The Last Resort
Bankruptcy can be a good solution for individuals who have tried other methods of debt resolution and have experienced no relief. Sometimes, a debtor has tried budgeting, refinancing is not an option, and credit counseling has even proven ineffective because they can not afford to pay their bills through the counseling company and still meet their other obligations. After being forced into a “rob Peter to save Paul” last ditch effort, the debtor realizes they need salvation. Often, debtor’s finances are stacked against them. Limited financial resources cause a situation in which attempts to handle the debt is just prolonging the agony and making it nearly impossible to effectively satisfy all of their obligations. Bankruptcy may be the only effective alternative to dealing with the tension and emotional distress that are created by the financial hopelessness. When a consumer files bankruptcy, they are protected from the emotional distress of collection attempts because the creditors must obey an automatic stay that requires them to cease any collection activity, including telephone calls, bills, and even law suits that are pending against them. Each bankruptcy case is assigned a court appointed trustee who acts as an intermediary and is responsible for seeing that the creditors re-cooperate as much as possible within the legal limits of the bankruptcy court.
The decision to file bankruptcy is one that should be thought out thoroughly. Many consumers learn, only after filing, that it has lasting negative effects that limit financial options and ability to obtain credit. Many bankruptcy attorneys are overzealous in their approach to soliciting the benefits of bankruptcy because they earn money by helping consumers file. Likewise, in their pursuit of money, aggressive collectors scare consumers, who are unaware of their legal rights, into unnecessarily filing bankruptcy. Often, consumers realize that the long-term sacrifices created by the lasting effects of filing bankruptcy outweigh the pain that the collectors were causing. In many cases, if the debtor had “called the collector’s bluff” and simply ignored the threats, they would have realized that they were unfounded.
Instead of viewing it as a last resort, many consumers view bankruptcy as a “get out of debtors prison free card” that can be redeemed when debt repayment gets too difficult. Bankruptcy can help consumers get out of debtor’s prison but it certainly comes with a price. Viewing bankruptcy as an “easy way out” can cause extremely poor spending habits by consumers who fail to face the reality of their financial mismanagement and fall right back into the same situation. Bankruptcy often carries long term derogatory affects on credit and successful future financial management and understanding. Individuals who view bankruptcy as an easy way out, often fail to learn from their mistakes and continue to exhibit the adverse spending behaviors that created their problem in the first place. Bankruptcy should be viewed as a right and not a privilege. Many consumers who want to file, learn after assuming massive amounts of debt, that it will not all be dismissed. There are different types of bankruptcy, each having it’s own guidelines and limitations. Financial circumstances often prohibit consumers from instantaneously eliminating all of their debt.
The Lingering Effects of Bankruptcy
Though bankruptcy may be a very good solution to a severe financial problem, filing carries negative effects that follow a debtor for a relatively long time. The debtor may lose property that is non-exempt (unprotected) and have to start over again in fulfilling their life long goals. Bankruptcy will appear on a consumer’s credit report for seven to ten years depending on which type of bankruptcy is filed. Chapter 7 will normally be reported for 10 years because it does not involve any form of repayment plan to creditors and debts are completely discharged. Chapter 13 may carry less of a stigma and often appears for only 7 years on a debtor’s credit file because the debtor arranges to repay a portion of their debt. Filing bankruptcy carries a negative stigma because it is viewed, by some, as an indication that an individual does not know how to live up to their financial obligations. However, bankruptcy gives consumers the ability to “wipe the slate clean” and start over again. The after effects of bankruptcy are severe and require reestablishment of “creditor confidence,” which often takes a long time. Bankruptcy may be a relatively quick and easy solution to financial woes, but it is also a quick way to severely damage credit worthiness. Repairing credit often requires a considerable amount of time and there is no simple solution to damaged credit.
Often, consumers who are in the process of rebounding from filing bankruptcy and reestablishing credit, suffer financial penalties as a result. Acquiring additional credit is very difficult and if the consumer is granted credit, they may be penalized by the interest rate that they have to pay on the money that is loaned to them. Obtaining unsecured lines of credit such as conventional credit cards is extremely difficult, if not impossible, immediately after filing bankruptcy because there is no collateral to offset the risk of loaning money. Since filing bankruptcy is the most drastic measure that can be taken as a solution to debt problems, most creditors consider lending to consumers who filed bankruptcy, a very risky proposition. Due to the increased risk in lending to individuals who have filed bankruptcy, the interest rate that the creditor will grant to bankruptcy filers can be significantly higher (sometimes double.) Over time, the high interest rates will cost the consumer a lot of money and will drive the consumer’s monthly payment obligations up considerably. Creditors are less reluctant to lend to consumers on secured lines of credit because the collateral helps offset the risk of lending to an individual who has filed bankruptcy. If the consumer defaults on the loan, the creditor can foreclose upon or repossess the collateral.
The Process of filing Bankruptcy
Title 11 of the United States Bankruptcy Code governs bankruptcy proceedings and bankruptcy is a matter of public record. To file bankruptcy, you must first file a bankruptcy petition. You must also complete schedules of assets and liabilities, and prepare a statement of financial affairs. These forms will require you to list your property and account for recent sales of personal property. They also require you to list your income, the debts that you owe, and account for any money that you spent during the two-year period prior to filing. You must list all of your debts on the bankruptcy petition. The bankruptcy court will require that you pay a filing fee, which is approximately $175. The filing fee is separate from the fees that a consumer pays to their personal bankruptcy attorney for representation and guidance in filing.
In chapter 7 cases, the debtor is required to attend at least one meeting of creditors, during which, they may be questioned, under oath, by a court appointed bankruptcy trustee and the creditors about their finances. In chapter 13 cases, the debtor may be required to attend multiple meetings with the creditors to work out a repayment plan in detail. A valuation hearing may be needed if the creditors are in disagreement with the value of the assets that the debtor listed on their schedules. During a bankruptcy proceeding, if a creditor suspects that a consumer is withholding information or that they have hidden or transferred assets to other individuals, they are entitled to question the debtor at the meeting(s) of creditors. The creditor reserves the right to file an adversary proceeding if they feel that a claim is non-dischargeable. Typically, a creditor will file an adversary proceeding against claims involving criminal misconduct such as debts incurred on the basis of fraud or larceny, breach of trust or embezzlement, or debts from willful or malicious injury to another person or their property. The creditor may also file an adversary proceeding against damages arising from drunk driving obligations. The trustee will be particularly interested in determining if the filer is attempting to abuse the bankruptcy system. The trustee will be particularly interested in determining the following:
- If there are any assets that are non-exempt
- If the debtor has concealed or transferred assets
- If the debtor ran up debts prior to filing
- If the debtor used false information on credit applications to obtain credit.
If a debtor is found guilty of misconduct, their debts will not be discharged for that filing or for any future bankruptcy proceedings. Additionally, the trustee may attempt to recover any assets that were transferred out of their name and liquidation of their assets may continue for the benefit of the creditors to whom the debtor must repay the debt.
The Most Common Forms of Bankruptcy
Chapter 7 Bankruptcy
Chapter 7 is otherwise known as “straight bankruptcy” and is considered to be the “quick fix” solution to eliminating debt. The debtor is allowed to retain all assets that are considered exempt assets. Filing Chapter 7 may require that the courts liquidate the value of non-exempt personal property. This means that the trustee may sell unprotected personal property to repay the creditors who loaned money to the debtor. Non-exempt assets may include collateral such as a house, car, or land that the debtor used to secure a loan. There are limitations from state to state that determine what personal property may be exempted but Chapter 7 provides adequate protection for most assets.
Chapter 7 is best for debtors who have excessive unsecured debt because it completely eliminates the debtor’s legal liability and responsibility for repaying unsecured debt. However, if the debtor is behind on secured debt (debt involving collateral), such as a home or car, it will not eliminate their obligation to repay the debt nor the amount that they fell behind. For chapter 7 bankruptcies, the time frame from filing to receipt of discharge can usually take anywhere from 3 to 5 months. Discharge is when the bankruptcy court officially ends your case and dismisses you from the legal liability to repay the debts. Only debts that are listed on the bankruptcy petition forms and existed on the date that the bankruptcy was filed may be discharged. If a debtor desires to retain property that is secured by collateral, they will have to make acceptable arrangements to pay for it during or after the bankruptcy because the discharge does not eliminate the creditor’s right to reclaim the property. It only prevents them from holding the debtor responsible for legal liability. In other words, if they take the property and sell it and the proceeds do not cover the balance that is owed, they cannot hold the debtor responsible for the difference (their loss.)
If a debtor files chapter7, the creditors may pursue any cosigner who agreed to accept legal liability for the debt. The creditors will probably require that the debtor signs a reaffirmation agreement if they desire to keep personal property that was used to secure a loan. Through the reaffirmation agreement, the creditors allow the debtor to keep the property, but the debtor agrees to remain legally liable for it. When a debtor reaffirms, they forfeit the automatic stay that protects them and the debtor and creditor then have the same rights and liabilities that they had before the bankruptcy was filed. After signing the reaffirmation agreement, if the debtor falls behind during or after the bankruptcy, the creditor can repossess the property and legally pursue the debtor for any losses that remain after selling the property.
Following are Debts that cannot be discharged through Chapter 7:
- Credit card, personal loans, and installment purchases made within 40 days of filing.
- Debts resulting from fraud
- Debts resulting from drinking and driving or reckless driving.
- Fines from traffic tickets or debts that result from criminal negligence
- Debts from willful or malicious injury to another person or their property Alimony
- Child Support
- Student Loans(*)
In 1998 the law changed with regard to discharge of student loans. Prior bankruptcy law allowed student loans to be discharged once they were 7 years or older from the day they were first due. Currently, student loans cannot be discharged unless the debtor passes an undue hardship test. The debtor has to prove that they made good faith efforts to repay the loan and prove that they cannot maintain a minimal standard of living if you were forced to repay the loan(s). The guidelines of a “minimal standard of living” are very rigid and discharge of student loans under Chapter 7 is uncommon.
Income Taxes (*)
* Generally speaking, for taxes to be discharged, the following criteria must be met: A tax return filed for the year in question was filed on time, or if not, then it was filed at least two years before the bankruptcy. The tax is over three years old. The tax was assessed more than eight months before the bankruptcy was filed. The debtor did not willfully evade the tax.
Chapter 13 Bankruptcy
Chapter 13 differs from chapter 7 because it involves a repayment plan that is submitted to the trustee and the bankruptcy court for approval. The debtor is required to create a feasible monthly budget that will enable them to meet their basic needs and still be able to afford to make scheduled payments to the bankruptcy trustee. A formal plan is prepared and submitted with the bankruptcy petition to determine how much money will be repaid to the creditors through a deed trust payment each month. Chapter 13 permits a debtor to repay in monthly installments for three to five years and allows the debtor to keep all of their assets, even if their value exceeds the amount of the exemptions allowed by the state. Chapter 13 allows debtors to propose repayment of unsecured debts such as credit cards at a fraction of what was owed. You may maintain your secured assets because, over time, you will be repaying your creditors the amount that you had fallen delinquent. To qualify for chapter 13, your unsecured debts must be less than $250,000 and your secured debts must total less than $750,000. In addition, you must have a stable and regular income.
If a debtor has considerable debts that may be liquidated and lost under Chapter 7 they may consider chapter 13. Debts that would not be discharged under chapter 7 can be included and retained under chapter 13. For example, if a debtor’s mortgage or auto payments are behind and they do not have the ability to bring them current, Chapter 13 may be the answer. It will allow the arrears to be paid back over a three to five year period and the creditors would not be permitted to repossess the vehicle, provided the debtor made the bankruptcy payments on time. Chapter 13 allows a debtor who was in arrears on federal income tax to establish a payment plan through which they can pay the IRS back over time. Under chapter 13 the automatic stay will protect any cosigners on the consumer’s debts. A chapter 13 bankruptcy is not discharged until all deed trust payments have been made which usually takes three to five years.