Chapter 7 Bankruptcy

    If you have serious financial problems, Chapter 7 bankruptcy can resolve your debts, but expect to lose some property in the process.

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    What is Chapter 7 Bankruptcy?

    Some people refer to Chapter 7 as “liquidation bankruptcy’’ because it discharges most of your unsecured debt. That includes credit card debt, medical bills and personal loans.

    It’s the quickest, simplest and most common type of bankruptcy. More than 63% of the 819,159 bankruptcy cases filed in 2016, were Chapter 7.

    An even more encouraging bankruptcy statistic: 95.5% of Chapter 7 filings had their debts discharged. You must pass a “means test’’ to qualify for Chapter 7 filing. The means test examines financial records, including income, expenses, secured and unsecured debt. You must qualify under income limits that vary by state. You might be forced to sell any non-exempt assets, although important assets like home, car, equipment for work, are exempt and can be retained.

    Generally, the Chapter 7 process can be completed in three to four months.

    Bankruptcy Myths

    Filing for bankruptcy can be a traumatic experience, particularly for people who believe some of the “myths’’ that supposedly surround the process.

    Some of the myths include:

    Losing Everything — Actually, the majority of Chapter 7 filings are “no-asset cases,” meaning the debtor gives up no possessions. The law allows you to retain basic assets necessary for day-to-day life, like your house, car, computers or other equipment needed for you to work. These are called exemptions. Beyond that, it’s likely that creditors won’t want the possessions that aren’t covered under exemptions.

    Relief from ALL Debts — As a general rule, debts you are deemed personally responsible for – taxes, alimony, child support, student loans – won’t be forgiven. Some consequences can’t be erased.

    Paying off Debts Is a Better Decision — Maybe. But maybe not. If your debts are more than 50% of your annual income — and you can’t see a way to pay them off within five years — bankruptcy is the best choice to achieve a long-term, debt-free life.

    Bankruptcy Is a Personal Failing — It’s not an admission of failure or a character flaw. Filing bankruptcy is a financial remedy, especially if unforeseen events occur in your life. Things like job loss, meltdowns in the real estate market and especially medical emergencies, aren’t easy to predict. The fact is, medical bills account for more than half of the bankruptcies in America.

    Bankruptcy Will Ruin Your Financial Future — Yes, credit will be difficult to obtain. Yes, higher interest rates will be a given for the 10 years the bankruptcy is expected to remain on your credit report. But in time, there is a way back. Many people have prospered after taking the short-term hit that comes with filing for bankruptcy.

    Pros and Cons of Filing Chapter 7 Bankruptcy

    Deciding to file for Chapter 7 bankruptcy is a big decision that shouldn’t be taken lightly. There are pros and cons, which must be weighed carefully while studying your situation.

    Pros

    • It will prevent your lenders from aggressive collection action.
    • Chapter 7 is easily understood and explained to curiosity-seekers and future lenders. Sure, there might have questions about bankruptcy and it will hurt your credit. But if you talk yourself out of Chapter 7 when it could be the right decision, consider a future of trying to explain your missed debt payments, defaults, repossessions and lawsuits. And yes, all of those will hurt your credit, too.
    • You will be forced to be more disciplined financially. If you ever intend to borrow money again, you will need to be frugal and responsible about debt. Even though you might be able to open new lines of credit anywhere from one to three years after filing for bankruptcy, the interest rates will be much higher. Demonstrating ability to pay those debts on time is the only way to get the interest rates down.
    • In many states, exemptions will allow you to keep many of the things you own, including more property than you probably need. After you file, you will be able to keep any salary you earn and any property you purchase.

    Cons

    • Your credit will take a severe beating. Chapter 7 bankruptcy can remain on your credit report for up to 10 years.
    • You will lose all of your credit cards.
    • You will lose property that you own if it’s not exempt from sale by the bankruptcy trustee.
    • You likely will lose luxury possessions, like a boat or second home.
    • It will be nearly impossible to get a mortgage if you don’t already have one.
    • It won’t relieve you of student loan debt or obligations to pay alimony and/or child support.
    • You can only file under Chapter 7 once every six years, but you can repeatedly turn to a Chapter 13 plan if there are more financial hardships and each filing will appear on your credit report.
    • Bankruptcy court could convert your Chapter 7 case to a Chapter 13 bankruptcy. Instead of being free from most debts within four to six months, you might be required to repay your debts over the course of three to five years.

    Signs You Are a Candidate for Chapter 7 Bankruptcy

    Is bankruptcy right for me? Do I qualify for bankruptcy? Those are questions considered by nearly everyone with severe financial woes.

    Here are five strong signs that indicate you qualify for bankruptcy:

    • Your debts total more than half your annual income.
    • It would take five years (or more) to pay off your debt, even if you took extreme measures.
    • Your debt interferes with other essential aspects of your life, such as relationships and your ability to sleep.
    • You have little to no disposable income.
    • Your monthly income is below the median level in your state.

    Real Life Examples of Chapter 7 Bankruptcy

    Patrice Washington, an Atlanta-based personal-finance expert and author of three books, is the self-proclaimed “America’s Money Maven.’’ You probably have seen her on television. She has provided inspiration while teaching people how to manage and grow their money.

    You might be surprised to know that Patrice Washington has filed for Chapter 7 bankruptcy.

    Twice.

    That’s one example of how bankruptcy, which allows overwhelming debt to be forgiven or restructured under the protection of a federal court, can happen to anyone. You will hear that statement a lot — because it’s true. Even the President of the United States has been in bankruptcy court.

    Six times.

    Dan LaBert, executive director of the National Association of Consumer Bankruptcy Attorneys, said bankruptcy “gives you the chance for a fresh start. It’s a legitimate option for anyone who feels overwhelmed by the pressure of financial stress.

    Here are some real-world examples of people who qualified for Chapter 7 bankruptcy, starting with Patrice Washington, the personal finance expert mentioned at the top of the story.

    Washington graduated from college with $18,000 in credit card debt.

    Years later, as the Great Recession hit America, the real-estate company founded by Washington and her husband was on the verge of collapse. Between business and personal expenses, they were $2-million in debt. Financial ruin can occur for someone struggling to make ends meet. It can also occur for someone like Washington, seemingly the picture of financial savvy and success.

    Washington now calls herself “an expert on living with less.’’

    “We had wanted to pay back everything we had signed our names to, but the debt would have loomed over us forever,’’ wrote Washington, referring to the $2-million debt that forced her into filing for Chapter 7 bankruptcy in 2011. “Though it wrecked our credit, bankruptcy gave us the reset we needed. … I used that knowledge to rebuild my life.’’

    These next three scenarios were provided by bankruptcy attorneys, who used fictional names for the clients in describing the bankruptcy cases.

    Example 1

    Maria is a retired teacher on a fixed income. She sold her home and moved in with her daughter. She had excellent credit because of on-time payments on her mortgage. Careful with her money, she also had no debt.

    She agreed to cosign on a mobile home loan for her grandson and a car loan for her granddaughter. How could she say no? And her credit was sterling.

    But two years later, the mobile home was repossessed after the grandson was divorced. The granddaughter’s car was repossessed after she lost her job. There was substantial debt remaining when the car and home were sold at auction.

    Maria, in failing health, was hounded by creditors who called about the deficiency claims. Maria filed a Chapter 7 bankruptcy, which stopped the harassment and eliminated the deficiency claims. Her social security and retirement income were exempt and protected in the bankruptcy.

    Example 2

    After graduating from nursing school, Traci got a job at the local hospital. She used student loans to pay for most of her college expenses. As some college students will do, she ran up some credit card debt with frivolous purchases.

    In her last year of school, she was injured in an automobile accident. The medical bill was $2,500 and she didn’t have health insurance. But she made payment arrangements with all of the creditors, so things seemed fine as her nursing career began.

    When the first payments for her student loans were due, she barely had money left after paying utilities and other expenses. She had already deferred her student loan payments. The collection notices began arriving. She found herself distracted and unable to sleep because of worry over her finances. When Traci filed a Chapter 7 bankruptcy, she eliminated the credit card debt and medical bills. She then had enough money to make her student-loan payments.

    Example 3

    Pete and Sheila have two small children. When Pete was discharged from the Army after six years of service, the money was tight. After their children were born, Pete landed a job as a delivery man, but the salary was substantially less than his military pay. Monthly bills became a struggle, considering the decreased income and increased expenses.

    Trying to be smart and prudent, they stopped using their credit cards. But there was still credit card debt that began early in their marriage. The finance charges and late fees began taking a toll. When the creditors began calling, Sheila already was unnerved while caring for two active children.

    The creditors soon called Pete at his job and said they would garnish his paycheck. Pete and Sheila decided they had enough. They contacted a bankruptcy lawyer for a consultation. By filing a Chapter 7 bankruptcy, they stopped the phone calls and harassment. Their credit-card debt was eliminated. Because they rented a house and owned two older vehicles, much of their life was kept in order.

    Common Bankruptcy Questions

    From a practical standpoint, there are two questions that generally come up for anyone considering bankruptcy. How much debt do I need to file for bankruptcy? And, is there an income limit for bankruptcy?

    Under Chapter 7, there is no minimum debt limit (there are stipulations under Chapter 13). Every situation is different, but here are some factors to consider before filing for bankruptcy.

    • Types of Debt — If you largely have unsecured debt (credit cards, medical bills, cash advance debts), bankruptcy could offer a respite from creditors.
    • Employment — If you are out of work, bankruptcy could help you get rid of some debts and allow you to keep up with a mortgage or car payment.
    • Non-Bankruptcy Options — For those with little income and few assets, bankruptcy may be unnecessary. The scenario of being “judgment proof’’ is when a creditor sues the person for repayment of a debt, but the person is unable to repay it because of limited finances.
    • Cost to File Bankruptcy — For Chapter 7, there’s a filing fee, courses for Credit Counseling and Debtor Education and legal fees. Is the bankruptcy cost on par with these fees? If so, it may not provide much financial freedom.

    As for the question of whether there is an income limit, the simple answer is: Yes!

    To qualify for a Chapter 7 bankruptcy, the debtor must earn less than the state median income on a monthly basis and submit to a “means test’’ that examines their financial records, including income and expenses, along with secured (mortgages and car loans) and unsecured debt (credit card bills, personal loans, medical expenses). Certain non-essential credit purchases, designated as “luxury items,’’ might remain the debtor’s responsibility, although that can be appealed to the court.

    Preparing for Bankruptcy

    There’s some protocol to follow in the months before filing for bankruptcy. Failing to follow these instructions could undermine your efforts.

    Don’t Pay Creditors — It seems counterintuitive and you should definitely make routine payments. But any large or unusual payments could be viewed as “preferential transfers.’’ That means one creditor has benefitted unfairly over others.

    No New Debt — A new creditor could claim you took out a loan or ran up the balance on a credit card without intending to pay it back. Legally, that’s fraud and it will not be forgiven.

    No Unusual Transactions — Don’t stray from the routine. Don’t transfer titles of cars or homes. Don’t buy luxury goods. Don’t transfer your business or remove your name from it. They can all be classified as fraud.

    Be Truthful — You are required, while filing for bankruptcy, to provide full and complete information. You must disclose any debt, assets, accounts or other financial information. Failure to comply could lead to fraud and potential criminal charges.

    Don’t Touch Retirement Funds — You are generally allowed to keep retirement funds and accounts, so keep them safe while considering bankruptcy and don’t use those funds to pay down debt.

    Use Common Sense — You should not file for bankruptcy if you’re about to receive a large sum of money, such as an inheritance. You could use that money to pay down your debts. Otherwise, if you’re involved in a bankruptcy process, that money could be seized by a court representative to pay your debts.

    Never think you can get away with something sneaky or dishonest. Your bankruptcy lawyer is always a good resource for what you should and shouldn’t do.

    How to File Chapter 7 Bankruptcy

    Once you qualify to file for Chapter 7 bankruptcy, it will take up to four months to complete the bankruptcy process.

    The most important factor is finding an experienced and reputable bankruptcy attorney.

    To start the process, the debtor must file a petition with the local bankruptcy court. Financial statements must be filed, detailing records of assets, liabilities, income, expenses and overall financial standing, plus any existing contracts or leases in the debtor’s name.

    Pre-bankruptcy credit counseling ($50) is required for debtors filing under Chapter 7. There are also payments for petition filing ($335), court fees (which vary by state) and attorney fees (the national average for Chapter 7 bankruptcy is $1,250, according to the National Bankruptcy Forum).

    Bankruptcy involves a lot of paperwork, which becomes public record. Bankruptcy court participants are generally featured in newspapers and online, so there’s a potential loss of financial control and privacy.

    It might seem tempting to avoid attorney’s fees and handle the bankruptcy proceedings on your own. Beware! It’s a complicated process. Any mistakes in filing and it could be rejected by the court, putting you back at square one.

    Look for an attorney who has bankruptcy knowledge, the ability to develop a professional relationship and legal fees that are commiserate with the complexity of your case. The fees might seem high, but as a general rule, you get what you pay for in bankruptcy proceedings. It’s not a time to cut corners.

    Once you decide on an attorney, you can refer creditors to your lawyer’s office. Filing the petition will trigger an “automatic stay,’’ which means creditors can’t pursue lawsuits, garnish your wages or contact you about your debts. Here’s a potential timetable:

    You are required to attend a meeting of creditors, which will take place about 30 days after the case is filed. The trustee, an attorney or accountant appointed by the government to oversee and review the bankruptcy, will preside over the meeting.

    The trustee will need copies of the last two years of tax returns and proof of income for the preceding six months. The trustee likely will ask some questions and delve further into your financial situation, perhaps even sending an appraiser to your home for a determination of its value.

    Sometimes, the trustee will say the Chapter 7 case should have been filed as a Chapter 13.

    The trustee has 30 days for objecting to property the debtor wants the right to retain. Other creditors have 90 days from the meeting to file a suit alleging that their debt should not be eliminated in the bankruptcy. Without objections or lawsuits, the process should be completed within three months.

    Once completed, your financial situation will seem like a mess. Without debts, though, you can start on the road back. Setting up a budget and applying for a secured credit card are some preliminary steps.

    You will likely need to change your spending habits. Regular credit counseling or help from a financial planner could be a smart approach. It’s also very important to pay all your bills on time and never use credit cards or loans as an extension of your income. It’s common sense time. Live within (or beneath) your means. Be thankful for what you can afford. The new financial goal: Never ending up in a bankruptcy situation again.

    The rebuilding process can be quite rigorous. Bankruptcy will stay on your credit report as a negative mark for up to 10 years. It’s also required that you declare your bankruptcy filing to future employers and on medical forms, along with state or government official reports.

    So, it’s something to consider, primarily because it can drastically affect your chances of getting a mortgage or a college loan.

    But facing dire financial straits, bankruptcy might be your best option. You wouldn’t be alone. Bankruptcy can happen to anyone.

    Alternatives to Filing

    If bankruptcy isn’t the answer, there are many nonprofit consumer credit counseling organizations that have the ability to negotiate more favorable terms with creditors. It’s particularly effective with credit-card companies. The repayment program will be managed expertly and fees could be avoided.

    Here are some options:

    Debt Management Plan — Entering into a debt management program can provide relief from interest rates, late fees and penalties from creditors. Under a DMP, which is negotiated by credit counselors, you promise to pay back the full principal over time in an efficiently managed manner.

    The debt management program provides an organized monthly payment plan. It provides an opportunity to handle the debt more efficiently than trying to sort it out yourself. By keeping the payments on track, it will be good for your credit score.

    Some caveats: There is generally an enrollment and maintenance fee and the DMP is never a guaranteed option. Creditors have no obligation to participate.

    Debt Consolidation— This option reduces interest rates and combines all of your debts into one manageable monthly payment. Under debt consolidation, you take out a loan, which is used to consolidate and pay off all of your other debts.

    Debt consolidation companies are experienced at acquiring loans and finding the lowest monthly payment. With credit-card loans, the consolidated interest rate can be significantly less than what is being charged on each of your credit cards.

    A word of caution, though. Be sure to look for a dependable and experienced debt consolidation company (with at least five years of experience). Also, be wary of consolidating several unsecured loans into one secured loan. If you can’t pay back the loan, collateral items at stake typically include your home or car and you could lose one or both!

    Debt Settlement — It’s a lump-sum settlement payment with creditors, although this option is generally a consideration only for people with very poor credit. It allows you to decrease the principal you owe while eventually retiring the debt.

    In most cases, you will around 50%-75% of the original debt. But it’s important to determine — up front — whether the company is charging a percentage of the debt as its fee or you could find yourself paying even more. Be aware that debt settlement is damaging to your credit score. Lenders often will report the debt as “settled for less than agreed’’ or “settlement accepted’’ for seven years.

    Need help finding if bankruptcy is an option for you?

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    Author

    Staff Writer

    Bill Fay is a journalism veteran with a nearly four-decade career in reporting and writing for daily newspapers, magazines and public officials. His focus at Debt.org is on frugal living, veterans' finances, retirement and tax advice. Bill can be reached at bfay@debt.org.

    Sources

    1. United States Courts. Individual Debt Adjustment. Chapter 7. Retrieved from: http://www.uscourts.gov/federalcourts/bankruptcy/bankruptcybasics/chapter7.aspx
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