Bankruptcy FAQs

Q: Will Bankruptcy Wipe Out All My Debts? What Debts Will Remain?

A. It all depends on what type of Bankruptcy you file and the nature or kind of the debt involved: Bankruptcies can generally be described as “liquidation” (Chapter 7) or a “repayment” or “reorganization” (Chapter 13 for individuals and Chapter 11 for companies.). Under a Chapter 7 bankruptcy, you ask the bankruptcy court to wipe out (discharge) the debts you owe. Therefore, most or all of your unsecured debts (that is, debts for which collateral has not been pledged) will be discharged or eliminated. This includes credit card debt, bank loans, most court judgments and medical bills. And you get to keep any property that is classified as exempt under the state or federal laws available to you (such as your clothes, car, and household furnishings). Many debtors who file for Chapter 7 bankruptcy are pleased to learn that all of their property is exempt.

Certain debts cannot be discharged in bankruptcy; you will continue to owe them just as if you had never filed for bankruptcy. Debt that is “non-dischargeable” includes certain types of tax debt, most student loans, government fines, restitution for outstanding child and spousal support (alimony), and debts incurred from criminal or fraudulent conduct. Student loans will not be discharged unless you can show that repaying the debt would be an undue hardship, which is a tough standard to meet.

Q: What Is The Process For Filing Chapter 7?

A: In a bankruptcy petition filed under Chapter 7, a debtor files a petition requesting the court to issue a discharge of outstanding debt through a court order which releases you from having to pay debt classified by the bankruptcy law as “dischargeable.” Then, a court order called an “automatic stay” goes into effect. The automatic stay prohibits most creditors from taking any action to collect the debts you owe them unless the bankruptcy court lifts the stay and lets the creditor proceed with collections.

Upon filing a Chapter 7 petition, a bankruptcy court trustee is assigned to evaluate and sell a debtor’s nonexempt assets. The trustee will schedule a creditors (“341”) meeting. The proceeds of any such sale are used to pay off creditors. A Chapter 7 bankruptcy debtor is able to retain all property categorized as “exempt.” In many cases, nearly all of a debtor’s assets are exempt and, therefore, may be kept by the debtor. Within usually 3-6 months from filing, the court will issue an order finalizing the discharge of debt and closing the case.

Q: Am I free to choose between Chapter 7 bankruptcy and Chapter 13 bankruptcy?

A: If you meet the eligibility requirements for both types of bankruptcy, then you can choose the type of bankruptcy that makes the most sense for your situation. However, you may not have a choice: Not everyone can file for Chapter 7 bankruptcy. Chapter 7 is ideal for debtors who are incapable of repaying debts, and who are eligible for Chapter 7, meaning they can pass the means test.

The means test went into effect with the 2005 changes in the bankruptcy laws, and it is used to determine if you have too much household income compared to the median income in California to qualify for Chapter 7. Filers whose incomes are higher than the median income for a family of their size in their state may not be allowed to file for Chapter 7 bankruptcy if their disposable income, after subtracting certain allowed expenses and required debt payments, would allow them to pay back some portion of the unsecured debt over a five-year repayment period.

To qualify for Chapter 13 bankruptcy, you must be either salaried, self-employed or operate an unincorporated business as long as your unsecured debts total less than $1,010, 650 (currently) in secured debt and $336,900 in unsecured debt. If a debtor failed to appear in court within the previous 180 days for another bankruptcy hearing then he or she cannot file for Chapter 13 bankruptcy. As with Chapter 7 bankruptcy, debtors wishing to file for Chapter 13 bankruptcy must receive counseling from an approved credit-counseling agency within 6 months prior to filing the bankruptcy petition.

Both kinds of bankruptcy have numerous rules — and exceptions to those rules — about what kinds of debts are covered, who can file, and what property you can and cannot keep.

Q: What Are Some of The Pros & Cons Of Filing Under Chapter 7 vs. 13?

A: In Chapter 7 bankruptcy, you ask the bankruptcy court to discharge or eliminate most of the debts you owe. In exchange for this discharge, the bankruptcy trustee can take any property you own that is not exempt from collection (see below), sell it, and distribute the proceeds to your creditors.

In Chapter 13 bankruptcy, you file a repayment plan with the bankruptcy court to pay back all or a portion of your debts over time. You lose no property in Chapter 13 bankruptcy, because you fund your repayment plan through your income and you can usually still eliminate some of your debt.

Secured debts. Under Chapter 7, if you owe money on a secured debt (for example, a car loan for which the car is pledged as a guarantee of payment), you have a choice of allowing the creditor to repossess the property; continuing your payments on the property under the contract (if the lender agrees); or paying the creditor a lump sum amount equal to the current replacement value of the property. Chapter 13 gives you an option to make up missed payments to avoid repossession or foreclosure. You can include these past due amounts in your repayment plan and make them up over time.

Most people who file for bankruptcy choose to use Chapter 7, if they meet the eligibility requirements; Chapter 7 is a popular choice because, unlike Chapter 13, it doesn’t require filers to pay back any portion of their debts. However, Chapter 13 might be a better choice if you are behind on your mortgage and want to keep your house since you can include your missed payments in your Chapter 13 plan and repay them over time. In Chapter 7, you would have to make up the whole past due amount right away — and you might still lose your house, if your equity exceeds the exemption amount available to you.

Q: What Property Is Exempt (Protected) From Distribution To Creditors Under Chapter 7?

A: In Chapter 7 bankruptcy, you select property you are eligible to keep from a list of state exemptions. Although state exemption laws differ, states typically allow you to keep these types of property in a Chapter 7 bankruptcy:

• Equity in your home, called a homestead exemption.
• Insurance. You usually get to keep the cash value of your policies.
• Retirement plans. Most retirement benefits are protected in bankruptcy.
• Personal property. You’ll be able to keep most household goods, furniture, furnishings, clothing (other than furs), appliances, books and musical instruments. You may be able to keep jewelry only worth up to $1,000 or so.
• Public benefits. All public benefits, such as welfare, Social Security, and unemployment insurance, are fully protected.
• Tools used on your job. You’ll probably be able to keep up to a few thousand dollars worth of the tools used in your trade or profession.

Q: How long will a bankruptcy show up on my credit report?

A: An individual’s bankruptcy filing can be reflected on their credit report for up to ten years. That does not mean that an individual will not obtain credit again. Many lenders in the credit card and mortgage industry do not automatically disqualify an applicant because they previously filed bankruptcy. In addition, it is important to note, that if someone is behind on their bills their credit rating is typically already be poor and getting worse. A bankruptcy filing allow the debtor to begin improving his credit by decreasing the debt-income ratio.

Q: What Are The Major 2005 Changes In The Bankruptcy Laws?

A: Here are the most important changes:

Restricted Eligibility for Chapter 7 Bankruptcy

Under the old rules, most filers could choose the type of bankruptcy that seemed best for them — and most chose Chapter 7 bankruptcy (liquidation) over Chapter 13 bankruptcy (repayment). The new law prohibits some filers with higher incomes from using Chapter 7 bankruptcy.

How High is Your Income?

Under the new rules, the first step in figuring out whether you can file for Chapter 7 bankruptcy is to measure your “current monthly income” against the median income for a household of your size in your state. If your income is less than or equal to the median, you can file for Chapter 7 bankruptcy. If it is more than the median, however, you must pass “the means test” — another requirement of the new law — in order to file for Chapter 7.

The Means Test

The purpose of the means test is to figure out whether you have enough disposable income, after subtracting certain allowed expenses and required debt payments, to make payments on a Chapter 13 plan. To find out whether you pass the means test, you subtract certain allowed expenses and debt payments from your current monthly income. If the income that’s left over after these calculations is below a certain amount, you can file for Chapter 7. While the means test that went into effect with the 2005 changes in the bankruptcy law arguably make it harder to qualify for Chapter 7 (liquidation), a 2005/2006 study showed that approximately 80% of past filers would still qualify today under the new law.

If you’re looking for an easy way to determine your eligibility under the means test, use our online means test calculator, created by the applicable income and expense standards for your state, county, and region to determine your eligibility.

Counseling Requirements

Before you can file for bankruptcy under either Chapter 7 or Chapter 13, you must complete credit counseling with an agency approved by the United States Trustee’s office. (To find an approved agency in your area, go to the Trustee’s website, www.usdoj.gov/ust, and click “Credit Counseling and Debtor Education”.) The purpose of this counseling is to give you an idea of whether you really need to file for bankruptcy or whether an informal repayment plan would get you back on your economic feet.

Counseling is required even if it’s obvious that a repayment plan isn’t feasible or you are facing debts that you find unfair and don’t want to pay. You are required only to participate, not to go along with any repayment plan the agency proposes. However, if the agency does come up with a repayment plan, you will have to submit it to the court, along with a certificate showing that you completed the counseling, before you can file for bankruptcy.

Toward the end of your bankruptcy case, you’ll have to attend another counseling session, this time to learn personal financial management. Only after you submit proof to the court that you fulfilled this requirement can you get a bankruptcy discharge wiping out your debts. (The website above also lists approved debt counselors.)

Some Chapter 13 Filers Will Have Less Income To Live On

Under the old rules, people who filed under Chapter 13 had to devote all of their disposable income — what they had left after paying their actual living expenses — to their repayment plan. The new law added a wrinkle to this equation: Although Chapter 13 filers still have to hand over all of their disposable income, they have to calculate their disposable income using allowed expense amounts dictated by the IRS — not their actual expenses — if their income is higher than the median in their state.

Value of Property and Residency Requirements For Exemptions

There are other changes that can affect bankruptcy filers negatively, including how property is valued (at replacement cost instead of auction value) — this means more debtors are at risk of having their property taken and sold by the trustee — and how long a filer must live in a state to use that state’s exemption laws. (This can make a big difference in the amount of property a bankruptcy filer gets to hold on to).

Q: Did The 2005 Bankruptcy Law Changes  Eliminate Consumers’ Rights?

A: Not necessarily. Passage of the Bankruptcy Prevention and Consumer Protection Act in April 2005, did result in major reforms in bankruptcy laws but not all changes hurt debtors. The 2005 changes to bankruptcy law make it harder for some people to file bankruptcy. On the flip side, the changes penalize creditors who unreasonably refuse to negotiate a pre-bankruptcy debt repayment plan with a debtor. And the laws strengthen the disclosure requirements for reaffirmation agreements so that debtors will be better informed about their rights and responsibilities.

Q: Are IRA Assets Protected Under Bankruptcy Law?

A: Yes. A key 2005 decision by the Supreme Court actually shifted some power back towards the debtor. In Rousey v. Jacoway, (April 4th, 2005), the Court held that assets in Individual Retirement Accounts (IRA’s) are protected under 11 U.S.C § 522(d) and thus exempt from withdrawal from the bankruptcy estate. This decision has broad implications for the baby-boomer generation, providing millions of Americans nearing retirement with increased protection of their earnings.