Bankruptcy: What It Is, When to File, FAQ & More

Bankruptcy Information

Bankruptcy filings have increased more than 500% since the early ‘80s, and well over 1 million people now file each year.  Interestingly enough, the dramatic rise in the “popularity” of bankruptcy has coincided with our increased societal reliance on credit cards.

“Overall, the increase in credit card and possibly mortgage debt levels since 1980 provides the most convincing explanation for the increase in bankruptcy filings in the United States,” Michelle J. White, a professor of economics at the University of California, San Diego and a research associate at the National Bureau of Economic Research, wrote in an article for the Journal of Economic Perspectives.  “But adverse events and debt levels interact with each other in explaining the increase in bankruptcy filings because, as debt levels increase, any particular adverse event is more likely to trigger financial distress and bankruptcy.”

In other words, it’s now easier for us to habitually spend beyond our means, and we are putting our finances in jeopardy by doing so, especially during times of economic turmoil when debt can easily become unsustainable.  This is not to say that we should all forgo credit card use or that bankruptcy is always the answer to serious debt, but rather that understanding the bankruptcy process is certainly worthwhile in this day and age.

With that in mind, you can find information on the following topics below.

Types of Bankruptcy

There are six different chapters of bankruptcy under U.S. code, but Chapter 7 and Chapter 13 are undoubtedly the most common for consumers.

  • Chapter 7:  Often referred to as “straight” bankruptcy, Chapter 7 provides for the discharge of unsecured debts (i.e. those not backed by property such as a car or a house), as well as the liquidation and sale of certain assets by a designated trustee in order to repay creditors.

    “In a chapter 7 bankruptcy, most bills are done away with (discharged) and you get to keep almost all of your property because it is exempt under state or federal law or is secured,” according to Bruce Comly French, Director of Clinical Programs and Professor of Law at the Ohio Northern University Pettit College of Law, who says roughly 80% of consumer cases are Chapter 7.

    As French notes, many assets are exempt from liquidation and can be kept after filing.  The exempt assets vary from state to state, but typically include your primary automobile, certain tools used for business, personal belongings such as furniture and clothing (up to some maximum), and part or all of the equity in your personal home.  It’s also important to note that a number of debts can’t be discharged and will still be due after filing. They usually include certain current taxes, certain fines, fraudulently incurred debt, family support obligations (including child support and alimony), and federally insured student loans.

  • Chapter 13:  Often referred to as “consumer reorganization” bankruptcy, Chapter 13 bankruptcy requires debtors to restructure their debts and create a three-to-five year repayment plan. Under the repayment plan, the debtor will use his future income to pay off, in full or partially, his creditors. As such, Chapter 13 bankruptcy is applicable only to debtors with regular income. The process of a Chapter 13 repayment plan is supervised by an impartial trustee that is appointed by the court.
  • Chapter 11:  Often referred to as “corporate reorganization” bankruptcy, Chapter 11 is typically utilized by indebted businesses to restructure their operations in the name of financial relief.  Chapter 11 bankruptcy enables a business owner to refinance debts and cancel certain contracts without ceding ownership in their company, unless the company’s debts exceed its assets – in which case equity may fall to the company’s creditors. Chapter 11 bankruptcy is typically regarded as the most complex and most expensive type of bankruptcy.
  • Chapter 12:  This type of bankruptcy is quite similar to Chapter 13 but is targeted to farmers and fishermen.
  • Chapter 9:  This segment of the bankruptcy code applies to municipalities (e.g. cities, towns, and school districts) and helps them restructure debts.  More specifically, Chapter 9 bankruptcy offers local governments and other similar organizations protection from creditors as they seek to extend the terms of their loans, refinance interest rates, garner forgiveness for certain amounts of interest or principal, and other forms of debt relief.
  • Chapter 15:  This chapter provides for cooperation between U.S. and international court systems in bankruptcy cases involving multi-national corporations.

Bankruptcy Means Test

The bankruptcy means test is m a way for the courts to determine whether you are eligible for Chapter 7 bankruptcy based on your income, assets, debts, and liabilities, or if Chapter 13 bankruptcy (or no bankruptcy at all) is more appropriate.  Chapter 7 is the form of bankruptcy most favorable to the filer, after all, as it enables debtors to completely avoid paying certain bills, rather than having to do so on an extended timeframe or with a lower interest rate – as would be the case with Chapter 13.

The means test can be broken down into four basic steps, only two of which necessarily apply to all potential filers.

  1. Calculate Your Current Monthly Income (CMI):  The word “current” can create confusion, but what this really means is that you need to calculate your average gross income (before taxes and credits) for the last six months.
  2. Compare Your CMI to the Median in Your State:  If your current monthly income is less than the median for a family of your size in your state, according to data published by the Census Bureau, then your means test is done – you qualify for Chapter 7 bankruptcy.  If it is above the state median, you will need to complete steps 3 and 4.
  3. Determine Your Disposable Income:  To find your disposable income, subtract from your CMI the following expenses (using IRS averages for your area):  housing, food, clothing, medical care, transportation, debt payments, taxes, charitable donations, etc.
  4. Figure Out Where You Fall:  If your monthly disposable income falls below a certain amount ($117 in recent years), you are eligible for Chapter 7 bankruptcy.  If your monthly disposable income falls above a certain amount ($195 in recent years), then you must file for Chapter 13 bankruptcy instead.What happens if your income lies somewhere between $117 and $195?  That’s a bit more complicated.  If you can afford to repay 25% of your “non-priority unsecured debts” – such as your credit card and personal loan balances– within 60 months, you must opt for Chapter 13 rather than Chapter 7.  If not, you are likely eligible for Chapter 7 bankruptcy.

Benefits & Repercussions of Bankruptcy

Deciding whether or not to file for bankruptcy requires careful consideration of the inherent pros and cons of doing so – of which there are many of both.

Pros Cons
Debt Forgiveness Often entails forgiven amounts owed or lower monthly payments. Monetary Expense Bankruptcy can be expensive, with attorney’s fees and filing charges.
Legal Protections Filing for bankruptcy puts into effect an “Automatic Stay”, which stops most creditors from trying to collect. Credit Score Damage Bankruptcy will remain on your credit reports for 7-10 years from the date of filing.
Line of Sight to Debt Freedom A defined plan will give you peace of mind and the ability to make strategic decisions. Reputation Bankruptcy may be frowned upon by creditors and community.

When to File for Bankruptcy

Bankruptcy is merely one of the various forms of debt relief that are potentially available to consumers, and it should be treated as such.  In other words, you shouldn’t make up your mind that bankruptcy is necessary until you fully explore your options and exhaust all other, potentially less-damaging courses of action.

“Use bankruptcy as a last resort,” says UCLA Law Professor Kenneth N. Klee.  “Once you get a discharge, there is an 8 year bar to getting another one.  Don’t use the safety valve unless you need it.”

You can find more information about when bankruptcy is necessary in CardHub’s How to File for Bankruptcy guide.  You can also get more advice from Klee and other bankruptcy experts below.

How to File for Bankruptcy

Filing for bankruptcy should begin with a trip to a bankruptcy attorney to determine your options and next steps.  Not only will an attorney help you evaluate your financial situation and make a decision regarding bankruptcy, but he or she will also help you navigate the complexities of the bankruptcy code, gather together and submit all of the required documents and forms, and ultimately leverage the bankruptcy process to maximum value.  Corporations and partnerships are required to have an attorney.

Nevertheless, some individuals do decide to try do it yourself (DIY) bankruptcy.  This isn’t advisable, particularly given the ban on multiple Chapter 7 filings within an eight-year timeframe, but you can check out CardHub’s article on How to File for Bankruptcy if that is your chosen course of action.

The best course of action, however, is to interview a few bankruptcy attorneys who offer free consultations, read some reviews about them, and at least consider professional assistance before deciding how exactly to proceed.

Bankruptcy Filings by Year

 

Number of Bankruptcy Filings & Average Household Credit Card Balance by Year

 

Ask The Experts:  Bankruptcy FAQ

CardHub consulted bankruptcy experts – both professors and practitioners – from around the country for insight into some of the most common questions people have about the bankruptcy process.  Hopefully their advice can help you navigate these treacherous financial waters as safely as possible.

  1. What part of the bankruptcy process do you think people understand least?
  2. What advice do you have for people who are contemplating bankruptcy?
  3. What are the best ways to recover from bankruptcy?
  4. Does bankruptcy have a social stigma?
  5. How often are bankruptcies misrepresented on credit reports?
  6. To what extent has the BAPCPA changed the bankruptcy landscape for individuals and small business owners?

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Gregory Germain

Professor of Law and Director of the Bankruptcy Clinic and Pro Bono Bankruptcy Program, Syracuse University

What part of the bankruptcy process do you think people understand least?

Filing bankruptcy is a very detailed process. Debtors have to schedule and itemize all of their assets, debts, income and expenses. When we first interview them, people want to get through the process as quickly as possible and will say things like ‘I don’t have anything.’ Do you have a car? Yes. Do you have furniture? Yes, etc. It’s a very detailed process, and it must be done carefully and completely. People who rush through it and leave things out have problems later on.

The hardest part is getting an accurate list of creditors. Most debtors don’t keep copies of the bills they receive and don’t know who they owe money to. We have to rely on credit reports, which unfortunately only list those creditors who report to the credit bureaus. Many creditors don’t report. Debtors who want to minimize their legal expenses and have a smooth experience need to keep records and organize themselves before going to see their lawyer.

What advice do you have for people who are contemplating bankruptcy?

Bankruptcy is for people who have gotten over their heads in debt and can’t see any way out. With the outrageous default interest rates imposed on credit cards (25+ %), a short term cash flow problem can quickly turn insurmountable. It has also become very hard to work with large bureaucratic creditors to restructure. It’s time to consider bankruptcy if you’re suffering under the weight of unsecured debts that you fell you will never be able pay.

The most important thing is for people who receive the benefit of bankruptcy to change their lifestyle and live within their means. Most people are not taught the basics of financial management in school, and have no idea how to budget, or even to balance their checkbooks. Most people do not understand the time value of money, or the importance of savings. It is stunning how fast the average debtor spends their tax refund, for example. As soon as debtors get their hands on money it is spent. The concept of saving is completely foreign to most of the people I assist in my bankruptcy clinic. Sometimes the money is spent quite frivolously. It’s not just that people at the bottom income levels can’t afford to save anything. Certainly, it’s more difficult, but I’ve seen high income people unable to save too. In other countries, people with much lower average incomes are able to save. We have a culture of excess consumption that is difficult to change.

What about recovering from bankruptcy – what are the best ways to get back on the right track?

Bankruptcy wipes most of the slate clean (with the exception of things like student loans, which are not dischargeable except in the case of undue hardship which is very narrowly defined). The way to get on track is to create a budget, make sure that your income exceeds your expenses (and if it doesn’t you need to either increase your income or more likely cut your spending), track your spending – recommend tracking every penny, and start saving. Credit cards should be used only for convenience, and should be paid off in full each month. If you cannot control your credit card spending, then don’t use credit cards. Make sure all of your bills are paid on time – never incur a bank fee of any kind – no ATM fees (withdraw from your own bank), no late fees, no bounced check charges, etc. These concepts may seem like common sense, but many people don’t like to think about their finances. They believe that everything will take care of itself, and that there is no reason to plan for the future. The hope is that the bankruptcy process, as unpleasant as it is, will make at least some of the people who file realize the error of their ways and change.

Does bankruptcy have a social stigma?

State and local

To what extent has the BAPCPA changed the bankruptcy landscape for individuals and small business owners?

BAPCPA is generally regarded in the bankruptcy community as a poorly written and poorly thought-out set of changes that are easily circumvented. The main change made by BAPCPA in 2005 was the means test, which was designed to prevent people who could afford to make significant payments to creditors from filing Chapter 7. But the backward looking test trips up people who cannot afford to pay, and grants a pass to people who can afford to pay. It is also easily manipulated with some advance planning. I think it’s been a big waste of time. I think the discretionary ‘substantial abuse’ process in place before BAPCPA worked a lot better than the means test does. The priority rule changes for domestic support never made sense to me. The debt relief agency disclosure rules always seemed stupid and unnecessary to me. The technical sloppiness in the bill was unforgivable. So in general, I believe BAPCPA has made it a lot more expensive to file bankruptcy but has done little else.
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Neil L. Sobol

Associate Professor and Director of Legal Analysis, Research & Writing, Texas A&M University School of Law

What advice do you have for people who are contemplating bankruptcy?

The decision to file bankruptcy is a complicated one that depends on one’s individual circumstances including the state where one resides. A person contemplating bankruptcy should explore the alternatives that exist under both federal and state law. These laws provide protections against harassment and set up procedures to dispute alleged debts that may not be owed or are not accurate. Additionally, consumers may be able to avoid bankruptcy by settling claims with creditors. Typically, I look for triggering events before advising someone to file bankruptcy – - for example, have settlement discussions failed and have creditors taken steps such as initiating foreclosure or repossession to seize property. Ultimately, the decision to file bankruptcy is one that should be made after consultation with an attorney who is aware of the rights and remedies under bankruptcy and state law. Bankruptcy for individuals may also involve a choice between chapter 7 designed to provide an orderly liquidation of non-exempt assets or chapter 13 designed to allow debtors to retain their property by establishing a payment plan.

What about recovering from bankruptcy – what are the best ways to get back on the right track?

Bankruptcy is often touted as providing debtors a fresh start. Debtors should take advantage of that fresh start and try to avoid situations that can derail that start. They should be careful about entering in new credit relationships. Typically, after debtors receive a discharge in bankruptcy, a flood of new credit-card offers arrives as the credit card companies know that federal law places time limits before a new discharge can be granted. Debtors should be proactive in disputing alleged debts that are not active or that they do not owe. They should routinely review their credit reports to ensure that the information listed on the credit reports is accurate. If the information is not accurate, they should take steps to correct the discrepancies.

To what extent has the BAPCPA changed the bankruptcy landscape for individuals and small business owners?

The ‘means test’ is one of the major changes in the bankruptcy landscape for individuals. Before BAPCPA, individuals typically chose between filing a chapter 7 liquidation or a chapter 13 reorganization plan. Under chapter 7, a debtor’s non-exempt assets are liquidated and the proceeds (if any) are used to pay creditors. The process normally takes about six months and at the end of the process, the debtor would typically receive a discharge of debts. Under Chapter 13, a debtor typically sets up a three to five year payment plan. Payments are made to the chapter 13 trustee and if the debtor successfully completes the payment plan, the debtor receives a discharge. BAPCPA set up a “means test” to determine whether debtors are eligible to file chapter 7. The theory behind the test is that if the debtor has the ability to pay her debts, she should not have the right to liquidate them in to chapter 7. A means test also applies in chapter 13 to determine the length of a chapter 13 plan. The means test has added extra layers of paperwork, has created some complicated interpretation questions, and has impacted the timing of the filing of bankruptcies as the determination of monthly income is typically based on income received within six months of the filing date.
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Robert D’Agostino

Professor, Atlanta’s John Marshall Law School

What part of the bankruptcy process do you think people understand least?

The issue of what is and what is not dischargeable . This particularly true of tax liabilities and the IRS’s ability to impose a 100% penalty on bankrupt small business owners when the business has not paid its required taxes.

BAPCA has clarified and broadened the law applicable to what assets of an individual do not become part of the bankruptcy estate. The “mini’ chapter 11 has made that process more accessible and less expensive for small business.

What advice do you have for people who are contemplating bankruptcy?

Pay bills on time. Do not get another credit card including a secured credit card. Opt for a debit card instead. Create a monthly budget. For a small businessman with vision team up with a manager.
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David G. Carlson

Professor, Benjamin N. Cardozo School of Law, Yeshiva University

What part of the bankruptcy process do you think people understand least?

The means test for consumer debtors in 707(b)(2). Although BAPCPA made bankruptcy more expensive, it basically did nothing to bar access to chapter 7 bankruptcies. The public did not understand this and so, for at least a couple of years, bankruptcy cases plummeted, which meant that people kept the balances going on the credit cards, vastly enriching the banks. All along they could have gotten rid of that credit card debt, probably in chapter 7 cases.

What advice do you have for people who are contemplating bankruptcy?

One should file when something bad is about to happen — a mortgage foreclosure or a wage garnishment.

What about recovering from bankruptcy – what are the best ways to get back on the right track?

Don’t use credit cards. Live within your means!
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Katherine Porter

Professor, University of California, Irvine, School of Law

What part of the bankruptcy process do you think people understand least?

The choice between chapter 7 and chapter 13 is the single most important legal decision in a bankruptcy. Chapter 7 is a much faster, cheaper process with a higher likelihood of discharging debt. But chapter 13 offers certain tools to deal with back taxes, missed mortgage payments, and the like that can be useful–if one can make all the required payments over a period of three to five years. All the research suggests that consumers are often steered into one chapter or the other by attorneys, or they make a less than fully-informed choice. The complexities of bankruptcy law make it quite difficult to explain the options and consequences of chapter 7 and chapter 13. A simpler system would be easier for people to understand.

What advice do you have for people who are contemplating bankruptcy?

My research shows that most people deliberate carefully before filing bankruptcy, and often reach the decision after two or more years of serious struggle with debts. Sometimes it is the risk of losing a house or car, but for many it is the collection calls and the emotional effects, such as stress, insomnia, marital problems, that comes from the overwhelming debts that lead them to seek help.

What about recovering from bankruptcy – what are the best ways to get back on the right track?

The best advice is to use the painful decision of bankruptcy to take a hard look at what your family can afford. Many people try to save homes, cars, and other things through bankruptcy when they would right themselves financially much faster–and perhaps create a less stressful environment for their family–by downsizing and giving up the asset. It’s tough on children to change schools and moving is difficult, but if your attorney or the trustee or the judge is telling you that your home is unaffordable, you should listen. They have a lot of experience, and they all want to see you get a fresh start after bankruptcy. Giving up the house often means that chapter 7 is the right choice, and that is a faster process to clean up medical bills, credit card debt, and other bills. If you’ve lost your job, another great tip is to wait to file bankruptcy until you get employed. Without income–even after bankruptcy wipes out the old debt–you are going to get back into trouble if you don’t have the money to make ends meet.
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Jean Braucher

Roger C. Henderson Professor of Law, University of Arizona, James E. Rogers College of Law

What part of the bankruptcy process do you think people understand least?

It is all very complicated to lay people, but I think chapter choice is perhaps the hardest thing to understand. A chapter 13 repayment plan sounds reasonable, but most people who file in that chapter do not complete their plans and get a discharge. Chapter 7 is a much better bet for getting a discharge from old debt. There are reasons to file in chapter 13, but trying to pay creditors as much as possible is not a good one, and too many debtor try that and fail.

What advice do you have for people who are contemplating bankruptcy?

You need a good lawyer with experience. Don’t try to do it yourself. When things are still getting worse, it is too soon to file. Bankruptcy isn’t a solution unless the debtor has enough income to pay current expenses going forward and the debtor’s main problem is just too much old debt. It often makes most sense to file as things are starting to look up. For example, if the debtor has been out of work and running up a lot of debt to get by but then gets a new job, that could be the time to file. If the debtor can make ends meet except for old debt, bankruptcy is most likely to work. But some old debts can’t be wiped out in bankruptcy–student loans and child support, for example. A chapter 13 may make sense to deal with those debts. Another problem is that sometimes the debtor needs to give up a home or car that it is just too expensive to make the budget work.

What about recovering from bankruptcy – what are the best ways to get back on the right track?

The key thing is to keep expenses under control and save. It is best to have enough savings to live with no income for at least six months to be able to withstand financial shocks. It is also really important to have health insurance. Debt trouble comes from a combination of low savings, running up debt, and then suffering a shock to income or expenses such as job loss or loss of hours, divorce (which means the expense of two households instead of one), and a medical issue with uninsured expenses.
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Matthew J. Notowidigdo

Neubauer Family Assistant Professor of Economics, The University of Chicago Booth School of Business

What about recovering from bankruptcy – what are the best ways to get back on the right track?

My main piece of advice is motivated by my own research. I think one barrier that catches people by surprise is simply the significant financial costs (in terms of filing fees and legal fees) that are associated with filing for bankruptcy. My impression is that individuals are sometimes caught by surprise that they may actually have to be ‘saving up for bankruptcy.
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W. Lewis Burke

Professor, Director of Clinical Education, University of South Carolina School of Law

What part of the bankruptcy process do you think people understand least?

The general public seems to think that the reason people file bankruptcy is because they are deadbeats. The most common cause of personal bankruptcies are illness, loss of a job and divorce. This also leads to the belief that people who file bankruptcy get off easy. If a debtor has an income of over $37,000 he has to file a Chapter 13 which requires monthly payments to be made for 5 years. However, for debtors with a modest income a chapter 7 bankruptcy will usually discharge all of the unsecured debtor and allow the debtor to keep most if not all of their property.

What advice do you have for people who are contemplating bankruptcy?

When the debtor feels overwhelmed by the phone calls, letters and other collections efforts they need to consult a lawyer. They should not wait until they are being sued or they have had their car repossessed. Of course, when one is in financial straits the debtor assumes they cannot afford a lawyer, but most bankruptcy lawyers can help them find a way to pay for the process. Also legal services and bar association pro bono programs may offer free legal services.

What about recovering from bankruptcy – what are the best ways to get back on the right track?

Any debtor who has gone through bankruptcy has had to complete a debt counseling and a budget counseling. If the debtor follows the guidance offered by these courses they can work to regain their credit. But they should not rush into debt and apply for credit cards and other forms of easy credit. Yes, there are predatory lenders who like to lend a very high interest rates money after bankruptcy. Debtors must do everything they can to void this type of credit, and live within a budget.
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Kenneth N. Klee

Professor of Law, UCLA School of Law

What part of the bankruptcy process do you think people understand least?

People least understand the complexity of the means test and the choices and differences between chapter 7 and chapter 13 relief.

What advice do you have for people who are contemplating bankruptcy?

People should only seek bankruptcy as a last resort because a bankruptcy filing can hurt a consumer’s credit rating for years. When possible, consumers should consult a consumer debtor’s bankruptcy lawyer and get a free consultation explaining the options. It is generally time to file for bankruptcy when you have no realistic hope of repaying your debts and the burden of the debts in too heavy. Beware of going to credit counselors who are often pawns of the consumer credit industry and will advise consolidation loans with steep fees when bankruptcy is the better option.

What about recovering from bankruptcy – what are the best ways to get back on the right track?

To get back on the right track after bankruptcy, avoid using credit cards and live within your means. This requires budgeting and leaving a cushion for unexpected expenses. In addition to cost cutting and avoiding the fool’s game of paying outlandish interest on credit cards, if you must use a credit card, be sure to pay the balance in full each month. Don’t insist on hanging onto a house you can’t afford. Subprime loans, variable rate loans, and reverse mortgages have put consumers at risk of losing their homes if they miss even one payment. Look for lawful ways to increase your income by working a second job or taking part time work. Minimize luxury options and limit your outside dining to restaurants that supply healthy food at a reasonable price. Reconcile your budget at the end of the month to see how you did and how you should adjust your financial plan going forward.

Does bankruptcy have a social stigma?

The interference varies geographically and is less in large cities. The stigma is very real in small towns and parts of the south.

To what extent has the BAPCPA changed the bankruptcy landscape for individuals and small business owners?

BAPCPA has hampered the ability of individuals and small businesses to get a fresh start and achieve financial rehabilitation. Specifically, BAPCPA was drafted by the consumer credit industry and its allies to impose barriers to entry to bankruptcy, to make the process more complex and costly, and to make the discharge and fresh start less attractive.
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Daniel A. Austin

Associate Professor of Law, Northeastern University School of Law

What part of the bankruptcy process do you think people understand least?

What are bankruptcy exemptions, and how do they work. People tend to ‘know’ that debtors can usually file personal bankruptcy and keep their property, but most debtors have no idea how this happens before they meet with their attorney.

What advice do you have for people who are contemplating bankruptcy?

Most important: do not try to cope with debt by cashing in retirement assets. As for timing, there are at least two situations where the debtor should file fairly promptly. First, when facing a home foreclosure where the debtor has sufficient income to pay the mortgage (include catch up on arrearages, if applicable) if his/her non-priority unsecured debt is discharged AND it makes economic sense to remain in the home. Second, where the debtor’s non-priority debts are dischargeable and discharging the debt would allow the debtor pay his/her post-bankruptcy bills in full and on time.

Let me also add: Many debtors have student loan debt. It is possible that the debtor lives in a jurisdiction where judges permit favorable treatment of student loan debt in chapter 13, or the debtor’s circumstances would appear to meet the test for discharge of student loan debt. In these fairly rare circumstances, and assuming the debtor satisfies the other requirements for bankruptcy, then filing bankruptcy to discharge student loan debt might be something to seriously consider.

What about recovering from bankruptcy – what are the best ways to get back on the right track?

Pay all bills in full and on time. For some debtors, if it is possible obtain a credit card, even if it has a credit limit of only a few hundred dollars. Use the card for purchases, but no more than 40% of the credit limit. Pay the card in full each month—do not carry a balance. But only one credit card, no store cards, etc. And, do not reaffirm any unsecured debt, even if the creditor promises to extend credit post-discharge.

Does bankruptcy have a social stigma?

Filing bankruptcy is certainly something debtors don’t want their friends to know about, but it does not have nearly the same social stigma that it did 20 years ago or even ten years ago. People know that the economy and making a living are tough, and there is plenty of underlying social empathy when someone has to do it.

Preconceived notions that would deter people from filing are more likely to be fear of what it will do to a person’s credit, fear and humiliation of having to set forth your inner financial life down on public schedules, plus the cost of filing and paying an attorney.
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Judith Klaswick Fitzgerald

Professor of Law, Indiana Tech Law School

What part of the bankruptcy process do you think people understand least?

I assume you are asking about an individual who is likely to file either a chapter 7 liquidation or a chapter 13 ‘wage earner’ reorganization case. In those cases, many debtors never even see a judge and their confusion is most likely about the process of bankruptcy itself. As examples:

• Many are confused about why there are so many filing fees when the reason they are filing bankruptcy is because they have so little money.

• The means test is very confusing but, fortunately, most experienced bankruptcy lawyers are able to walk debtors through the process.

• Understanding avoidance actions and how they may be used in a bankruptcy confuses and alarms both debtors and creditors.

• Why some matters are handled in the bankruptcy court but others go to the district courts or into the state courts baffles many people, particularly when there are filing fees associated with the matter and/or parts of a case are handled by two different courts with the parties shuffling back and forth between courts.

What advice do you have for people who are contemplating bankruptcy?

As a practical point and without providing legal advice, I would advise a prospective debtor to seek legal counsel. The bankruptcy process is quite complex, as is the choice of chapter to file, and counsel familiar with bankruptcy law and procedure should be consulted before those critical decisions are made. How does one know when it’s time to go through with filing? Counsel can assist in answering that question.

What about recovering from bankruptcy – what are the best ways to get back on the right track?

Again, from a practical standpoint without providing legal advice, the solution is to change the practices and habits that led to the bankruptcy - keep track of income and expenses using a budget; don’t overspend; pay all bills when due, including taxes; put some funds away for a rainy day.

Of course, all this assumes that the debtor has income sufficient to sustain a minimal standard of living, has affordable housing, remains in good health and does not suffer some unanticipated event such as a divorce that adds to expenses without increasing income. A bankruptcy discharge can assist a debtor with relief from the financial crisis that led to the bankruptcy but is not a remedy for future bad planning, poor spending habits or unanticipated life changes.

Does bankruptcy have a social stigma?

I am not certain that ‘social stigma’ is any longer a primary reason why most individual debtors would fail to maximize the benefits available to them from filing a bankruptcy. Years ago, the idea of a social stigma was frequently raised by debtors as a reason why they did not want to file bankruptcy.

Anecdotally, in the past several years, I have heard very few debtors talk about that as a determining factor. The vast majority of cases are ‘no asset’ chapter 7 cases, so debtors retain the property that the law allows through the applicable exemptions.

The bigger question may be whether exemptions fulfill the purpose for which they exist. With the change in the bankruptcy law that now allows debtors who choose ‘state’ exemptions to claim additional exemptions as specified in the Bankruptcy Code, an empirical study of this topic may be in order.
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Bruce Comly French

Director of Clinical Programs and Professor of Law, Ohio Northern University, College of Law

What part of the bankruptcy process do you think people understand least?

In a chapter 7 bankruptcy, most bills are done away with (discharged) and you get to keep almost all of your property because it is exempt under state or federal law or is secured; probably 80% of the cases.

What advice do you have for people who are contemplating bankruptcy?

I encourage people (perhaps those who are higher income and have more debt) to look into state court trusteeships or have an attorney negotiate many bills to a more manageable level.

What about recovering from bankruptcy – what are the best ways to get back on the right track?

Keep with a budget. Usually credit is available because you cannot file a chapter 7 for 8 years.

Does bankruptcy have a social stigma?

I do not think that there is any adverse stigma at this point.
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David R. Hague

Assistant Professor of Law, South Texas College of Law

What part of the bankruptcy process do you think people understand least?

There are several misconceptions about bankruptcy, but I think one of the most common misunderstandings is the idea that bankruptcy will discharge all of your debts. This is simply not true. The most common debts that an individual will still be required to repay include, but are not limited to, federal and specific state taxes, student loans, child support, alimony, and other debts that were the result of fraud or misrepresentation.

I think another misunderstanding is the idea that you will lose your home in bankruptcy. This is not necessarily accurate. Unless one’s home has a substantial amount of equity beyond the applicable state’s homestead exemption, then the risk of losing the home is relatively small. But most individuals filing for bankruptcy are not in this situation. Instead, they are living in a home that is ‘under water.’ If that is the case, a debtor may be able to reaffirm his or her obligation on the mortgage.

Finally, and related to the above, bankruptcy typically does not take away a secured creditor’s property rights. While the individual may be discharged on the underlying debt, bankruptcy will not wipe away a creditor’s consensual lien (e.g., security interest in a vehicle, deed of trust on the home, etc.)

What advice do you have for people who are contemplating bankruptcy?

The biggest piece of advice that I would give is to consult with an attorney before filing. In my experience, bankruptcy is oftentimes not the best option. I’ve dealt with several clients who come to me thinking they must file for bankruptcy, but then come to the realization that they are simply experiencing what I refer to as a ‘two-party dispute.’ In that case, the attorney is hired to do a ‘workout’ instead of a bankruptcy.

Creditors can be reasonable, especially if bankruptcy is a threat. It is not uncommon for a creditor to agree to receive less than 50% of what it is owed, or agree to an extended payment plan. If this can be accomplished, then bankruptcy is oftentimes not necessary and the debtor will not even have to face the stigma associated with filing for bankruptcy.

Bankruptcy becomes necessary when creditors are refusing to participate in the workout and are filing lawsuits and seeking to garnish wages, bank accounts, etc. Bankruptcy may also become necessary when a foreclosure is imminent or when a bank has tied up one’s funds that would otherwise be used to service debt or even daily living expenses.

What about recovering from bankruptcy – what are the best ways to get back on the right track?

Bankruptcy will appear on one’s creditor report for 7 to 10 years. The best way to get back on the right track is to start rebuilding your credit. If you’ve reaffirmed debt (e.g., car loan, home loan, etc.), never be late on those payments again so that you can prove to future lenders that you are credit worthy. Avoid credit cards. While these may seem attractive and are another mechanism to rebuild credit, they are usually a trap. The reason one files for bankruptcy is because they’ve incurred too much credit card debt and the default interest rates are out of control. Try using a cash system and a budget, and work on paying down secured loans (e.g., car, home, etc.) so that you can prove to lenders that you are not only capable of paying on time, but also that you now own some assets.

Does bankruptcy have a social stigma?

Bankruptcy will always be frowned upon by one’s creditors. That simply can’t be avoided. And if those creditors are people or businesses with whom you work or associate, one could certainly experience some isolation and even humiliation. To those that are financially sound, bankruptcy can sometimes be seen as a sign of weakness, failure or breach of integrity. I’ve had several clients who, despite receiving a discharge in bankruptcy, continue to pay some selected creditors for this very reason.

I think a lot of the time debtors go through the analysis of whether they absolutely must file for bankruptcy, or whether life would simply be easier if they filed for bankruptcy. Because of the social stigma associated with bankruptcy, some individuals will choose never to file for bankruptcy, even if it means never getting out of the hole.
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Kenneth H. Barnett

Assistant Professor of Law, University of Georgia -School of Law

How often are bankruptcies misrepresented on credit reports?

It’s an empirical question for which there may be research. The ones that tend to get the most media coverage are those that concern identity theft.

Some have suggested that the main problem is the highly automated nature of the investigation process at the agencies that leads to very little time being spent on the consumer’s dispute and too much reliance on the furnisher’s ‘verification.’
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Steven A. Schwaber

Bankruptcy Expert, Schwaber Law

Is there any way to minimize the credit score damage associated with bankruptcy?

Yes, there is, but it takes time. The only legitimate way to do this is to incur some very limited post-bankruptcy credit (perhaps a secured credit card) or continue to make payments on items being retained (most commonly the car, could be the home) and make certain every payment is made on time, then, if possible, pay off the remaining balance of the debt ahead of schedule. Be sure the creditor reports the payment history on that debt to the credit reporting agencies.

There really is no particular function in this process that requires an attorney.

 

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