If a creditor has a court judgment against you, you can often discharge (wipe out) the debt in bankruptcy. But a judgment can create a lien that gives the creditor the right to seize and sell your property to pay the debt. While you might be able to get the debt to go away, it isn't always possible to get rid of a lien in bankruptcy, making it difficult for you to sell or refinance property later. Learn about when bankruptcy can do the following:
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Most people end up with a money judgment after a creditor files a lawsuit for an unpaid debt. If you fail to file an answer or you lose the case, the court will enter a judgment for the amount of the debt, plus other amounts, such as the attorneys' fees and costs for bringing the suit.
Depending on the laws of your state, a creditor with a judgment against you might be able to
When you file for bankruptcy, you get the benefit of the automatic stay—an order that will stop such collection attempts as soon as you file your case.
After finishing your Chapter 7 bankruptcy or Chapter 13 matter, the court will wipe out the judgment creditor's right to collect on the debt if it qualifies for discharge (more below). But you won't be out of the clear if the money judgment provides the creditor with lien rights to your property.
A creditor with a money judgment can use it to create a lien against any property you own, but the specific procedure will depend on your state. Here are the most common procedures:
If your state follows the second approach, you might want to file your bankruptcy before the creditor records the judgment and creates the judgment lien. Once in place, the lien gives the creditor property rights similar to those your mortgage or car lender has in the house or car you put up as collateral, but broader. A judgment lien will usually cover all of your property.
Creditors know judgment liens are powerful, but you might be able to counter the effects by filing for bankruptcy and meeting these conditions:
All debts are dischargeable unless the bankruptcy code states otherwise. These debts never go away:
Also, a creditor can ask the court to declare additional debts nondischargeable by filing a lawsuit called an "adversary proceeding." The debt will get discharged unless the creditor can prove:
Discharging the debt is only half the battle, because the bankruptcy filing doesn't change a creditor's lien rights. Eliminating all or part of a lien requires filing a motion in the bankruptcy court asking the court to "avoid" (eliminate) the lien. You must also be able to show that you can exempt (protect) some or all of the equity in the property with the lien on it.
Start by checking the federal and state property exemptions available to you—they tell you the property you can keep in bankruptcy. If successful, you can avoid the lien up to an amount equal to the property exemption. Here are two examples that illustrate how this works.
Example 1: Molly filed Chapter 7 bankruptcy to discharge her debts, including a judgment of $12,000 she owed on a credit card.
Molly's house is worth $120,000. The balance of her mortgage is $90,000. Her state allows an exemption of $40,000 on her residence, therefore, her equity of $30,000 in the house is fully covered.
The $12,000 is impairing her exemption because, with the judgment, her equity is reduced to $18,000, but without the judgment, she can exempt the full $30,000 equity. Molly will be able to avoid the judgment lien by filing a motion in the bankruptcy court because the judgment impairs her exemption.
Example 2: Reggie also has a judgment of $12,000. His home is also worth $120,000, and the balance of his mortgage is also $90,000, with $30,000 in equity. Reggie's state has an exemption for homesteads of $25,000. But his equity is $30,000. That means his exemption will not cover $5,000 of his equity. The $12,000 judgment impairs only a portion of Reggie's exemption -- $7,000. It does not impair the other $5,000 because that amount is not exempt. If Reggie files a motion to avoid the lien, the bankruptcy court will erase only part of the lien, $7,000 worth. Therefore, the lien will only be worth $5,000.
Even though Reggie can't eliminate the entire lien, he will likely see benefits that make his action worthwhile. Reducing the dollar amount can reduce the creditor's incentive to use foreclosure to collect the debt. Later, when Reggie puts the property on the market, he'll only have to pay off $5,000 (plus accrued interest) instead of the original $12,000.
The lien will remain attached to your property if you do nothing. However, if you don't address lien issues during your bankruptcy case, most courts let you reopen the case later (although this will cost you another filing fee).
Bankruptcy is an unusual area of law because it's essentially a qualification process. The laws provide instructions for completing a 50- to 60-page bankruptcy petition, and because all rules apply in every case, you can't skip a step.
The forms and resources below will help you find more information. Also, you can use this list of Chapter 7 and 13 bankruptcy forms to see where this topic falls. And this handy bankruptcy document checklist will help you gather the things you'll need to complete the petition.
More Bankruptcy Information
You'll find fillable, downloadable forms here:
We want to help you find the answers you need. Go to TheBankruptcySite for more easy-to-understand bankruptcy articles, or consider buying a self-help book like The New Bankruptcy by Attorney Cara O'Neill.
We wholeheartedly encourage research and learning, but online articles can't address all bankruptcy issues or the facts of your case. The best way to protect your assets in bankruptcy is by consulting with a local bankruptcy lawyer.