Bankruptcy: When Is It An Option?
In 2017, household debt reached a new peak of $12.7 trillion – more money than Americans borrowed during the peak of the 2008 credit bubble. Student loans make up the majority of that debt, but credit card bills, auto loans, and housing are factored into that total as well. For many, bankruptcy becomes the best option. Cheapism talked to financial experts across the country about when bankruptcy is an option and when it isn't.
Financial experts say bankruptcy is an option to consider when you have significant debts and are only making the minimum payments. "Look at your overall debt package year-to-year. Is it going up or down? And is there any realistic prospect of paying it off?" says former judge and bankruptcy attorney Ronald Levine. "If you can only afford to pay the minimums, it's only going to get worse as time goes on."
When considering filing for bankruptcy, it's important to understand the difference between Chapter 7 and Chapter 13, since it will impact what assets your keep. "Chapter 7 is full liquidation. You don't care about keeping property; you just want to start from scratch," explained Ash Exantus, director of financial education at BankMobile. "If you own property and want to keep it, or some of it, then you would do Chapter 13, which also gives you a time frame to pay down your debt." In order to qualify for Chapter 7, you must have little or no disposable income. If you make too much money, you could be required to file for Chapter 13.
Divorces can be expensive. There are often legal fees, division of assets, and more. "Often times people incur large attorney fees as a result of divorce, and they can discharge those attorney's fees through bankruptcy," bankruptcy attorney Barry Roy. explains. Legal bills are not the only burden tied to divorce that may trigger a bankruptcy. The end of a marriage typically means the end of shared finances and income, and one partner with personal financial debt no longer has the benefit of a spouse's income to help pay those bills.
Spending too much on credit cards is one of the most common reasons for individuals to seek Chapter 7 relief. "Most of the consumer bankruptcies involve credit, and the large majority specifically involve credit cards," says bankruptcy attorney Ronald Levine. "Credit cards are ubiquitous and relatively easy to get." Chapter 7 bankruptcy allows you to discharge (wipe out) credit card debt. That means under most circumstances, your obligation to pay the credit card balances goes away.
Another reason many people seek bankruptcy is medical bills. As of the third quarter of 2017, 12.2 percent of Americans are uninsured. "Often when people are uninsured and have to receive medical treatment without insurance, they end up resorting to bankruptcy," says Barry Roy. Medical bills are considered unsecured debts, just like credit cards, which means they can be discharged by filing for bankruptcy.
One debt scenario not often talked about is parents filing for bankruptcy after taking on too much burden in association with their children. "Parents go into bankruptcy for co-signing loans for children," said BankMobile's Ash Exantus. "A parent is looking out for their child and might cosign for a car or a school loan. When the child is not able to pay that debt, the parent is left with the responsibility."
"Clients often come to me when they can no longer afford their home mortgage and the bank has filed for foreclosure," says Barry Roy. "They can file a bankruptcy to stop the sheriff's sale of their home." Filing bankruptcy is only a temporary fix, as it does not guarantee the house won't ultimately be foreclosed upon. Still, it can work for people who feel they'll be able to start making mortgage payments again or who are going to negotiate a modification of a mortgage, said Roy. Even if the home is ultimately foreclosed on, a bankruptcy allows for discharging any deficiency claim in favor of the lender that might result.
A failed business is another major event that triggers bankruptcy filings. "People will often personally guarantee the debts of their business, because often the only way a bank is going to give your business a loan is if you personally guarantee the debt. When a business suddenly no longer becomes viable, you're on the hook," says Barry Roy. This includes such debt on corporate credit cards. Credit card companies will often require the business owner to personally guarantee the credit cards issued in the name of the company, but when filing bankruptcy an individual's obligations are also dischargeable.
Depending on how you accumulate gambling debt, it can be discharged with a bankruptcy filing. "You can run up large amounts of debt as a result of cash advances on your credit card, or as a result of receiving markers in places like Atlantic City – this, too, can be discharged in bankruptcy," says Barry Roy. Freeing yourself of gambling obligations this way is complicated, however. While there's no law specifically prohibiting the discharge of gambling-related debt, the court takes a harder look at this type of filing if a creditor, such as the casino, objects to your discharge arguing that you had no intention of repaying.
There are several instance when bankruptcy is not an option, and student loans are typically one of them. In order to get student loans discharged through bankruptcy an individual must prove "undue hardship," which is no easy task. Individuals seeking this route must prove to the courts that you would not be able to maintain a basic standard of living if required to pay back federal student loans, and that the hardship will last for a significant percentage of your repayment period.
Taxes are also among the financial obligations that cannot be done away with under bankruptcy laws. "Student loans, recent taxes, domestic obligations, all of those things are non-dischargeable," says Ronald Levine. These debts usually must be paid back at the end of a Chapter 7 bankruptcy, and will likely have to be paid back in full following a Chapter 13 claim. In very limited cases, federal taxes that are at least three years old can be wiped out under Chapter 7.
While bankruptcy should never be a first option, it does offer some benefits. "One, your credit score will usually begin to rise shortly thereafter, and access to credit may become more prevalent at that point in time as well," said David Bakke of Money Crashers. "The most important thing to realize is that if you're considering declaring bankruptcy, it's better to do so sooner rather than later."
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