Should I File for Bankruptcy?
More and more Americans are turning to bankruptcy as a means of getting out from under an insurmountable amount of debt. Each year, more than 1.5 Million insolvent Americans file for bankruptcy protection. Driven by an overextension of credit, difficultly obtaining and maintaining employment, widespread income reductions and an upside-down real estate market, it can become impossible for many people to realistically repay debts. For many, bankruptcy offers a way out to a fresh start and a return to financial stability.
Considering Bankruptcy
The decision to file for bankruptcy is not an easy one to make, but given an honest analysis of your financial situation and the solutions available through bankruptcy, you should be able to determine the most appropriate course of action. This guide will walk you through some of the important issues you will want to consider when thinking about bankruptcy.
In order to find out if bankruptcy is the right choice, you will need to consider several important questions:
- Are you eligible for bankruptcy protection?
- Does your debt to income ratio suggest bankruptcy as an option?
- Are most your debts covered in bankruptcy?
- How will your assets be affected?
- How will bankruptcy impact your financial situation in coming years?
Let’s go through these considerations in detail one at a time.
1. Bankruptcy Eligibility
Depending on the chapter of bankruptcy, there are some eligibility requirements that must be met in order to file for bankruptcy. We will focus on the two most common types of consumer bankruptcy: Chapter 7 and Chapter 13.
Chapter 7 Requirements
State Incomes
| State | Household Size | ||||||
|
One |
Two |
Three+ |
One |
Two |
Three+ |
||
|
AL |
$38,018 |
$70,015 |
$85,621 |
MT |
$37,954 |
$68,000 |
$88,037 |
|
AK |
$51,112 |
$89,785 |
$118,346 |
NE |
$38,287 |
$70,309 |
$88,339 |
|
AZ |
$41,915 |
$74,461 |
$92,045 |
NV |
$42,346 |
$76,027 |
$96,008 |
|
AR |
$32,304 |
$63,508 |
$79,668 |
NH |
$50,630 |
$86,462 |
$106,235 |
|
CA |
$47,234 |
$86,906 |
$97,571 |
NJ |
$58,107 |
$102,955 |
$119,698 |
|
CO |
$47,814 |
$83,137 |
$98,864 |
NM |
$36,672 |
$69,503 |
$84,915 |
|
CT |
$56,929 |
$100,833 |
$117,818 |
NY |
$45,548 |
$88,327 |
$109,333 |
|
DE |
$47,634 |
$85,535 |
$107,920 |
NC |
$37,171 |
$72,194 |
$85,472 |
|
FL |
$39,383 |
$69,898 |
$85,308 |
ND |
$40,774 |
$72,786 |
$90,289 |
|
GA |
$38,748 |
$75,790 |
$88,413 |
OH |
$40,091 |
$74,488 |
$91,812 |
|
HI |
$49,846 |
$86,149 |
$116,809 |
OK |
$36,289 |
$68,361 |
$86,278 |
|
ID |
$38,420 |
$62,729 |
$78,704 |
OR |
$43,986 |
$72,113 |
$87,238 |
|
IL |
$45,607 |
$83,149 |
$99,615 |
PA |
$44,172 |
$78,250 |
$98,043 |
|
IN |
$39,487 |
$71,299 |
$90,391 |
RI |
$45,391 |
$86,886 |
$102,328 |
|
IA |
$39,803 |
$72,320 |
$88,700 |
SC |
$36,457 |
$69,729 |
$87,343 |
|
KS |
$40,982 |
$72,680 |
$92,214 |
SD |
$35,008 |
$66,399 |
$80,345 |
|
KY |
$36,999 |
$68,960 |
$89,397 |
TN |
$37,528 |
$68,357 |
$85,101 |
|
LA |
$37,493 |
$74,933 |
$94,866 |
TX |
$37,676 |
$74,750 |
$86,196 |
|
ME |
$38,860 |
$69,347 |
$88,243 |
UT |
$49,818 |
$67,893 |
$95,781 |
|
MD |
$54,874 |
$102,736 |
$122,598 |
VT |
$42,347 |
$76,056 |
$92,223 |
|
MA |
$54,161 |
$98,513 |
$119,700 |
VA |
$49,484 |
$88,825 |
$108,017 |
|
MI |
$41,875 |
$74,517 |
$90,974 |
WA |
$49,124 |
$84,439 |
$100,832 |
|
MN |
$45,022 |
$81,592 |
$98,019 |
WV |
$39,109 |
$67,419 |
$87,527 |
|
MS |
$32,131 |
$64,262 |
$83,046 |
WI |
$40,486 |
$75,608 |
$92,303 |
|
MO |
$38,697 |
$71,181 |
$91,311 |
WY |
$45,427 |
$76,314 |
$94,714 |
Table of Median Household Income (Census 2009)
Click Image
The most important requirement for chapter 7 bankruptcy, and the most common reason debtors may have trouble filing under chapter 7, is the income requirement. If you income is above the median for your state, then you may have to pass the “means test.” The means test involves completing a complex calculation to determine your “ability” to repay your debts.
Exclusions to the Means Test for Military Members
- Disabled veterans whose debt was incurred primarily during active duty are exempt from the means test.
- Members of the national reserve who were called to duty for 90 days or more after September 11th 2001 need not take the means test.
Other Chapter 7 Requirements
- Petitioners who received a chapter 7 discharge within the past eight years, or a chapter 13 discharge within the past six years, are ineligible to file chapter 7.
- Petitioners who had a bankruptcy case dismissed in the past 180 days due to a failure to appear in court are ineligible to file chapter 7.
- Petitioners must complete the pre-bankruptcy credit counseling within 180 days of filing. There are exceptions to this rule, however, for debtors requiring immediate court stay protection.
The fundamental concept that courts will look at to determine chapter 7 bankruptcy eligibility is the consumers’ honest need for assistance. Chapter 7 bankruptcy is designed to offer honest debtors a “fresh start.” However, since bankruptcy law changes in 2005, courts begin with the assumption that petitioners are abusing the assistance offered by bankruptcy. This means debtors must show their legitimate need for a discharge of debts.
Chapter 13 Requirements
Consumers with significant non-exempt assets (such as multiple real estate properties with significant equity, a large amount of equity in a primary residence or several non-financed cars) may elect to file for a chapter 13 “debt restructuring” bankruptcy instead.
Individuals and small business owners are eligible for relief under chapter 13 with the following limitations:
- Business owners must be sole proprietors, or partners. LLC’s may be included in some cases. Otherwise, corporate business owners must file under chapter 11.
- Unsecured debts, such as credit cards, medical debt and personal loans, cannot exceed $360,475.
- Secured debts, such as mortgages, secured HELOC’s and auto loans must be less than $1,081,400. Keep in mind, any debt exceeding the value of the property secured is considered unsecured debt. This includes HELOC’s secured by a home whose value is less than the amount of the primary mortgage note.
- The petitioner may not have had a bankruptcy case dismissed in the preceding 180 days of filing.
- Petitioners must complete the pre-bankruptcy credit counseling within 180 days of filing. There are exceptions to this rule, however, for debtors requiring immediate court stay protection or those where approved agencies are not readily available.
2. Your Debt versus Your Income
It’s a fact that our society has embraced the use of credit to purchase goods that otherwise would be unavailable. The result is an economy driven largely by the leveraging of borrowed money. While under most circumstances this system works well, it also introduces the risk of over-extension.
The result is that some portion of debtors will become insolvent, that is, unable to repay their debts. Common reasons are divorce, medical problems and a loss or reduction of income. Bankruptcy was designed as a remedy to this fundamental problem.
Considering Your Debt and Income
There are a few ways to determine whether your income and debt makes you a good candidate for bankruptcy. Generally, the following two situations can be applied:
- If you cannot realistically repay your revolving debts in three years, you are a good candidate for bankruptcy.
- If your debt to income ratio, DTI, is greater than 50 percent, you may be a good candidate for bankruptcy. To calculate your DTI, take the sum of all your monthly bills and divide it by your monthly income.
Repaying Your Debts
If you find you have been in a situation where you’ve been making only minimum payments for many months or years, and you’re not seeing a significant decrease in the amount of money you owe, then bankruptcy may be a solution. This is especially true if much of your debt is composed of credit cards, because the high interest rates can often lock debtors into a cycle of interest only payments that can last for a long time.
How Much Debt Is Too Much?
You must also consider the amount of debt owed. If you are carrying around only a couple thousand dollars in debt, then you would probably be better of consolidating it or negotiating with your lender. After all, filing bankruptcy costs money, so you want to ensure there is a financial benefit.
However, if you’re consistently defaulting on payments, borrowing more money to pay off other debts, being called by creditors, or simply struggling each month to make ends meet, then you may want to talk to a bankruptcy lawyer for advice. Each case is different, so it’s difficult to place a dollar amount on how much debt is enough for bankruptcy.
3. Types of Debt in Bankruptcy
Not all types of debt are eliminated in bankruptcy. Specifically, there are three groups of debt that get different treatment in a typical bankruptcy case. These include secured debts, non-priority unsecured debts and priority unsecured debts.
Secured Debts
Secured debts are not discharged in bankruptcy. They are said to be “non-dischargeable.” These include:
- Mortgages – Bankruptcy cannot remove a lien on property, so if the debt goes unpaid the home can be foreclosed. However, chapter 13 bankruptcy does offer options for homeowners to stop a foreclosure and catch up on unpaid mortgage arrears.
- Auto Loans – Any loan amount exceeding the value of the car becomes unsecured. For example, if you owe $15,000 on a car that’s worth $10,000, then only $10,000 of the debt is “secured,” and the remainder is unsecured and can usually be “stripped” and discharged.
- Home Equity Loans – In cases where a homeowner’s first mortgage is greater than the value of the home, HELOC’s are considered unsecured and may be stripped and discharged.
Priority Unsecured Debts
Priority unsecured debts are those that get special protection under bankruptcy law and are typically non-dischargeable. These include:
- Family Support Obligations – Debts stemming from unpaid child support and/or alimony are generally protected from bankruptcy discharge.
- Recent Tax Debts – Tax debt from within the past three years is generally non-dischargeable.
- Student Loan Debt – Debts from student loans are non-dischargeable in a typical bankruptcy case. There are exceptions in cases where the petitioner can show that repayment of the debt would pose an undue hardship. This is difficult to do and requires that the petitioner show more than just a temporary financial hardship.
Non-Priority Unsecured Debts
Non-priority unsecured debts are basically everything else. These debts are almost always discharged in bankruptcy. They include:
- Credit card debt
- Personal loans
- Medical debt
- Payday loan and cash advance debt
- Retail store debts
- Credit card cash advances
- Judgments from lawsuits
- Business debts
- Deficiencies stemming from property repossessions and foreclosures
- Unexpired leases
- Tax debt over three years old
If you find that the majority of your debt is not going to be discharged, then bankruptcy may not be a viable option. Alternatively, if you have a lot of non-priority unsecured debt then you can use bankruptcy for relief.
4. Your Assets
One of the most important considerations in a bankruptcy case is how your assets will be handled. For some in financial distress, this may not be a problem because they don’t own any assets of significance. For others, such as property owners, protecting this property while still getting relief from debt is a real concern.
Property in Chapter 7
Commonly referred to as “liquidation bankruptcy”, the trustee handling a chapter 7 bankruptcy case does have the power (and motivation, as trustees are paid a percentage of property sold) to sell off certain assets to raise cash to repay some debts. However, there property exemptions allowed by law that protect certain property from liquidation. These exemptions vary by state, but typically are something like below:
- Homestead Exemption – The homestead exemption protects some amount of your home equity. In California, for example, typically $75,000 is protected. So if your equity in a primary residence is less than that, your home is safe. Florida on the other hand, protects 100 percent of your home equity.
- Auto Exemption – Your car works the same way. Most states offer around $5,000 as an exemption to automobile equity. For most people with a car and a car note, there is nothing to worry about.
- Retirement Plans – Retirement assets such as a 401k or 403b are exempt from liquidation up to just over $1,000,000, so you don’t have to worry about losing your nest egg.
- Other Personal Property – There are a wide array of exemptions covering everything from household goods, tools, jewelry and even burial plots.
Property in Chapter 13
Property in a chapter 13 case is not an issue, as the trustee’s goal is not to repay creditors, but rather to ensure that you are truthful in your report of income and monthly expenditures used to come up with your monthly payment.
5. Your Financial Future: Credit and Retirement
The real test of whether bankruptcy is a good option or not is the impact it will ultimately have on your financial future vs. not filing bankruptcy. You have to consider how bankruptcy will affect your ability to get credit in the near-term compared to how continuing with repaying debt for a long period will affect your financial plans.
While some people would believe that filing bankruptcy will ruin your credit for 10 years, this is simply not true. While it is true that the bankruptcy will remain on your credit report for ten years, you can begin rebuilding your credit score right after filing bankruptcy. Typically, in 18 months most bankruptcy petitioners can get their credit score back up above 700, which is more than enough to get credit at reasonable interest rates.
Additionally, for those struggling to pay off lots of unsecured debt, suddenly much of their monthly disposable income is freed up to put into better places, such as planning for retirement or towards a mortgage or down payment on a house.
On the other hand, if you are stuck in a monthly cycle of minimum payments, struggling to pay bills, your credit will certainly take a hit over time as you continue to carry a lot of revolving debt while not paying much in principle. In two years, you will probably be in the same place.
Bankruptcy has a bad rap as a “last resort for failures.” This is just not the case. Bankruptcy is a tool offered by the US government to help honest debtors get back on their feet. It certainly is not for everyone with debt, but for those who are struggling financially, it is definitely worth the time to talk to a bankruptcy lawyer to find out if it is the right choice for them.
Next Steps
4. What Bankruptcy Can Do
5. Your Property in Bankruptcy
6. Your Options: Chapter 7 vs. Chapter 13
Thinking About Bankruptcy?
