Bankruptcy

From the last two case studies, you can see that bankruptcy cases define a lot of the rules about how credit card debt is handled by courts. But many people have a too-casual attitude toward bankruptcy.

Declaring personal bankruptcy should be considered the path of last resort (although some lawyers will tell you otherwise to get your business). In most situations, bankruptcy will damage your credit rating so severely that you won’t be able to get credit of any sort for several years. There are some situations in which bankruptcy can improve an extremely poor credit rating—but these are rare.

The most common causes of personal bankruptcy are:

• unemployment;
• divorce and other marital problems;
• large unexpected expenses, such as medical bills; and
• seriously overextended credit.

Bankruptcy does have a profound affect on your credit score. It stays on your credit report for 10 years—longer than any other black mark.

Also, a bankruptcy can be reported to insurers and potential employers for the rest of your life, which could make it difficult for you to get life insurance or get a new job.

However, your current employer may not discriminate against you because you filed bankruptcy. In fact, it is highly unlikely that your employer will find out, unless you reveal the information yourself—or the company is one of your creditors.

In spite of the obvious drawbacks to declaring bankruptcy, it is important to at least consider all options, if you are overwhelmed with debt.

Bankruptcy is a legal proceeding, in which a federal bankruptcy court discharges some or all of your debts. In other words, the court says you no longer have to pay the money you owe. The goal is to grant a fresh start to an honest consumer who is in debt way beyond his or her ability to pay.

Of course, you will have to pay something. At the minimum, there’s a filing fee at the courthouse, along with an administrative fee—the total fee is usually about $200. You also may need to hire an attorney, and legal fees can vary dramatically.

When it comes to individuals, there are two main kinds of bankruptcy: Chapter 7 and Chapter 13.

Specific bankruptcy rules vary from state to state, but the following is a general overview of your options. Both Chapter 7 and Chapter 13 allow you to:

• get rid of unsecured debts;
• stop foreclosures;
• stop repossessions;
• stop garnishments of your wages;
• avoid having your utilities shut off; and
• avoid dealing with debt collectors.

Once you have filed for bankruptcy protection, your creditors are required by law to stop trying to collect. They will be notified by the bankruptcy court, typically within a couple weeks of your filing, but you also can notify them sooner to stop the phone calls and other collection efforts.

Chapter 7 is the most common form of bankruptcy in the United States. In this proceeding, almost all of your assets will be liquidated to pay off your debts. In other words, you turn over all of your property (except items that are considered exempt) to a court-appointed official or trustee. The trustee then sells your personal property, and distributes the money to your creditors.

The court probably will liquidate:

• valuable collections, such as stamps or coins;
• antiques;
• stock, bonds and other investments;
• a second car or truck; and
• a vacation home.

But some of your possessions may be exempt from liquidation under Chapter 7 bankruptcy. Exemptions vary by state, and they also are determined based on an analysis of your situation. In general, exempt property includes:

• a primary residence;
• a car;
• work-related tools;
• pensions and retirement plans;
• life insurance;
• personal effects and clothing (though you probably won’t be able to keep a mink coat); and
• basic household furnishings.

If you have many secured debts, such as several houses, a boat or several cars, your creditors likely will take back the property. But you’ll usually be able to keep your primary residence and one car.

You can declare Chapter 7 bankruptcy more than once in your lifetime—but no more often than once every six years.

For this reason, some credit card companies offer cards to people who’ve just declared bankruptcy. The companies consider those people better credit risks because they can’t declare bankruptcy again any time soon.

Once you file all the paperwork, you will have to appear in court for a hearing, called the First Meeting of Creditors. The judge will question you regarding the information, your debts and assets, and so on. Your creditors also may appear at the hearing (though few non-secured creditors usually do).

Ordinarily, if everything meets with the court’s approval, the court will issue your discharge within 60 to 75 days after the hearing.

Credit card issuers’ reactions to a Chapter 7 filing can vary widely. For instance, you may be able to keep one or more credit cards when you declare Chapter 7 bankruptcy. It will depend on the balance on the cards in question, the desires of the credit card issuers and your ability to pay your credit card bills in the future.

On the other hand, as we’ve seen in this chapter, one or more of your credit card issuers may try to block the discharge of your debt to that company.

If a credit card company files a non-dischargeability action, you may want to negotiate directly with the company to reach a settlement. In many cases, this is what the credit card company wants you to do.

Another option is to convert your filing from Chapter 7 to Chapter 13 bankruptcy, since even debts tainted by fraud can be discharged there.
Chapter 13 bankruptcy is quite different from Chapter 7. Rather than a liquidation program, Chapter 13 involves a repayment plan.

If you can prove that you have regular income, and if you have relatively little nonsecured debt, a Chapter 13 filing may allow you to keep property that you otherwise might lose if you didn’t declare bankruptcy, or if you declared Chapter 7.

With a Chapter 13 filing, the court will approve a repayment plan negotiated between you and your creditors. So, you will have to pay back at least some of the money you owe—usually within three to five years—rather than give up your property.

Whether you declare Chapter 7 or Chapter 13 bankruptcy, you still will be responsible for:

• child support payments;
• alimony;
• taxes (in most cases);
• non-dischargeable debts from a prior bankruptcy; and
• student loans.

Divorce plays a big part in personal bankruptcy filings. If you are separated or divorced from someone who declares bankruptcy, your credit can be affected—especially if there’s still joint debt or joint property. Also, child support and custody arrangements can be affected. We discuss family matters in more detail in Chapter 10.

Next: Debt Reaffirmation