A group of bankruptcy attorneys from all over the United States have started blogging about the “Bankruptcy Alphabet.” I decided to join in, so here is my first contribution: A is for Abuse.
I’m not talking about abusive debt collectors. I’m talking about the presumption of abuse that arises in some Chapter 7 bankruptcy cases. In short, a presumption of abuse arises if the debtor’s income is above the median income for a similarly-sized household AND the debtor cannot “pass” the means test.
The first prong of this test is very mechanical. We simply look at the debtor’s income over the last six months, multiply it by two, and compare the resulting annual income to the median. In Wisconsin, the median income for a household of four is $76,000. Social Security income is not included in this calculation, but most other forms of income are included. If the debtor’s income is below the median, the case is not presumed to be an abuse of the bankruptcy system.
If the debtor’s income is above the median, we need to go to the second prong of the test, the means test. The means test is essentially a set of deductions Congress has decided debtors are allowed to subtract from the income that was calculated in the preceding paragraph. After taking all the deductions, if the debtor has more than approximately $115 left over AND could pay back 25% of the amount he owes to his unsecured creditors over 60 months, the case is presumed to be abusive.
If a Chapter 7 case is presumed to be an abuse of the system, the debtor can file a statement rebutting that presumption. The U.S. Trustee’s Office will then review the case and either (1) ask the Court to dismiss the case or require the debtor to convert the case to a Chapter 13 or (2) agree that the case is not abusive and should be allowed to proceed under Chapter 7.
This is a simplified version of the means test and question of abuse. If you have general questions about the presumption of abuse in Chapter 7 cases, please post them in the comments below and I’ll answer them as best I can. If you have specific questions about your individual situation, contact your local bankruptcy attorney.
Bankruptcy attorneys from around the country are taking part in this “Bankruptcy Alphabet” exercise. Please take a few minutes to check out these other blog posts on the letter “A.”
Abandonment – by New York Bankruptcy Lawyer, Jay S. Fleischman
Abuse of Bankruptcy – by Pittsburgh Bankruptcy Attorney, Shawn N. Wright
Address – by Tuscaloosa/Birmingham Bankruptcy Lawyer, Melinda Murphy Dionne
Advantages of Filing – by Columbus, Ohio Bankruptcy Lawyer, Athena Inembolidis
Adversary Proceeding – by Philadelphia Bankruptcy Lawyer, Kimberly Coleman
Alimony – by Philadelphia Suburban Bankruptcy Lawyer, Chris Carr
Allowance – by Westlake Bankruptcy Attorney William Balena
Application – by Lakewood, CA Bankruptcy Attorney, Christine A. Wilton
Arrest – by Cleveland Area Bankruptcy Attorney Bill Balena
Ask – by San Francisco Bankruptcy Attorney, Jeena Cho
Assets – by Hawaii Bankruptcy Attorney, Stuart Ing
Assets – by Marin County Bankruptcy Attorney, Catherine Eranthe
Assets – by Metro Richmond Bankruptcy Attorney, Mitchell Goldstein
Assume – by Northern California Bankruptcy Lawyer, Cathy Moran
Assumption – by Los Angeles Bankruptcy Lawyer, Mark J. Markus
Assumption – by Taylor Michigan Bankruptcy Attorney, Christopher McAvoy
Assumptions – by Newnan, Georgia Bankruptcy Lawyer, Rick Palmer
Attachment – by Vermont/New Hampshire Bankruptcy Lawyer, Michelle Kainen
Attorney – by Daniel J. Winter, Chicago Bankruptcy Attorney
Automatic Stay – by Connecticut Bankruptcy Lawyer William E. Carter
Automatic Stay – by Omaha/Lincoln, Nebraska Bankruptcy Attorney, Ryan D. Caldwell
Automatic Stay – by Chicago Bankruptcy Attorney, Kyle A. Lindsey
Automatic Stay – by Livonia Michigan Bankruptcy Attorney, Peter Behrmann
Automatic Stay – by Birmingham Bankruptcy Attorney, Elizabeth Johnson
Automatic Stay – by Houston Bankruptcy Attorneys, Busby & Associates
Automobiles – by Colorado Springs Bankruptcy Lawyer Bob Doig
Avoidance – by Ormond Beach Bankruptcy Attorney, Lewis Roberts
Avoidance of Preferential Transfers – by St. Louis, Missouri Bankruptcy Attorney, Nancy Martin
Image credit: cheesy42/Flickr
A few months ago, I wrote about seven things you shouldn’t do if you are considering bankruptcy. This post expands on one of them, using credit cards.
In bankruptcy, the general rule is that debts are discharged while liens remain intact. Section 523 of the Bankruptcy Code lays out exceptions to this rule. Section 523(a)(2) tells us that a debt incurred fraudulently is nondischargeable and will still be owed after the bankruptcy case is closed. Other than cases of identity theft, where one uses someone else’s name to buy goods on credit, how can credit card debts be fraudulent?
The short answer is that using a credit card without intending to repay the debt is fraudulent. Because people don’t state, “I’m not going to pay this bill!” when swiping their credit cards, courts must look at the surrounding circumstances to determine if a particular debtor used his credit card fraudulently. Here are a few facts a court will consider if a creditor accuses a debtor of fraudulent credit card use:
1 – Using the card after talking to a bankruptcy attorney. Consider this scenario: Debtor meets with her attorney on Friday. On Saturday, she goes to an electronics retailer and uses her credit card to buy a new TV, a Blu-ray player, and an Xbox 360. On Monday, she files for bankruptcy protection. Could she really keep a straight face when telling the judge that she intended to repay those Saturday charges?
2 – Using the card to purchase luxury items. The Bankruptcy Code presumes that charges totaling over $600 for luxury goods or services made within 90 days of the bankruptcy filing are nondischargeable. Defining “luxury goods” is more art than science, but the determination will be made using a reasonableness standard (i.e. if the purchases were reasonably necessary living expenses).
3 – Failing to make any payments on the card after making purchases. If the debtor made purchases without making any payments on the account, the court could infer the debtor never intended to repay the debt. On the other hand, if the debtor made monthly payments for a few months after his last purchase, it would appear that he was making his best effort to repay the debt.
Before you get to the point where you are relying on credit cards to pay for food, clothing, and rent, speak to a bankruptcy attorney. If you decide to file bankruptcy, you’ll want to make sure your pre-filing credit card use doesn’t prevent you from getting the discharge you deserve.
Image credit: Images_of_Money/Flickr
Are taxes dischargeable in bankruptcy? Your brother’s neighbor’s cousin may have told you, “no. Taxes cannot be discharged in bankruptcy.” Like most pearls of legal wisdom that come from non-lawyers, there is some truth to this, but the statement is incomplete. While many taxes are nondischargeable, some taxes may be discharged in a bankruptcy.
The relevant sections of the Bankruptcy Code are Section 507 and Section 523. Reading them together, we see there are four grounds of non-dischargeability. Think of them as four tests; if you can pass all four tests, the tax debt is dischargeable.
Taxes are dischargeable if:
1 – the tax was due more than three years ago,
2 – the tax was assessed more than 240 days ago,
3 – the tax return was filed more than two years ago, and
4 – the filed tax return was not fraudulent and the debtor did not willfully evade the tax.
This is a simplified explanation, but these are the questions your bankruptcy attorney will ask when trying to determine the dischargeability of your tax debt.
As you can see, the four tests above exclude from discharge taxes which were last due within three years and taxes for which a return was never filed. This is why I usually advise my clients to file their tax returns on time, even if they can’t afford to pay the tax. It’s typically best to start the clock ticking on the 240-day, two-year, and three-year tests.
Other taxes, such as employer withholding taxes or sales taxes, are never dischargeable. These are in the nature of “trust fund” taxes, meaning the debtor was merely holding this money for the taxing authority and was required to turn it over when due. Of course, trust fund tax issues nearly always arise only with business owners who file bankruptcy.
Admittedly, such topics don’t come up in most casual conversations. But the next time you hear someone say, “you can’t discharge taxes in bankruptcy,” you can politely correct them. As Oscar from The Office would say, “actually, taxes may be discharged in some cases.”
If you live in southwestern Wisconsin and are considering bankruptcy to help deal with your tax debt, please contact me. I’d be glad to analyze your individual situation and tell you if bankruptcy is a viable option for you.
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One question bankruptcy clients are asked at their 341 meetings is, “have you transferred anything to a third party in the last two years?” I prepare my clients for this question, but I have seen other debtors stumble when asked. Sometimes, it’s because they don’t understand what exactly a “transfer” is.
Many people don’t realize that the definition of a transfer is quite broad. The term is defined in the Bankruptcy Code under 11 U.S.C. §101(54). It includes, “each mode, direct or indirect, absolute or conditional, voluntary or involuntary, of . . . parting with property or an interest in property.” This means that “putting the guns in my dad’s name” is a transfer. So is “selling” the cabin up north to your buddy for $10 to keep it out of the reach of your creditors.
Certain transfers can be “avoided” by the bankruptcy trustee under §547 and §548 of the Bankruptcy Code, meaning that the trustee may undo the transfer and reclaim the property for the benefit of your creditors. This is why bankruptcy attorneys will tell you NOT to pay back that loan to Grandma shortly before filing bankruptcy. Depending on the specific facts of the situation, the trustee might avoid the transfer, recover the money from Grandma, and use it to pay your other creditors. In most cases, the transferred property could have been retained and exempted had the transfer not been made. (You can pay Grandma back after filing your bankruptcy. Just don’t pay her before filing.)
If you are having financial problems, be sure to talk to a qualified bankruptcy attorney before selling, trading, or giving away anything. If you later decide to file bankruptcy, the transfer you didn’t make might turn out to be your wisest decision.
I read an article on Bankrate.com that said nearly 20% of Americans felt the need to dip into their retirement savings in 2010-2011 to deal with immediate financial needs. Borrowing from your 401(k) or IRA might make sense in some situations, but consumers should consider all their options before making the decision.
One problem with using retirement savings to pay down unsecured debt is that those savings are almost always fully exempt in bankruptcy. This means that your 401(k)/IRA is protected and you will get to keep it despite your bankruptcy filing.
If borrowing $10,000 from your future is going to allow you to avoid bankruptcy and come out ahead in the long run, it’s the wise choice. For example, if you have credit card debt of $10,000 and also have nonexempt assets worth $20,000, a bankruptcy filing would likely cost you more than using some of your retirement savings to settle that $10,000 debt. However, most of the people I see on a daily basis don’t have nonexempt assets. In those cases, the bankruptcy filing is the better choice because it allows the client to discharge the majority of unsecured debt and keep the retirement savings for its intended purpose.
Another problem with using retirement savings to pay down credit card debt is that it is often a temporary solution. Too often, I see people who have tried to avoid bankruptcy by draining all of their retirement savings only to discover that they still can’t afford the payments on the remaining debt. They struggle along for as long as they can, until they are hit with a small claims judgment or foreclosure suit. While a bankruptcy filing can help at that time, the client would have been much better off saving the retirement funds and filing the bankruptcy sooner.
Before raiding your retirement savings, think about your reasons for doing so. If you need the money to catch up on your mortgage payments and keep your house, it’s worth considering (assuming you’re not using your other available funds to pay credit card bills instead of the mortgage). But borrowing that money to pay down credit card debt and to stave off an inevitable bankruptcy for a few months merely delays the fresh start that you need.
Which should be the last resort, filing for bankruptcy or depleting your exempt retirement savings to make credit card payments? I’d really like to read your thoughts in the comments below.
Image credit: Ken Teegardin
Check out this recent article from the New York Times. The law firm of Steven J. Baum, P.C. is one of the largest foreclosure firms in New York. During its Halloween party in 2010, many employees dressed up as people complaining about losing their homes to foreclosure. They laughed about the fact that the firm had successfully evicted so many people from their homes. When contacted about the story, a Steven J. Baum spokesman denied that any employees had mocked those who had lost their homes. But Mr. Baum himself apologized the next day.
While I do not believe such behavior is common in the foreclosure world, the story did not shock me. I have heard of debt collectors calling consumers names, threatening them, and otherwise harassing people who cannot pay their debts. (What really gets me is when the debt collectors then call me to discuss, “a mutual client.” I have no mutual clients with debt collectors. Their clients are creditors, mine are debtors.) Is it really surprising that these people would also make fun of their victims at an office party?
Although most debt collection agencies probably do not display this kind of contempt for debtors, I doubt that attitudes like this are rare. If you live in southwest Wisconsin and have either been harassed by a debt collector or served with foreclosure papers, give me a call. I may be able to help you save your home. At the very least, I can usually help stop the harassment. If you’re already struggling with overwhelming debt, you shouldn’t also have to deal with disrespectful behavior from debt collectors.
(Oh, and debt collection script writers? Please delete that “mutual client” bit from your next version. As we don’t have any mutual clients, there’s no need for you to start off our conversation with a lie. Thanks.)
A couple of weeks ago, I wrote about the means test in a Chapter 7 bankruptcy case. I pointed out that it helps determine if the Chapter 7 filing is presumed to be abusive and that the means test serves a different purpose in a Chapter 13 case.
The means test may affect your case differently depending on where your case was filed. This post will only explain the Chapter 13 means test in the Western District of Wisconsin, where I practice.
In a Chapter 13 case, the means test helps determine the length of your plan and the amount your plan must devote to general unsecured creditors. As in the Chapter 7, we first compare your income to the median income for a similarly-sized household. If your income is above the median, you will likely be required to propose a 60-month plan. If below median, you will be able to propose a 36-60 month plan.
The next step is to determine how much your plan must provide to general unsecured creditors. After determining your actual monthly income (averaged over the last six months), we apply the allowable means test deductions. The resulting “disposable income” is the amount that must be devoted to your general unsecured creditors each month. Your total plan payments will also include amounts necessary to pay secured creditors, priority creditors, and the trustee’s commission.
Your bankruptcy attorney can tell you how the means test may affect your individual Chapter 7 or Chapter 13 case.
Many clients ask me, “who will find out about my bankruptcy filing? Will my name be published in the local newspaper?” They are concerned that their friends, family, neighbors, or employer may learn of the bankruptcy.
Bankruptcy cases are a matter of public record. If someone really wants to find out if you have filed, they’ll be able to dig up the records. It’s not as simple as a Wisconsin CCAP search but the information is available. If your neighbor is anything like Mrs. Kravitz, she’ll find it.
The Bankruptcy Court will also mail notices of your case to certain people. All of your creditors & co-signers will receive notice because their rights will be affected by your filing.
Now for the good news: Bankruptcy cases are a matter of federal law, not state law. This means that the local county court does not participate in the proceedings. Any court hearings are held in the federal courthouse for your district (nearly all of my cases are handled at the federal courthouse in Madison, Wisconsin). The local newspapers that print the “Court News” every week, with notices of foreclosure sales, OWI violations, etc., typically don’t print notices relating to federal cases. They could do so, but it’s quite rare in Wisconsin.
• Unless you owe them money or co-signed with them, your family members, friends, neighbors, and employers will not be sent notice of your bankruptcy filing. They may find the information if they’re really interested and determined, but they most likely have their own problems to worry about.
• While local newspapers could print the names of consumer bankruptcy filers, they rarely do so in Wisconsin.
• If your neighbors do learn that you filed bankruptcy, relax. You may be the topic of their gossip for a couple of days, but someone else will take your spot as their target soon enough. The neighborhood gossips will forget about you and talk about that other neighbor’s divorce, job loss, wild party, marital problems, arrest, rehab stint, terrible cooking or housecleaning habits, noisy kids, drunken escapades . . . .
I’ve had clients tell me that they “know” high-income debtors can’t qualify for Chapter 7 bankruptcy because they can’t pass the means test. While this isn’t entirely accurate, it does give me the opportunity to explain what the means test is.
To start, you need to know that it’s not really a question of “qualifying” for Chapter 7 bankruptcy. It’s a question of whether a Chapter 7 filing would be presumed to be an abuse of the bankruptcy system. This presumption may be rebutted, but the burden of proof is on the debtor. If the presumption of abuse arises and is not successfully rebutted, you will have the option of allowing the case to be dismissed or converting the case to a Chapter 13 bankruptcy.
(In a Chapter 13, the means test has another purpose. I’ll address that some other time.)
Whether a Chapter 7 bankruptcy filing is presumptively abusive is a two-part test. First, we compare your income to the median income for a similarly-sized household in your state. Currently, the median income in Wisconsin for a household of four is $77,000. If your income is below the median, you’ve passed the first test and your case is not presumptively abusive. If your income is above the median, you are required to go to the second part of the test, the means test.
The means test is essentially a set of deductions Congress has decided bankruptcy filers are allowed to take. Once your monthly income has been determined by looking at your last six months of employment and other income, the means test allows deductions from that monthly amount. Allowed deductions include:
• payments on secured & priority debts,
• withholding taxes,
• insurance premiums,
• reasonable housing, transportation, and food allowances,
• child care.
After these deductions, if you have less than approximately $100 left over, you’ve passed the second test and your case is not presumptively abusive. If you have more than $100 or so left over, your case may be presumed to be an abuse. In that case, the U.S. Trustee will file a motion to have your case dismissed or converted. You can either allow your case to be dismissed, convert to a Chapter 13 and pay that surplus to your unsecured creditors each month for the life of your Chapter 13 plan, or argue to the judge that you should be allowed to remain in Chapter 7.
Remember, the means test only helps determine if your filing is *presumed* to be abusive. The presumption can be rebutted so that higher-income filers who can’t pass the means test can remain in Chapter 7. On the other hand, the U.S. Trustee may believe a case that is not presumed to be abusive is actually an abuse of the system based on the totality of the circumstances. In that case, the U.S. Trustee may still file a motion to have your case dismissed or converted to Chapter 13.
The choice between filing under Chapter 7 and Chapter 13 is one of the most important decisions my clients make. Your bankruptcy attorney can let you know how your particular circumstances will affect the means test calculations in your case.
Chapter 7 bankruptcy filers need to choose how to handle secured debts. There are three official options:
1 – Surrender the collateral. If your car is worth less than the amount you owe on the loan and you don’t need to retain the car, it may make sense to surrender it to the lender. If you choose to surrender, you will not owe any deficiency after the lender resells the collateral. The lender will get the collateral, but nothing more. This option is also available for secured debts secured by real estate (i.e. a home mortgage).
2 – Redeem the collateral. Maybe your truck is worth $3000 but it is collateral for a $15,000 loan. Although you want to keep the truck, you’re not willing to pay $15,000 for the privilege. In this situation, §722 of the Bankruptcy Code permits you to redeem the truck by paying the lender $3000 in exchange for a lien release. Section 722 only allows redemption of personal property, not real estate.
3 – Reaffirm the debt. Your bankruptcy discharge will eliminate your personal liability on most secured debts, but the liens will remain. (See this post for the differences between secured and unsecured debts.) After the personal liability is eliminated, secured creditors can enforce their liens through repossession if you default on the loan, but they cannot sue you for any deficiency. If you sign a reaffirmation agreement, you take that personal liability back on and allow the creditor to sue you for any deficiency if you default on the loan. Whether your bankruptcy attorney advises you to sign a reaffirmation agreement will largely depend on where you live.
Those are the three official options. An unofficial option is to retain the collateral and continue making your contractual payments. While not specifically authorized by the Bankruptcy Code, “Retain and Pay” is available with many creditors. Rather than repossess a vehicle that has a loan of $5000 against it (and receive $1000 for it at an auction), the smarter creditors will agree to just continue taking your money without a reaffirmation agreement if you’re willing to continue paying.
When you first discuss your bankruptcy case with your attorney, be sure to learn which options for dealing with secured debts serve your best interests.
Bankruptcy filers with secured debts will likely be offered reaffirmation agreements by their secured creditors. Your bankruptcy discharge will eliminate your personal liability on most secured debts, but liens on your property will remain. (See this post for the differences between secured and unsecured debts.) This means that secured creditors can enforce their liens through repossession if you default on the loan, but they cannot sue you for any money. The most they can get is their collateral.
A reaffirmation agreement reimposes the personal liability that would otherwise be discharged in your bankruptcy. By signing, you agree that if you default on the loan, the secured creditor can both repossess its collateral AND sue you for the balance due on the loan. Whether to sign a reaffirmation agreement is a serious decision, and the state in which you live is a factor. Your bankruptcy attorney can give you advice for your specific situation, but here is a general list of pro’s and con’s.
PRO (reasons for signing)
• The secured creditor will report all of your post-bankruptcy payments to the credit reporting agencies, helping you rebuild your credit sooner.
• The secured creditor won’t try to repossess or foreclose as long as you continue making your payments.
• The secured lender may offer a better interest rate in exchange for your signature.
The first two items are easily handled without a reaffirmation agreement:
• If you don’t reaffirm the debt but want the credit reporting agencies to show you’ve been making your payments, you can request a payment history from your lender once per year. You can submit that report to the credit reporting agency to have your credit report updated or you can submit it to any lender from which you are applying for credit.
• A mortgage lender can’t foreclose on your home in Wisconsin unless you default on the loan, even if you don’t sign a reaffirmation agreement. A vehicle lender is a slightly different story. If the Wisconsin Consumer Act applies to the loan, the creditor cannot repossess without a default in payments. Although this law is unambiguous, some judges choose to ignore the language of the Act and may allow a creditor to disregard the creditor responsibilities included in the WCA. If a creditor tried to repossess your vehicle solely because you chose not to sign a reaffirmation agreement, I believe you would win that fight in most Wisconsin circuit courts. But there are no guarantees; you could lose the suit (and the vehicle). Even if you won, you would end up paying legal fees to have an attorney argue your case for you.
CON (reasons for not signing)
• If you default on the loan, you’ll lose the collateral PLUS you can be sued for a deficiency if the collateral is worth less than the balance on the loan. Can you say for sure that nothing will happen in the next few years that will cause you to default?
• Your bankruptcy discharge will eliminate the personal liability and the ability of the creditor to sue you for anything other than return of the collateral. If you sign a reaffirmation agreement, you give back that benefit without getting anything in return.
Because reaffirmation agreements rarely benefit the debtor, I usually discourage clients from signing them. Before making this important decision, be sure to discuss the issue with your attorney.
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Section 541(a)(5) of the Bankruptcy Code provides that property of the bankruptcy estate includes:
“Any interest in property that would have been property of the estate if such interest had been an interest of the debtor on the date of the filing of the petition, and that the debtor acquires or becomes entitled to acquire within 180 days after such date –
(A) by bequest, devise, or inheritance;
(B) as a result of a property settlement agreement with the debtor’s spouse, or of an interlocutory or final divorce decree; or
(C) as a beneficiary of a life insurance policy or of a death benefit plan.”
What does this mean to the average filer?
Basically, if someone dies in the 6 months after you file bankruptcy and you inherit anything or receive life insurance proceeds, the inheritance or life insurance proceeds are part of your bankruptcy estate and could be used to pay the claims of your creditors. (§541(a)(5) also deals with property settlements in a divorce. This blog post focuses only on the inheritance issue.)
If you don’t want your inheritance to go to your creditors, you need to talk to the people you believe might leave you anything. Grandpa can change his will or life insurance beneficiaries any time until the day he dies. He can leave “your share” to your kids or other family members, remove you as a beneficiary, or include a valid spendthrift clause in his will. You could also disclaim any possible inheritance before he dies. Once he dies, you can’t retroactively change the will or disclaim the inheritance. If he decides to make any changes, he should speak with an estate planning or probate attorney.
You may feel the risk of someone dying and leaving money to you in those six months is slim. While you’re probably correct, remember that anyone can get hit by a bus tomorrow. And don’t forget about that great-aunt living in Las Vegas who is planning to leave you her $500,000 in gambling winnings. You might want to talk to her.
If you are considering filing bankruptcy, you need to carefully consider whether you want to (1) ignore this issue and hope no one leaves you money in the next six months, or (2) talk to your relatives about protecting any possible inheritances.
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Financial problems sometimes cause marital stress. In other cases, marital stress causes financial problems. Either way, a significant number of my clients are either considering divorce or have recently finalized a divorce.
For a couple considering both divorce and bankruptcy, is it better to file a joint bankruptcy before divorcing or each file individual bankruptcies after divorcing? It’s a very fact-specific question.
As long as you are married as of the date of filing the bankruptcy, you can file a joint case. Your divorce can usually be finalized while the bankruptcy is pending without affecting anything.
If much of the debt is owed by both spouses (joint credit cards, medical bills, home mortgage, etc.), I usually recommend a joint filing before divorce. This allows the couple to discharge much of their debt and keep more assets to divide under their marital separation agreement. A single joint filing is also less expensive than two individual filings.
If there is little joint debt, it may make sense to let the divorce run its course and file individually after the divorce is final. There are a number of variables to consider when analyzing this option. Is any debt being assigned to one spouse? Is the debt owed to a government agency or the former spouse? Are you considering filing a Chapter 7 or Chapter 13 bankruptcy? Is the debt in the nature of support or property division? Depending on the answers to these questions, certain debts may be nondischargeable in a future bankruptcy case.
Other considerations include available exemptions, household size, relative incomes between spouses, how well the spouses get along, and child placement/support. If you are going through a divorce and have a significant amount of debt, ask your divorce attorney if bankruptcy should be considered. I’ve worked with many divorce attorneys to decide (1) if bankruptcy would help a couple that is splitting up, and (2) the timing of any bankruptcy filing. If your divorce attorney cannot give you bankruptcy advice, ask for a referral to a local bankruptcy attorney.
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Most clients ask if I can help them keep their house or car if they file for bankruptcy protection. I tell them that they probably can keep the house, but it may not be in their best interests to do so.
When advising clients about keeping a house, it’s a pretty simple analysis. If the house is worth significantly more than you owe, keep it. If it’s worth significantly less than you owe, let it go. Anything in between requires a little more investigation. It’s the underwater house in the second category that concerns people.
There are plenty of reasons to keep a house that go beyond the objective numbers. There are also sentimental reasons for keeping a house. Maybe your great-great-grandfather built the house and he’d roll over in his grave if he knew you lost it. Maybe you built your dream house just 5 years ago, you love it, and it would break your heart to lose it. Or maybe you have so many memories of raising your kids in that house that you can’t bear the thought of losing it. These are all valid reasons for overpaying for an underwater house.
But before you make that decision, ask yourself if overpaying for that house will be worth the things you’ll have to sacrifice. If you continue to make that $1500/month mortgage payment instead of renting something for $1000/month, you’ll likely have to cut back in other areas. What would you do with that extra $500/month if you moved? You won’t start to build equity for many years, so you should think about those mortgage payments as little more than rent with the added benefit of a tax deduction. If you are still willing to pay more to live in that specific house rather than move after considering these points, a bankruptcy attorney can help you achieve that goal.
To summarize: Can you keep your house? Probably. Should you? Maybe not.
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This question comes up frequently in client interviews. Many people are convinced that a bankruptcy filing will ruin their credit and they’ll never be able to buy a car or house. In most cases, that’s simply not true.
– Don’t confuse a credit score with a “life score.” A credit score is simply a tool banks use to decide whether or not to extend credit to you and to determine what interest rate to charge you. A 760 credit score doesn’t make you a better person than someone with a 500 credit score. If you really believe a high credit score is valuable, take it to the grocery store and see how much you can buy with it.
– If you are behind on credit card payments or have had judgments entered against you, your credit score is already pretty shot. It will likely improve after filing bankruptcy, because your debt to income ratio will be significantly better.
– If you have a high credit score, it may be artificially high. Someone with $50,000 in credit card debt who makes the minimum payments each month on time may have a great credit score because of those timely payments. But if that same person is devoting nearly all of his disposable income to those payments, he’ll be denied a car loan or home loan because his income can’t support the additional payments. If it can’t get you a great rate on a loan, what good is that high credit score?
– A bankruptcy filing will show up on your credit report for approximately 10 years. That doesn’t mean your credit score will remain low the entire time. Your financial life after the bankruptcy will also appear, showing your record of payments post-bankruptcy. As a rough guideline, your credit score will return to its pre-bankruptcy level in about 4 years.
– You *will* get credit again after filing bankruptcy. In general, you’ll receive credit card applications within 6 months of getting your discharge. It’s fine to accept those offers as long as you pay your balance off in full and on time each month. You should qualify for a car loan in about 18 months, and a home loan in 5-6 years. The farther you get from the bankruptcy, the better your chances of getting credit extended to you and of getting a better interest rate. You may be able to shorten those times by having a cosigner or agreeing to a higher interest rate.
If you’re deep in debt, facing foreclosure, having your wages garnisheed, and fighting off the repo man, your credit score should be the least of your worries. Usually, it’s best to file the bankruptcy, get a fresh start, and begin rebuilding your credit. Talk to a bankruptcy attorney for advice tailored to your specific situation.
Many of my clients come to me after they’ve been sued by a debt collector for a past-due credit card bill. Other times, the threat of “being taken to court” spurs the call. The client is often worried about being sent to jail. After all, the sheriff hand-delivered the summons and complaint. Next time he shows up, it will be to handcuff me and take me to the Big House!
The first thing I do in such cases is to reassure the client that you can’t be locked up for failing to pay a debt. Debtors’ prisons have been gone for over 150 years. You may have a judgment entered against you, you may have your wages garnisheed, but you won’t be thrown in the slammer.
So what happens if you get sued for a money judgment or in small claims? The process will be different in other states, but here is how it works in Wisconsin:
– The creditor will have you served with a summons and complaint. You will probably be personally served by a sheriff’s deputy. You will have about three weeks to answer the complaint.
– If you have a defense to the lawsuit (“I don’t owe the money because…”), you will file your answer and the judge will schedule a hearing. You aren’t required to answer. In fact, I usually recommend that clients ignore the summons and complaint. In most cases, the clients admit they owe the money; they just can’t pay it. If you ignore it and don’t file an answer, the creditor will file a motion and obtain a default judgment. You won’t have to appear in court at all.
– Once the creditor gets its judgment, it will try to collect on the judgment. This will usually involve garnishment of wages, bank accounts, or other non-exempt personal property. If the creditor sends you an Order for Financial Disclosure, you MUST complete it and return it. You won’t have to send any money, but failing to comply with this court order may land you in jail for contempt of court.
It’s possible that you don’t have any non-exempt wages or property for creditors to take. A bankruptcy attorney can explain exemptions and the concept of being uncollectible.
If you’ve been sued and a creditor is threatening to garnish your wages, speak to an attorney soon. A bankruptcy filing can prevent the judgment and the resulting wage garnishment. If the judgment has already been entered, the bankruptcy filing can wipe it out and immediately stop any garnishments. A small claims or money judgment is no different from any other general unsecured debt and it is typically dischargeable.
No matter what the debt collector tells you on the phone, you cannot be jailed for defaulting on a debt. The person telling you differently is either a scammer trying to rip you off or an unethical debt collector lying to scare some money out of you.
When you file for bankruptcy, you will need to supply some documents in addition to the petition, schedules, statements, and disclosures that are filed with the Court. I don’t require my clients to bring these documents to their initial consultation, but here is a list of documents I will request if you decide to file bankruptcy:
– Tax returns, including all forms and attachments, for the last two years.
– All of the pay stubs you have received from employment in the last seven months.
– Copies of titles to any vehicles, boats, or mobile homes.
– The settlement statement from the sale of real estate in the last four years.
– The marital settlement agreement if you were recently divorced.
– If you own real estate, you’ll also need to submit your most recent real estate tax bill and copies of any recorded mortgages that are in effect. Recorded copies can be obtained from the Register of Deeds office in your county.
Gathering these documents is usually not too difficult. While it may take a bit of time, you’ll be glad you made the effort when your bankruptcy case proceeds smoothly from filing to discharge.
Image credit: kozumel/Flickr
A prospective client called me and started talking about an asset that he (apparently) couldn’t live without. I explained that most people don’t lose anything in a Chapter 7 case, and that an attorney could help him decide how to protect his assets. He didn’t like this answer. He started throwing out hypothetical situations and finally asked how “they” would ever know he had concealed assets from the Court and the trustee. (As an aside, people usually get caught because of the X factor. Ex-spouses, ex-friends, ex-business partners, etc. often report suspected fraudulent activity to the U.S. Trustee Program.)
I told him that he might get away with it, but I wasn’t going to help him. Bankruptcy fraud is a serious matter; convictions can lead to fines of up to $250,000 and up to 5 years in federal prison. I told him to think about it like speeding: If you choose to go over the speed limit, be prepared to pay the consequences if you get caught. While you may be willing to risk a $200 traffic fine, are you really willing to risk going to federal prison? He hung up on me and I never heard from him again.
The bankruptcy system demands full disclosure of all your assets, all your debts, and all your sources of income. The people who typically get into trouble (see Mr. Hecker & Mr. Dykstra, above) are the ones who try to hide assets from the Court. While most debtors don’t have multi-million dollar estates, they still want to protect what they have. As I tell my clients, the best way to lose your assets is to try and hide them. Disclosure and exemption of assets is the way to protect them.
Most debtors never have to worry about any of this. If you make an honest mistake in your paperwork, you will usually be given a chance to correct it. The fraud charges happen when someone knowingly conceals assets in a misguided attempt to protect them. There’s a significant difference between forgetting about your $10 bicycle and forgetting about your $35,000 bank account.
Your bankruptcy attorney can tell you if you have assets that cannot be protected in a Chapter 7 bankruptcy. If that’s the case, a Chapter 13 plan may allow you to keep everything. However you decide to deal with the issue, fraud is not the answer.
For more on this issue, check out this post from the Bankruptcy Law Network.
When you speak with a bankruptcy attorney, you will be asked how much secured debt you have and how much unsecured debt you have. What is the difference and why does it matter?
Secured debt means the lender has collateral (an asset tied to the debt). Another way of saying this is that the creditor has a lien on your property. If you default, the creditor may be able to repossess the collateral. The most common secured debts are vehicle loans and home mortgages.
When you receive a bankruptcy discharge, most liens will survive. You will no longer have the legal obligation to pay anything toward those debts, but if you stop paying, the creditor will be allowed to enforce its lien by repossession or foreclosure. You can either keep the house/car/other collateral and continue making your payments, or you can surrender the collateral and stop making the payments. The choice is yours. Short version: if you don’t pay on a secured debt, the creditor can take your stuff. Secured creditors either get paid or they get their collateral.
With unsecured debt, there is no collateral tied to the debt. If you default, the creditor may sue you but it can not repossess, foreclose, or otherwise take your property, although a wage garnishment may be allowed. Typical unsecured debts include credit card debt, medical debt, student loans, and personal loans. Tax debts and domestic support obligations (child support, alimony, maintenance, etc.) are usually unsecured, but they often fall into a separate category known as “priority” debts. I’ll write more about priority debts in a future post.
Keep in mind that the secured/unsecured distinction is not a question of dischargeability. Whether or not a debt is secured or unsecured has no bearing on whether or not it is dischargeable. For example, your car loan is a dischargeable obligation, but the lien will survive the bankruptcy. Remember, secured creditors get paid or they get their collateral. And your student loan is probably nondischargeable (although there are exceptions), but it is still unsecured. The secured/unsecured question is one of collateral, not dischargeability.
It’s important to speak with your bankruptcy attorney about your secured and unsecured debts. I’ll write about why the difference between the two matters next time.
If you’ve spoken with a bankruptcy attorney or done any research on your own, you know that the 2005 amendments to the Bankruptcy Code added a counseling requirement. What does the counseling requirement involve?
The Bankruptcy Code requires debtors to complete two counseling sessions. Upon finishing each, you will receive a certificate of completion. For the sake of efficiency, ask the counseling agency to email the certificate directly to your attorney. Think of the first certificate as your ticket into bankruptcy. Without it, you cannot file. The second certificate is your ticket out of bankruptcy. Without it, you won’t get your discharge. Most agencies will allow you to complete both sessions online or over the phone.
The First Counseling Session (Pre-filing counseling)
In this session, you will be asked about your income, expenses, and debts. A debt repayment plan may be prepared, but you will not be obliged to follow it. The session usually lasts 45 – 90 minutes. It must be completed within 6 months prior to filing your bankruptcy petition and schedules.
The Second Counseling Session (Pre-discharge counseling or Debtor Education)
You must complete this session AFTER filing for bankruptcy. You will need to provide your bankruptcy case number, which your attorney should give you shortly after filing your case. Instead of answering questions about your budget, you will listen to a series of short talks about financial management. At the end, you will take a brief quiz. Don’t worry, if you don’t pass, it won’t cost you extra to try again. This course and the quiz will usually last 2 – 3 hours and should be completed within 6 weeks after filing your bankruptcy petition and schedules.
Two separate counseling sessions, taken at two separate times, with two separate certificates for two separate purposes. Your bankruptcy attorney can answer any specific questions you have about credit counseling.