Bankruptcy can do many things for your personal finances. Chapter 13 can do even more than Chapter 7 for many individuals. However, bankruptcy is not always the best solution or a complete solution to debt problems. You should learn everything you can about bankruptcy options and alternatives to bankruptcy before you decide how to improve your personal finances and get rid of debt.
With that in mind, below is a list of the things that bankruptcy can and can not do for your personal finance.
What Can Bankruptcy Do for You?
Even though each person’s financial situation is unique, there are some things filing a personal bankruptcy case can do for everyone. Examples of what filing a Chapter 7 or Chapter 13 bankruptcy case can do for you include:
- Stop Creditor Harassment and Certain Collection Activities
The bankruptcy automatic stay prevents creditors from taking actions to collect debts once a bankruptcy petition has been filed. The creditor must obtain bankruptcy court approval to continue with collection actions. The automatic stay applies to debt collection lawsuits, telephone calls, letters, visits, and other collection activities.
The automatic stay also stops foreclosures and repossessions; however, the actions may only be temporarily halted depending on the chapter of bankruptcy filed. Evictions are also stated unless the landlord has already obtained an eviction judgment.
- Eliminates Most General Unsecured Debts
Filing bankruptcy wipes out most types of unsecured debts, including credit card debts, medical bills, personal loans, most personal judgments, and old utility bills. In a Chapter 7 case, these debts are discharged without the debtor paying any money to the creditors (if the case is a no-asset Chapter 7 case). In a Chapter 13 case, the debtor pays a percentage of the unsecured debts to the creditors through the Chapter 13 repayment plan. However, some unsecured debts are not eligible for a bankruptcy discharge.
- Discharges Legal Liability for Secured Debts
A secured creditor holds a lien on collateral, such as a mortgage or a car loan. Filing for bankruptcy can wipe out this debt if the debtor is willing to surrender the collateral to the creditor. In return for the collateral, the debt is satisfied in full, even if the creditor does not receive full payment of the debt when the collateral is sold.
If you were to surrender the collateral without filing a bankruptcy case, the creditor might obtain a deficiency judgment for any remaining balance owed on the account after the collateral was sold. The creditor could then attempt to collect on the deficiency judgment. Surrendering the collateral in a bankruptcy action eliminates a deficiency judgment.
What Can a Chapter 13 Do that a Chapter 7 Cannot?
Chapter 13 bankruptcy cases offer a few advantages over Chapter 7 cases.
- Stop Foreclosures
If you are behind on your mortgage payments, you can catch up the past due mortgage payments in a Chapter 13 repayment plan to keep your home. Filing Chapter 13 effectively stops a foreclosure action and prevents the home from being sold if you enter into a confirmed Chapter 13 repayment plan.
- Reduce Car Payments
The process is called a “cram down.” Instead of receiving the full amount owed on the car loan, the lender receives an amount equal to the value of the vehicle. Any remaining balance owed on the account above the value of the vehicle is treated as a general unsecured debt, which is typically not paid in full. When you complete your Chapter 13 plan, the lien on your vehicle is released.
A cram down only works if your vehicle is worth less than you owe to the lender. However, even if your vehicle is worth more than you owe to the lender, you may be able to reduce your monthly car payments by restructuring the payments through the Chapter 13 plan at a lower interest rate and a longer term.
- Eliminate a Second Mortgage
If your home is worth less than you owe to the first mortgage holder, you may get rid of a second mortgage by valuing the second mortgage at zero in a Chapter 13 case. To be successful, you need proof that the value of your home is less than the payoff of the first mortgage, such as a current real estate appraisal. The second mortgage holder then becomes an unsecured creditor who receives only a percentage of the amount owed on the account instead of the full payoff.
- Protect Non-Exempt Property
Bankruptcy exemptions protect the equity in property from being used to pay creditors. In a Chapter 7 case, the bankruptcy trustee may sell non-exempt property. The proceeds are used to pay unsecured creditors.
In a Chapter 13 case, you can protect non-exempt property by paying an amount equal to the non-exempt value of the property to your unsecured creditors. The money is paid through your Chapter 13 plan; therefore, your plan payment may only increase slightly to protect the property.
Things a Bankruptcy Cannot Do for You
Even though filing for bankruptcy relief is a powerful tool for resolving debt problems, there are some things that a bankruptcy filing cannot do for you.
- Bankruptcy Cannot Discharge All Unsecured Debts
Some debts cannot be discharged through bankruptcy. Past due alimony, past due child support, criminal restitution, and most debts owed to government entities are never discharged in bankruptcy. Debts related to personal injury caused by a DUI accident and debts incurred because of fraud are also not eligible for a discharge.
You can pay these debts through a Chapter 13 repayment plan to spread out the payments. If you owe past due support payments, you must remain current with all future support payments during your Chapter 13 case.
- Most Taxes Are Not Eligible for a Discharge
Most tax debt cannot be eliminated in a bankruptcy filing. You can pay tax debts through a Chapter 13 repayment plan without further interest or penalties. Some older tax debt might be eligible for discharge if it meets certain criteria.
- Student Loans are Typically Not Dischargeable
Most student loans cannot be wiped out in a bankruptcy filing. However, there is a chance that you could qualify for a hardship discharge for your student loans if repayment of the student loans would cause an “undue hardship.” The standards defining undue hardship and the requirements for discharging student loans is very strict. Most debtors do not meet the standard to discharge student loans.
- Prevent the Loss of Property That You Cannot Afford to Keep
Even though a bankruptcy filing may eliminate your legal liability to pay a secured debt, it does not void a valid lien on collateral. If you cannot afford to pay a secured creditor, the court may allow the creditor to repossess or foreclose to obtain the property. As discussed above, if the creditor does not receive payment in full when it sells the property, the creditor cannot pursue a deficiency judgment if you filed for bankruptcy relief.
Deciding whether to file for bankruptcy relief can be difficult. There are many factors to consider, including whether filing a bankruptcy case accomplishes your goal of getting out of debt in a cost-effective, timely manner.
Once you decide to file a bankruptcy case, you need to determine whether you qualify for a Chapter 7 or Chapter 13 case and which chapter of bankruptcy gives you the most benefits.