Filing Bankruptcy for Credit Card Debt

Bankruptcy is meant to give consumers drowning in debt a second chance, which a lot of people who overspent heavily using credit cards,  think they need.

But if you look at the average credit card balance in the United States in the summer of 2021 — $5,400 – is that really drowning in debt? It could be if you’re among the 60% of people who file for bankruptcy with an income of under $30,000.

That’s right – 60% of the people who file for bankruptcy take home less than $500 a week. Try paying for rent, utilities, food and transportation with that … then throw $5,400 in credit card bills on top of and see if it feels like you’re drowning financially!

“The vast majority of people who file bankruptcy are there because they really need it,’’ said Edward Janger, who teaches and writes about bankruptcy at Brooklyn Law School. “They don’t get into it because they think it’s going to be fun and easy. They’re struggling and bankruptcy let’s them hit the reset button.”

The goal of bankruptcy is to wipe out personal liability for debt and, at least in the case of Chapter 7 filings, that has become almost a sure thing. If you file Chapter 7, the success rate for discharging unsecured debts (like credit cards) is an astounding 95.3%.

You also should be aware that not everyone qualifies for Chapter 7 or Chapter 13 bankruptcy and there are some negative repercussions for having credit card debt discharged. There will be a large negative stamp on your credit report for 7-10 years, making it extremely difficult to get a loan and if your financial life goes haywire again, you can’t file for eight years.

Janger, who graduated from Yale and got his law degree at the University of Chicago, suggested anyone considering bankruptcy review those consequences.

“Filing bankruptcy isn’t something to take lightly,” he said. “There have been plenty of studies that show that people choosing this do so because they’re in deep trouble and this gives them a way out.

“But the cost is you’re going to have trouble getting credit for the next 10 years and if you do, it’s going to be very expensive. That means you’ve got to live on cash and wait until the bankruptcy works its way off your credit report.”

So, should you file for bankruptcy to eliminate credit card debt? If your goal is to get a restart on your finances, bankruptcy can do that, but know the financial consequences for making that choice.

Falling Behind on Credit Card Payments

The road to bankruptcy via credit card debt is fairly easy to follow. It starts by skipping one monthly payment on your credit cards, then finding a late fee slapped on your bill the next month. The next step is to miss payments two consecutive months. Do that and the Credit Card Act of 2009 permits card companies to raise the interest rate on your card.

They also can raise the interest rate if:

• Your credit score goes down
• You own the card for more than one year
• The prime interest rate increases
• The promotional introductory period ends

The amount the interest rate goes up varies, but it’s not uncommon for someone missing payments to see that rate jump from the national average of 17.8% to 30%. In fact, there is no law preventing card companies from going even higher.

When the interest rate jumps – and late payment penalties and over-the-limit charges compound the problem – your credit card debt goes soaring. If you stop making even minimum payments, that’s when the debt collection agencies arrive.

Debt collectors are notoriously aggressive in pursuing credit card debt. Their lawyers can sue you in court and obtain judgments that include garnishing wages and placing liens on your property.

Filing for bankruptcy can stop the lawsuits and collection agencies. It’s called an automatic stay and it prevents creditors from starting or continuing action against you to collect the debt. It is one of the definite positives for filing bankruptcy.

Chapter 7 Bankruptcy for Credit Card Debt

Filing Chapter 7 bankruptcy not only can wipe out credit card debt, it also can sweep all forms of unsecured debt into the garbage, if done properly. Among the bills that can go away are:

• Medical
• Utility
• Personal loans
• Back rent
• Phone
• Deficiency balances due to repossession

There are debts that you can’t wipe out with Chapter 7, including child support, alimony, taxes, student loans, legal judgments and debt obtained through fraud.

Remember that any non-exempt property you own, which typically would include a second house or car, jewelry, art and other non-essential “luxury items” will be sold by the bankruptcy trustee and proceeds turned over to the creditors involved in your case, including the card companies.

Exceptions for Eliminating Debt with Chapter 7 Bankruptcy

While there are plenty of reasons to eliminate credit card debt through Chapter 7 bankruptcy, there are two major reasons you would not have the debt successfully discharged:

• You incurred debt on your credit card as the result of fraud
• You used the credit card to purchase property that the creditor has a security interest in, such as a high-end appliance or piece of jewelry.

The issue of fraud could be the result of you making false statements that allowed you to get the credit card in the first place. For example, over-stating your income on your application; or possibly doctoring or counterfeiting a credit card to make purchases.

It also is considered fraud when you use the credit card to make “luxury” purchases of more than $725 or took a cash advance of more than $1,000 within 70 days of filing bankruptcy. In other words: If you know you’re going to file bankruptcy, don’t go running up tabs on your credit card.

The second reason is rare, but could result in purchases you made, being repossessed. If creditors see that you bought a top-of-the-line appliance or living room furniture or gold and diamond jewelry, that could be considered secured debt. They could call it “collateral” and ask for it.

The debts for these purchases can be wiped out, but you won’t be permitted to keep the property.

Chapter 13 Bankruptcy for Credit Card Debt

Chapter 13 bankruptcy is called “reorganization” and unsecured debt, like credit cards, is given a very low priority in the reorganization.

When you file for Chapter 13 bankruptcy, you submit a plan to the bankruptcy trustee that says you will pay most, if not all, of what you owe in three to five years. The next step is to prioritize the debts, starting at the top with secured debts (home, car), and priority debts (child support, alimony or back taxes).

Unsecured debt, like credit cards is at the bottom of the priority list.

The Chapter 13 filer then looks at his current and future income and determines how much will go to repay debts in a 3-5 year period. Very little, if any, is set aside for credit card debt.

If the bankruptcy trustee agrees with the plan, and the consumer makes the required payments, all debts are discharged, including credit card debt, when the final payment is made.

Because Chapter 13 bankruptcy does not put much emphasis on repaying unsecured debt, it’s likely most, or all of what you owe on credit cards will disappear with a successful discharge.

Filing Bankruptcy on Credit Cards Only

Filing bankruptcy just to eliminate credit card debt is not practical for one reason: You must include all debts when you file bankruptcy. That’s true whether you’re filing Chapter 7 or Chapter 13.

So, if you had no other debts, there are better options for paying off credit card debt, like debt management or debt settlement programs, that wouldn’t be as drastic or have as much negative impact as bankruptcy.

Qualifications for Filing Bankruptcy for Credit Card Debt

If you want to file Chapter 7 or Chapter 13 bankruptcy, there are qualifying standards to meet, most of which are intended to determine whether a consumer is capable of handling the debt themselves. People wanting to file Chapter 7 bankruptcy must pass a “means test” and those trying to file Chapter 13 have strict amounts of debt they can’t exceed.

The means test for Chapter 7 involves two considerations.  You can pass the test if your income over the previous six months is under the median income for your family size in the state you live. The majority of Chapter 7 filers pass the means test this way.

If you don’t, then you move on to the second consideration: Is there enough income left over to pay down your debt, after deducting expenses for essential items like rent, food, clothing, transportation, utilities, etc.

If there is enough money left, you will be dismissed from Chapter 7 and referred to filing for Chapter 13. If there isn’t enough money left over, you may qualify for Chapter 7.

In Chapter 13, the qualifying debt amount for an individual can’t exceed $419,275 for unsecured bills (credit cards, student loans) and $1.257 million for secured debt (home, car). Be careful with both categories of debt. If you have fallen behind on payments, your totals may exceed the allowed amount.

Can Credit Card Companies Sue Me After I File for Bankruptcy?

When you file for bankruptcy, the “automatic stay” protection goes into effect and prevents credit card companies from initiating or continuing a suit against you to collect money.

If the credit card company filed a debt collection lawsuit against you before you filed, — and the case hasn’t been settled – the lawsuit can’t proceed while the automatic stay is in effect, unless the bankruptcy court gives the card company permission.

If you do receive a discharge in Chapter 7, most often that will include discharge of judgments from debt collection lawsuits.

Bankruptcy Without an Attorney and Credit Counseling

While the process involved in eliminating credit card debt through bankruptcy is not difficult, it always is risky to represent yourself in a legal matter without an attorney.

If you do not have experience with the paperwork and timing involved in filing a bankruptcy case – not to mention knowledge of the sections and sub-sections of the law that apply specifically in your case – you would be doing yourself a grave disservice in not hiring a bankruptcy attorney to represent you.

One of the major qualifying conditions for filing, is taking a pre-bankruptcy credit counseling course within 180 days of filing for bankruptcy. You can fulfill that obligation by speaking with a credit counselor from a nonprofit credit counseling agency.

At the very least, the counselor can look at your financial situation during a credit counseling session and offer any alternatives to bankruptcy that might solve your financial problems, thus negating the need to file bankruptcy.

Chapter 7 is a potential source of relief and that is what it is designed to be. If you are an honest, but unfortunate debtor – you’ve run up debt because of job less, medical debt or just trying to provide the basics for you family – and you just can’t do … bankruptcy lets you hit the reset button.