans are your best option if your credit score isn't high enough for you to get a debt consolidation loan. Debt management plans do harm your credit score at first, but your credit score improves as your loan balances decrease. You can also negotiate with your creditors yourself or you can hire a debt settlement company. These debt settlements only make sense if you have substantial funds available to settle your debts and you don't care about your credit score. Debt settlements may be more harmful to your credit score than a bankruptcy. Another choice you have is to "do nothing." In some cases, "doing nothing" might be your best option.
"Doing nothing" is the best choice if you are collection proof. Being collection proof is sometimes referred to as being "judgment proof." The idea is, that even if a creditor used their best tool, a lawsuit, they wouldn't be able to collect from you. If the creditor wins the lawsuit against you and gets a judgment against you, they aren't able to collect because you have no nonexempt property or nonexempt income. In these "collection proof" cases, some people still want to file a personal bankruptcy to stop the collections calls. In such cases, it may be better to contact a consumer attorney and get relief under the Fair Debt Collection Practices Act (FDCPA).
Usually, being "collection proof" means that you have very little property and your income can’t be garnished. However, there are a few states that have an unlimited homestead exemption. If you have lived in one of these states for the necessary amount of time, you could have a home worth a million dollars and still be "collection proof."
Most people need help navigating through the complex considerations necessary to decide if they should file bankruptcy, or choose another debt relief option. The first place to look for help should be a nonprofit credit counseling agency. A professional credit counselor will be able to give you clear guidance based upon your unique situation.
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What Can Bankruptcy Do for Me?
All collection actions must stop as soon as you file bankruptcy forms due to the automatic stay. Your petition is time-stamped to show the exact minute the "stay" took effect. This means wage garnishments, repossessions, and foreclosures must stop. This halt of collection activity is rarely an issue. In rare cases when a creditor doesn't comply with the bankruptcy laws, the bankruptcy judge may issue sanctions against that creditor.
Repossessions and foreclosures involve secured debts. These are loans that have a collateral interest in some of your property. In the case of repossession and foreclosures, the collateral is your car and house respectively. In a Chapter 7 bankruptcy, you must catch up on these debts quickly, or the judge will grant relief from the automatic stay for the creditor. This means the repossession or foreclosure can continue even though you have filed for bankruptcy.
In bankruptcy proceedings under Chapter 13 of the United States Bankruptcy Code, the repayment plan must show that a car loan will be paid through the Chapter 13 plan or the creditor will be granted relief from the automatic stay. In a Chapter 13 bankruptcy, mortgages are not usually paid through the Chapter 13 plan if you’re current when your case is filed. If you’re behind, the "arrearage" on your mortgage is paid through your Chapter 13 plan and in some instances, all mortgage payments that come due during the repayment plan are paid through the Chapter 13 trustee. Even if your Chapter 13 plan shows that you will pay your mortgage arrearage through the plan, you must keep your regular mortgage payments current. If you fall behind on your regular mortgage payments after filing a Chapter 13 bankruptcy, the mortgage company will get relief from the automatic stay and be able to foreclose on your home. Child support arrearage can also be paid through your Chapter 13 plan, but if you fall behind on your child support payments while in a Chapter 13, you will not get your fresh start in the form of a bankruptcy discharge. In either chapter of bankruptcy, a creditor can get relief from the automatic stay if you fail to pay the insurance premiums on the collateral.
Evictions receive special treatment under the Bankruptcy Code when it comes to the automatic stay. Whether the automatic stay can stop eviction after an eviction order has been issued depends on the law in your state. If the automatic stay is available, then the tenant must deposit the amount due for the next thirty days with the clerk of the court when the case is filed. Then, the tenant has thirty days to catch up on the back rent. Note that this rule only applies when the eviction was due to nonpayment of rent. If the eviction was due to illegal drug use or endangerment, this provision doesn't apply regardless of where you live.
When you have successfully completed your bankruptcy, your discharged debts are eliminated. This means no one can ever try to collect these debts again. The discharge is similar to the automatic stay except that the discharge continues forever, whereas the automatic stay ends when the discharge is entered or the case is dismissed.
What Types of Bankruptcy Are There?
Chapter 7 and Chapter 13 bankruptcies are the two types of consumer bankruptcies. Chapter 7 bankruptcies eliminate most of your unsecured debts such as credit card debts. The Chapter 7 bankruptcy process takes about 3 - 6 months. A Chapter 13 bankruptcy is a debt consolidation plan supervised by the bankruptcy court. Chapter 13 bankruptcies are three to five-year payment plans. The advantage of a Chapter 13 bankruptcy is that you can pay off most secured debts through the repayment plan. A Chapter 13 bankruptcy can also eliminate some unsecured debts that can't be discharged in a Chapter 7 bankruptcy.
Eligibility Requirements for Chapter 7 vs. Chapter 13 Bankruptcy
To be eligible to file a Chapter 7 bankruptcy, you must either have an income less than the median income in your state, or you must pass the means test. If your income is above the median income for your state, the means test analysis determines whether you’re eligible to file Chapter 7 bankruptcy. The means test uses a table of what your expenses should be and deducts these expenses from your net income. These tables have set expense amounts based on household size. The housing, mortgage/rent, and utility expenses in the table will depend on the particular county where you live. Transportation expenses depend on the region of the country where you live. You must have permission from the Bankruptcy Court to claim expenses that are greater than the expense tables allow. Getting the Court to allow higher expenses is not an easy task.
Chapter 13 repayment plans must pay at least as much to the general unsecured creditors as the creditors would have received had you filed a Chapter 7. In most cases, this is nothing. However, many courts required that these creditors get at least a nominal amount such as 5% of the amount owed. Priority debts such as some taxes are fully paid through a Chapter 13 plan. Secured debts such as your car loan must be paid through the Chapter 13 plan if you want to keep the car. After adding the bankruptcy trustee's fee, the filing fees, and the attorney fees, you have the minimum amount that must be paid through your Chapter 13 plan. You can divide this amount by thirty-six months or sixty months to get your minimum monthly payment.
Once you have your minimum monthly payment amount, you need to determine if your disposable income is high enough to be able to afford this amount. To get your Chapter 13 plan approved by the Bankruptcy Court, you must prove to the satisfaction of the Court that you can afford the minimum payment. If your disposable monthly income is high enough that you can afford more than the minimum amount, you may have to pay a higher percentage to the general unsecured creditors.
In short, in Chapter 13 bankruptcies, your disposable income must be at least the minimum amount that must be paid in Chapter 13 bankruptcies. If the disposable income is higher than the minimum amount, your disposable income will be your monthly payment amount.
Bankruptcy is one option you have for debt relief. Your particular situation may not be one that requires bankruptcy. For you, a debt consolidation, debt management plan, or debt settlement might be the best option. The best place for help in deciding which debt solution is best for you is a nonprofit credit counseling agency. If it looks like bankruptcy is a good option for you, seeing a bankruptcy attorney for a free initial consultation may be a good idea. For many Chapter 7 bankruptcies, you can prepare your own bankruptcy forms through Upsolve for free. Upsolve wants you to make the best decision for your particular situation.