When Is Bankruptcy the Right Move?
The COVID-19 pandemic in the United States will officially turn one year old in March. But despite statewide closures, business closings and widespread layoffs triggered by COVID, personal bankruptcy filings have not increased. Data through November from the American Bankruptcy Institute shows deposits are down 35% from 2019.
Robert Lawless, a professor at the University of Illinois specializing in bankruptcy law, attributes the drop in bankruptcy filings to the economic stimulus adopted in early 2020, which included a moratorium on debt collection. Families spend less and save more, which also slows down deposits, he says. But this trend could change in the coming months. In his research, Lawless found that people tend to have financial difficulties for two to three years before they decide to file for bankruptcy. If you’re worried that you can’t get out of debt, here’s what you need to know.
Two options. Personal or consumer bankruptcy is separated into two sections, or chapters: Chapter 7 and Chapter 13 (business bankruptcies are called Chapter 11). Chapter 7 bankruptcy, also known as liquidation, is easier to file and takes less time to complete. Most people go for Chapter 7 because it allows you to erase most of your debt. This may require you to sell some of your assets, such as non-retirement investments you own, to pay off your creditors, although you may be able to keep your home. Chapter 13 is designed for people who have sufficient stable income to pay off some of their debts through a repayment plan. In a Chapter 13 bankruptcy, you can keep all of your assets, including your home.
While Chapter 7 offers the opportunity for a fresh start, it also weighs more heavily on your assets. Also, not everyone qualifies for Chapter 7. A lawyer will determine if you qualify based on your state’s household income requirements, which vary widely. For example, in California, a family of four with a gross (before tax) annual income of less than $ 101,315 qualifies for Chapter 7. In Arizona, a family of four must earn less than $ 86,950.
Your lawyer will also analyze other aspects of your financial life to determine if Chapter 7 is the best course for you. Chapter 7 may not be the best if you are a homeowner who has great equity in their home (but cannot access it with a home equity loan due to credit issues) because you could lose your home. and the net worth you’ve earned, says Gregory Wade, a bankruptcy attorney in Alexandria, Virginia. Each state has a homestead exemption that protects a certain amount of home equity in Chapter 7 and Chapter 13 proceedings, but you can still lose equity in a forced sale. For example, in New York, the maximum exemption for family properties is $ 165,550, which means that a couple with $ 250,000 in equity could still lose up to $ 84,450 in Chapter bankruptcy. 7.
Other exclusions. The home equity exemption is just one of many exclusions designed to help consumers declaring bankruptcy start a new financial life. The money in your 401 (k) plan and IRAs is protected from creditors, along with veterans’ benefits and pensions. For this reason, it is not a good strategy to liquidate your retirement accounts to pay off your debts, says John Colwell, president of the National Association of Consumer Bankruptcy Attorneys.
It is also important to understand that some debts cannot be discharged in Chapter 7 bankruptcy or reduced if you file the Chapter 13 case. A person who declares bankruptcy would be able to discharge or reduce the payments. for credit card debt, medical debt, and any other back taxes owed to the Internal Revenue Service. But they would still be subject to student loan debt and any child or spousal support owed.
Before Congress reorganized bankruptcy laws in 2005, bankruptcy lawyers could negotiate with creditors to reduce interest rates and amounts owed on student loans. Now, however, you have to prove that paying off student loans is undue hardship, an extremely difficult standard to meet. (To learn more about how to reduce your student loans, go to kiplinger.com/kpf/studentloans.)
Legal proceedings and costs. When you file for bankruptcy, a court will appoint a trustee to represent creditors, and all creditors will be treated equally. Expect to pay around $ 1,000 to file Chapter 7 bankruptcy. Fees will vary depending on the complexity of your situation, the amount of debt that should be canceled, where you live and your ability to pay. attorney fees. A Chapter 7 case typically takes about four months to a year or more to resolve. If something unexpected happens, it can increase your costs and the time it takes to close your case. For example, if you receive an inheritance within 180 days of your Chapter 7 filing, your case may be reopened and payments owed to your creditors may be adjusted.
In Chapter 13, the costs of your file, which can be twice the amount of a deposit in Chapter 7, are included in the payments. Your file is usually open for five years, and during that time you will be making monthly payments. You can either write a check to the trustee or have the payments deducted from your paycheck. Your payment plan will be tailored to your financial situation. For example, if you anticipate an increase in your income, you may be able to start with a lower payment amount that will increase in six to eight months.
If your situation changes and you cannot afford Chapter 13 payments, your plan may be changed to reduce your payments or converted to Chapter 7. For example, if you (or your spouse) lose a job , you can ask the court to renegotiate your plan.
A bankruptcy filing stays on your credit report for 10 years, but the damage is not permanent. While your credit score suffers initially, it will usually improve as the amount you owe is forgiven or reduced, Colwell says.
Go to the website of the National Association of Consumer Bankruptcy Attorneys (www.nacba.org) to find a bankruptcy lawyer near you. Most lawyers allow free consultation. If you cannot afford a lawyer, you may be eligible for pro bono assistance through Legal Services Corp. (www.lsc.gov).
When not to drop off
Even though bankruptcy is your legal right, not all situations are appropriate for this consumer reset.
For example, suppose you have crushing student loan payments, but you’re single, renting a house or apartment, have a retirement account from work, and have no other debt. Filing for bankruptcy will likely be a waste of time because it is nearly impossible to release federal student loans in bankruptcy. Your best bet is to go to www.studentaid.gov and look for ways to reduce your payments. If you have private student loans, talk to your lender about lowering your interest rate and other options available to you.
Likewise, filing for bankruptcy may not be a good choice for retirees with high credit cards or high medical debt, as income from pensions, social security, and retirement accounts are off limits to creditors. If all of your income comes from these sources, creditors cannot collect from you if they choose to sue you.
“I tell clients not to throw good money after bad,” says John Colwell, a bankruptcy lawyer. “I know they want to stop the collection calls, but it’s not worth it.”