There is a lot of information about bankruptcy floating around, and much of it is misleading, incomplete or just plain wrong. Here are four common things many people believe about filing for bankruptcy that are less than accurate.
1. Changes to the bankruptcy laws in 2005 make it impossible for most people to qualify for bankruptcy.
The new laws did add some eligibility requirements for Chapter 7 bankruptcy, but most people still qualify.
The Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) of 2005 did make filing for bankruptcy more complex, and some people may no longer be able to get a Chapter 7 discharge. However, despite the additional paperwork required, most people will still be able to file for Chapter 7.
Probably the most drastic change was the addition of the means test. If your income is above the median for your state, then you must pass the means test in order to qualify for Chapter 7 bankruptcy. The test compares your income to your expenses, and is designed to prevent you from getting a "straight" Chapter 7 discharge if you have the ability to pay back some of your debt. If you cannot pass the means test, you will need to file under Chapter 13, which requires you to pay back at least some of your debt over a three to five year period.
Other additions included in BAPCPA are the requirement to attend two sessions of credit counseling, as well as lengthening the amount of time required for you to be able to file bankruptcy again. You cannot file bankruptcy again for eight years after a Chapter 7 discharge and six years after a Chapter 13 discharge.
Most people will still qualify for Chapter 7 relief, although filling out the paperwork is more burdensome.
- The Bankruptcy Means Test
- 2005 Changes to the Bankruptcy Law
- Understanding the Bankruptcy Abuse Prevention and Consumer Protection Act
- What Happens During Pre-Bankruptcy Credit Counseling?
2. If I file for bankruptcy my credit score will be ruined forever (or at least for the next ten years)?
A bankruptcy will stay on your credit report for up to ten years, but your credit score will go back up over time if you take the right steps.
If you're considering filing for bankruptcy, chances are your credit score is not great, and probably already on a downward spiral. Eliminating your debts in a bankruptcy, and starting over certainly won't help it immediately, but it does offer the chance to begin rebuilding your credit history.
Effect on Your Credit Score
When you file for bankruptcy and get your debts discharged, your credit report will note that your debts were discharged in bankruptcy. This will have a negative effect on your score. The magnitude of that effect depends largely on your credit score prior to filing. If you're credit report was spotless prior to your bankruptcy, you can expect a serious drop. However, if you already had several negative items on your credit report (late payments, large debt balances compared to available debt, etc.), then the drop will be modest.
Your Credit After Bankruptcy
How quickly you can improve your FICO score after a bankruptcy depends, in large part, on how wisely you spend and use credit. If you're careful, carry no or very little unsecured debt, pay all your bills on time every month, and generally live within your means, you can rebuild your credit enough to qualify for a credit card, loan, or even a mortgage within a few years.
Bankruptcy will negatively impact on your credit score, but your credit will not be ruined forever. In fact, by getting out from under a mountain of debt, you may be able to get your finances in order more quickly than if you hadn’t filed for bankruptcy. With careful use of credit and tight control of your finances, you can improve your score over time.
- How Long Will Bankruptcy Affect Your Credit Report and Score?
- How can I minimize the negative effect of a bankruptcy? (MyFico.com)
- Life After Bankruptcy: Checklist for a Fresh Start
3. If I file for Chapter 7 bankruptcy I will have to give up all my valuable property and assets.
Most Chapter 7 bankruptcy filers keep all or most of their property.
In Chapter 7 bankruptcy, the court discharges all or most of your debts. In exchange you must give up non-exempt property; the trustee sells the property and uses the proceeds to pay your creditors. Luckily, bankruptcy law allows you to keep certain types of property up to certain value – this is called exempt property. For many people, the bankruptcy exemption laws will protect all of your important property (such as your home, car, and retirement assets) and the rest will probably be "abandoned".
Your Property, Exemptions and the Bankruptcy Trustee
In a Chapter 7 bankruptcy, the bankruptcy court will appoint an individual, called the bankruptcy trustee, to administer your case. The trustee has several duties, one of which is to seize your nonexempt property and sell it for the benefit of your unsecured creditors.
If the equity in your property is covered by an exemption (which vary by state), you get to keep the property. Most states exempt some equity in your home (some homestead exemptions are quite large, others are fairly small), your car, your personal property, retirement accounts, and other types of property.
Abandonment of Property
Even if all of the equity in a piece of property is not exempt, you still can keep it if the trustee “abandons” the property. This often happens if, after deducting the costs of selling the property and the trustee’s commission, little or nothing would be left over to give to creditors. If selling property won’t help your creditors, the trustee is likely to abandon the property – which means you get to keep it.
What if I Have Valuable Non-Exempt Property
If you have significant equity in property and that equity is not covered by an exemption, you will likely lose the property. For example, if you have $250,000 of equity in your home, and your state’s homestead exemption only protects $50,000, the trustee will sell your home, pay you $50,000 (the exempt amount is yours to keep), and distribute the remainder amongst your unsecured creditors.
If you want to keep nonexempt property, Chapter 13 bankruptcy may be a better option for you. In Chapter 13 bankruptcy, you keep your property and in return, pay all or a portion of your unsecured debt over a three or five year period.
Most people filing for Chapter 7 bankruptcy are able to keep most or all of their property.
- Bankruptcy Exemptions – What Do I Keep When I File For Bankruptcy?
- What Happens to Personal Property in Chapter 7 Bankruptcy?
- When is Chapter 13 Better than Chapter 7?
- Will I Lose My Checking or Savings Account if I File Bankruptcy?
4. There's no point in filing Chapter 13 bankruptcy because I'll have to repay all of my debt anyway.
Chapter 13 does involve a repayment plan, but has many advantages and can still cancel a lot of your debts.
If you do not qualify for Chapter 7 due to your income, or if Chapter 7 would put some of your property at risk, you may want to consider Chapter 13.
The Payment Plan Under Chapter 13
The repayment plan in a Chapter 13 bankruptcy case is designed to repay some or all of your unsecured debts, depending on how much monthly disposable income you have.
The monthly payment is calculated using the amount of income you have left over after taxes and regular monthly expenses (plus some rules regarding secured debts and your exemptions, see the links below for more information). For many people struggling with debt, a Chapter 13 payment plan can reduce their monthly debt payment significantly, and you may wind up repaying less than the full amount of your debt. Many Chapter 13 filers pay pennies on the dollar.
Advantages of Chapter 13 Over Chapter 7
Save Your Home from Foreclosure. While any type of bankruptcy will stop a foreclosure temporarily, only Chapter 13 allows you to make up past due payments as part of your repayment plan. This means you can not only stop a foreclosure, but save your house permanently (assuming you can afford your house, of course).
Protect Co-Signers. If you have a co-signer on any debt, they will still be on the hook if you file for chapter 7 bankruptcy. Chapter 13 offers you a way to protect your co-signer from creditors.
Strip Some Secured Debts. If you are upside-down on a car loan, you can get the difference between the value of the car and the loan amount stripped off your car note. If you house is worth less than the first mortgage, and you have a HELOC or second mortgage, you can "strip off" the additional loans without losing the property. The "stripped" off value of the loans becomes unsecured debt, which you pay off through your repayment plan, often at pennies on the dollar.
Most Chapter 13 bankruptcy filers are able to discharge some of their debts at the end of their repayment period. In addition, it allows you to repay other debts under the protection of the bankruptcy court, provides a way to make up arrears on secured debts so you can keep the property (such as your home or car), and can even reduce the loan amount of certain car loans and second mortgages.