Bankruptcy Myths vs. Reality

There is a lot of misleading information regarding bankruptcy. Here are just a few of the common myths to understand.

MYTH: You will lose your home once you file bankruptcy.

REALITY: In Chapter 7, as long as you stay current on your payments, you can keep your home. In Chapter 13, you can keep your home and other assets as long as you can present a viable repayment plan. In California, there is also a homestead exemption that will protect equity in your home up to certain limits.  The California homestead exemption increased by $25,000 as of January 1, 2010. The current amounts are $75,000 for individuals, $100,000 for couples, and $175,000 for seniors (over 65), disabled or over 55 with limited income.

MYTH: Bankruptcy will no longer eliminate most credit card debt.

REALITY: In 2005, some credit card companies launched a massive marketing campaign to convince consumers they could no longer file for bankruptcy. His is wrong. Credit cards areunsecured debts and will be discharged (eliminated) by Chapter 7 bankruptcy in most cases.

MYTH: Bankruptcy will destroy your credit.

REALITY: Bankruptcy remains on your credit report for 10 years. But this does not mean you cannot get credit post-filing. If most of your debt is wiped-out after bankruptcy, and you establish a pattern of timely payments, your credit scores will actually go up after filing bankruptcy, due to the debt-to-income ratio improving. Additionally, you cannot file bankruptcy again for 8 years (in case of Chapter 7) so you’re actually a good risk for the creditors.

MYTH: Debts under leases (e.g. apartment leases or computer leases) can’t be eliminated in bankruptcy.

REALITY: Lease obligations are almost always dischargeable (eliminated) regardless of lease language prohibiting discharge through bankruptcy.

MYTH: Bankruptcy can’t stop a creditor from garnishing your wages.

REALITY: When a bankruptcy petition is filed, there is an automatic stay that prohibits further collection activities, including a creditor seeking to go after and seize a portion of your wages. Further, under bankruptcy law, transfers of your property to a creditor in excess of $600 within 90 days of filing a petition are prohibited as “preferential transfers.” As such, if in the 90 days before you file, more than $600 of your wages were garnished, you are entitled to recover those funds.

MYTH: Bankruptcy won’t eliminate a prior civil court judgment against you.

REALITY: Not true. If someone sued you in court to collect money and they obtained a civil judgment against you for the money owed, they could normally garnish your wages, placeliens on your property, levy your bank accounts, and damage your credit. However, if you file bankruptcy, in most cases, the judgments will be eliminated or “voided” once the bankruptcy petition is filed. Once a debtor successfully completes bankruptcy and receives a discharge, the judgment is voided or eliminated permanently. The important exception to bankruptcy voiding a prior judgment is where the action includes allegations of intentional misconduct such as fraud as opposed to liability for mere negligence or breach of contract. Another exception would be monetary fines or damages you owe as part of a criminal conviction.

MYTH: If your gross salary is greater than the California median, you’ll have to file for Chapter 13.

REALITY: Eligibility is based on net income after adjustment, not gross income. Some debtors can gross more than $100,000, but still qualify. Besides, income is just one factor to consider in choosing between Chapter 7 and Chapter 13. If you are over the median income, there is an additional test, referred to as the “means test”.

MYTH: You can’t discharge any taxes in bankruptcy.

REALITY: Generally, taxes that have been “assessed” within three years are not dischargeable, but older taxes for which you’ve filed returns or that have been in collection may be subject to discharge.

MYTH: You won’t be able to qualify to file bankruptcy under the new laws.

REALITY: The 2005 Bankruptcy Reform Act made it more difficult to file for bankruptcy, but most people who qualified under the old laws will still qualify today. And some of the changes in 2005 actually benefit consumers and increase bankruptcy protection.

MYTH: You can avoid bankruptcy by hiring a debt settlement firm to negotiate and settle all of your debts.

REALITY: Debt settlement firms can negotiate for you but they aren’t lawyers so they can’t stop creditors from suing you and they can’t defend you if creditors decide to sue you. Debt settlement firms can’t obtain a legally binding “Settlement & Release of All Claims” on your behalf which is the only way you can guarantee closure without bankruptcy. If you do decide to hire a debt settlement company, please be sure to check with the Attorney General’s office of the state in which the company is located. There are warnings issued by governmental agencies regarding some of these companies.

MYTH: Bankruptcy is too costly compared to other options.

REALITY: Bankruptcy costs can actually end up costing you less than other options when you consider what you are paying in accumulated interest, penalties and charges on back debt. Court filing fees are currently $299 for Chapter 7and $274 for Chapter 13. Most bankruptcy attorneys handle Chapter 7 on a flat fee basis but you can sometimes enter into payment plans. In general, you will be advised to stop all credit card payments, which will also free up money for attorneys fees. In Chapter 13, the process is more involved but most of the fees are paid through a combined flat-fee and payment plan. Beware of teaser rates and always read your written attorney-client fee agreement (required by the California State Bar) to see what specific services are included in the flat-fee.

MYTH: You don’t need a lawyer to represent you in bankruptcy court.

REALITY: You indeed have the right to represent yourself in any legal proceeding unless you are a corporation or LLC. However, with the changes in the Bankruptcy Code in 2005, and the array of forms, schedules and documentation required to be filed, it is not advisable for most people. Federal bankruptcy judges and trustees will expect you to understand the laws and documents you have filed and be able to answer questions in court. You may have to file the appropriate court motions (e.g. lien avoidance) and be able to respond to creditors claims in separate lawsuits within your bankruptcy called adversary proceedings. The stress of bankruptcy is difficult enough without having the added stress of self-representation.