Over 80% of Americans are in debt and approximately 73% of American consumers take this debt to their grave. Overwhelming debt can be the result of medical expenses, job loss, divorce, student loans, or poor money management. While filing for bankruptcy should only be considered after exhausting all other options, it can offer relief from the suffocating burden of debt. Although by no means a desirable solution, nearly one million Americans per year file for bankruptcy under chapters 7, 11, and 13.
Bankruptcy: Chapter 7
Chapter 7 is the most common type of bankruptcy that an individual can file for and it allows debtors to discharge all or most of their debt. Often referred to as a “Clean Slate” Bankruptcy. It is the simplest and the quickest of the filings and because of this. Under Chapter 7, the debtor’s assets are liquidated to repay the debt to each creditor. All of these liquid assets are sold and converted into cash except for the “exempt” property, which is anything that cannot be used to repay said debt.
In order to qualify for Chapter 7 you must pass a means test, proving that your income is less than the average in your state. This test is meant to differentiate between those who have disposable income and unnecessary consumer debt from those who are living within their means. Qualifying for Chapter 7 also requires meeting with a Court-approved credit counselor to be sure that filing for bankruptcy is the right course of action.
Priority Debts Find Immunity
Even if you qualify for bankruptcy, there are certain debts that cannot be wiped out by Chapter 7. These debts that remain are referred to as non-dischargeable debts and include child support or alimony payments, court fees, recent federal, state, or local taxes, and student loans. Educational loans are generally not eliminated unless the debtor and his or her dependents will suffer “undue hardship” by continuing in these payments. Qualifying for undue hardship constitutes a financial situation in which paying back the loan would make a minimal standard of living unsustainable.
All of these debts are considered priority debts and will not be wiped from the debtor’s obligatory payment list, with child support being the most urgent of all the priority debts.
Medical bills are not listed as a priority debt and are considered unsecured debts, not dissimilar to the debt accrued from credit cards. By filing a Chapter 7 or a Chapter 13 you should be able to eliminate your medical bills, qualifying them as dischargeable debt. Similarly, if you file for bankruptcy prior to a foreclosure, your mortgage debt can potentially be discharged.
Bankruptcy: Chapter 11
In contrast to Chapter 7, Chapter 11 is the most complex of all bankruptcy cases, and usually the most expensive. It is a form of bankruptcy that requires a reorganization of a debtor’s business affairs, debts, and assets. Chapter 11 is most often filed by corporations that need time to restructure their debts and obligations. This type of bankruptcy does not generally close the business and in fact many large U.S. corporations such as General Motors, United Airlines, and K-mart have filed Chapter 11’s and stayed afloat.
In a Chapter 11 bankruptcy the debtor maintains control of the assets and the day to day operations and is given the title of debtor in possession (DIP). The DIP is given the first opportunity to propose a reorganizational plan and if that plan is approved by the courts the process moves forward. Generally these plans include one or more of the following: downscaling of business operations to lessen expenses, renegotiating debts, and liquidating all assets. If the plan is not approved by the courts it is most likely not in the best interest of the creditors. If this is the case, the creditors may receive control and put a new plan in place.
Bankruptcy: Chapter 13
Chapter 13 bankruptcy is the second most common type and concerned more with the reorganization of an individual’s finances and less with the elimination of debt. Also known as the “wage earner,” it allows the debtor to retain his or her valuable assets and property due to their reliable and steady source of income. The debtor presents a repayment plan and if the Court approves it, payments are made from the debtor’s future income to the creditors, through a trustee. This plan is completed over the course of three to five years and cannot exceed five years.
In filing for Chapter 7, 11, or 13 it is imperative to be both well informed and painstakingly honest. The consequences of bankruptcy fraud are severe and one found guilty of such a crime could be fined up to $250,000 or receive a jail sentence for up to 20 years in prison. The primary reason for committing bankruptcy fraud is to conceal assets in hopes of not having to forfeit them. Other ways this crime can be committed include bribing a court-appointed trustee, filing multiple times in several jurisdictions, and committing perjury by filing false information on a bankruptcy form.
Ultimately, filing for bankruptcy is not the solution to ending money woes as only sound money management can guarantee success in that department. Declaring for bankruptcy is increasingly complex, costly, and unleashes years-long damage to your credit, severely restricting financial freedom in the process. Despite its numerous drawbacks, in some cases, filing for bankruptcy is the best available vehicle to improving financial health and escaping debt.
Bankruptcy: Credit Reporting
As if filing for bankruptcy does not hurt enough! Did you that 80% of all credit reports have inaccuracies on them and half of those inaccuracies are enough to damage one’s credit score. The news is worse for people who file for bankruptcy, because there are some very common errors and mistakes on their credit reports that they face in addition to being part of the 80%. These include:
- A debt that was discharged in your bankruptcy, is reported with an outstanding balance. Sometimes a creditor will fail to update its records to show that you have filed for bankruptcy. When that happens, the original debt and payment can be reported as outstanding when, in fact, the debt was discharged. Showing an old debt and monthly payment negatively affects your credit score.
- A debt that was modified in your bankruptcy program still being reported with the old balance and/or the old monthly payment. Just like a debt that was discharged in bankruptcy, sometimes a debt that was modified in a Chapter 13 may not be updated on your credit report. We have seen many second mortgages that have been modified by bankruptcy, continue to be reported with the old balance and the old payment, even after they were reduced by the bankruptcy. You have to be vigilant to make sure that after your Chapter 13, that all effected balances and monthly payments have been changed.
- A bankruptcy that was dismissed results in trade lines reported as “included in bankruptcy.” Sometimes, people file for bankruptcy because of impending legal or enforcement action against them. When the crises is averted, they abandon or otherwise get their bk dismissed. Here’s the bad news. Under the public records section of your credit report, a Chapter 13 can remain on your credit report for up to 7 years and a Chapter 7 can stay on your credit report for up to 10 years. Still, if you did not complete your bankruptcy plan, then none of the trade line should be reported as “included in bankruptcy.”
- A non-filing spouse reported as having filed bankruptcy when he or she has not. Many times, when one spouse files for bankruptcy, so does the other. However, there are times when only 1 spouse files for bankruptcy. When that happens, the other spouse may have items on her credit report that are reported as “included in bankruptcy.” This, by itself, is not improper. For example, if both husband and wife are jointly liable for a 2nd mortgage and the husband files for bankruptcy that trade line will be reported as “included in bankruptcy” on the credit reports of both spouses. Where the line is crossed is when each spouse is reported as having filed for bankruptcy under the Public Records Section of each of their credit reports.
- Post-bankruptcy payments not being applied to loan balances in a Chapter 13. Sometimes, banks and other lenders get into a bit of a dither when a consumer files for bankruptcy. Sometimes, they are uncertain as to how to handle payments. For example, after Chapter 13, many of a consumer’s debts are modified; not vanquished. The consumer must still make payments on the debt, but the lender may fail to apply these to any loan balance. This creates the false impression to a user of your credit report that a debt is higher than it actually is. This kind of false reporting also has a negative impact on your credit score.
- A creditor reporting past due payments on a loan after a bankruptcy plan is confirmed and payments have been made pursuant to the bankruptcy plan. You filed for Chapter 13 bankruptcy. Your 2nd mortgage loan was modified whereby the outstanding balance was reduced along with the interest rate and the monthly payment. 2 months after your plan has been confirmed, the lender is now reporting you as late each month because you are not making the original payment. This happens now and again. It’s wrong. When your Chapter 13 plan is confirmed, your contractual obligations with your lenders is modified. If you make the modified payment, you are current with your obligation.
- Mortgage debts reported with a zero balance and zero monthly payment that have been modified by bankruptcy. Some large institutional lenders automatically suspend the reporting of any balance when a consumer files for bankruptcy. Indeed, we have seen cases where a lender has reported a zero-balance due even though the bankruptcy merely modified the outstanding balance and monthly payment and did not vanquish the debt, entirely. This would give anyone who read your credit report the false impression that you discharged the debt in bankruptcy when, in fact, you only modified it. This is illegal.
- Lawyers and Bankruptcy: It is very often for lawyers to make errors with their in house bankruptcy processing methods.
If you have items on your credit report that are inaccurate or unfair or that don’t belong to you, enroll with Credit World to confront your credit, get a full analysis with improvement options.