FAQ: Bankruptcy

(Click question to see the answer.)

I feel really bad about this. I never thought I’d end up in such a situation. How can I square bankruptcy with my conscience?

Answer: Don’t blame yourself for a bad economy. Or for a medical crisis or anything else beyond your control.   But even if you did make mistakes –  such as mishandling credit –  just figure out where you went wrong and how to avoid repeating your mistakes. Learn and do better next time.  The most important thing to remember is: this process is all about second chances.

Eligibility for Bankruptcy Protection

How can I tell if I might be eligible for bankruptcy protection?

Answer: Here is one test. How far does your take-home pay go? If there is nothing left over after living expenses and you see no way to pay the piled-up debts, maybe it’s time to consider options.  Bankruptcy protection might be one. There may be others. Here are three practical signs:

  1. Add up your credit card balances, medical bills, loans and whatever else you have been unable to pay, you determine it will take a miracle to pay it all off.
  2. You have to charge groceries to a credit card.
  3. Debt collectors call and call, but there’s nothing you can do to satisfy them.

I read that it's really hard to get bankruptcy protection since the law tightened up a few years ago.

Answer: The law was changed in 2005. The changes added more steps to the filing process and raised costs, but they seldom prevent people who really need bankruptcy protection from getting it.

I read about something called the means test. I heard if my income is too high I’ll be stuck in debt forever. What is it?

Answer: The means test is one of the steps added when the law changed. It is supposed to weed out persons who are not eligible for bankruptcy protection.  If a person doesn’t pass, the law presumes he is trying to abuse the bankruptcy system. If a person passes, then he may be eligible for protection.

If your before-tax income is below the legal average, you will skip the means test completely.  The legal average is called “median income” or “current median income”.

How do you do the means test?

Answer: For those with a pre-tax income above the median income, the means test is similar to doing a tax return. The attorney starts with before-tax income and takes deductions for things like food, clothing, housing, transportation, car payments, health insurance, child support, home energy use, taxes, child care, cell phones, donations to charity and others.  If before-tax monthly income minus deductions and multiplied by 60 is less than the lesser of 25% of most debts or $6,000, whichever is greater, or $10,000, you pass.

The means test sounds complicated. I bet most people flunk.

Answer: No. It can be hard work getting there, but most people pass. Most pass because they are usually in a pretty tight spot by the time I see them.

OK, I have more debts than I can possibly pay. Suppose I take the means test, but I flunk it anyway. I really need bankruptcy protection, but I am not eligible. I’m sunk, right?

Answer: Not necessarily. You might still be eligible. Work with your attorney to double-check your means test. Maybe you didn’t take all your deductions. Some are not listed in the law, but they’re still legal because they’re necessary to live or make a living. One easy example is car insurance. It isn’t a listed deduction, but it sure is necessary, which makes it a legal deduction. Take a closer look at your other expenses. People miss all kinds of expenses.

If you still can’t pass the means test, then you may be eligible for another kind of bankruptcy protection.  The payment plan form of bankruptcy may be used to pay part of what you owe, and the balance will be eliminated.  This is called Chapter 13 bankruptcy protection.

If I File for Bankruptcy, Will They Take Everything?

Will they take my house?

Answer: Simply speaking–if you can make the payments, you will keep your house.

Suppose I’m six months behind on mortgage payments and the bank won’t cooperate; what then?

Answer: There is a kind of bankruptcy protection that makes the bank accept a payment plan.  It is called Chapter 13. To make it work you need enough income to pay the regular mortgage payment, plus the payment plan payment, plus living expenses and certain costs.

If I file a Chapter 13 bankruptcy case, what happens to my other debts, like credit cards, medical bills and other debts that have no collateral?

Answer: Those kinds of debts gets paid a percentage – as little as 5% of the balance.  How much is paid depends on how much money is left over after the mortgage payment, the payment plan payment and living expenses.  In some cases the percentage is higher.

The credit card company is charging me 29% per year and it’s killing me. If I file for bankruptcy, what happens to that accruing interest?

Answer: The interest clock stops ticking. When interest is at 20% or 30%, that’s a very good thing.

What are secured debts? What are unsecured debts?

Answer: Debts that have no collateral such as credit cards, medical bills and others are called unsecured debts. By contrast, secured debts have collateral. Your house is collateral for your mortgage. Your car is collateral for your car loan. They are secured debts.

Are they going to take everything if I file for bankruptcy protection?

Answer: No. The basic rule is that a person gets to keep what they need in order to make a new beginning.  If they took the things you need to keep going, it wouldn’t be bankruptcy protection; it would be bankruptcy punishment.

The bankruptcy protection process is all about second chances. You get to keep the basics like furniture, home electronics, appliances, clothing, motor vehicles, retirement funds like 401ks and IRAs, the equity in your home and the things you need to make a living.  The things you get to keep are called exempt property.

Obviously, there are limits on what qualifies as “exempt property.” No one needs a timeshare or a Persian rug. Also there are dollar limits on many kinds of exempt property. For example, the equity in your car is protected up to $5,000. (Equity is the difference between what the car is worth and what you owe on it.) But for most people this is not a problem because they have little or no equity in theirs.

During bankruptcy, what happens to any items that are not exempt?

Answer: In most consumer cases everything a person has is protected, because in most cases people have sold off their little luxuries in a desperate effort to pay their bills.  If you still have something like a pleasure boat or a snowmobile, you may have to turn it over to the trustee, who would sell it and divide the money among creditors.  If your item is not worth much or if it is collateral for a loan, the trustee probably would leave it alone.

Here’s the important thing to remember: if you have something that is not exempt, tell your attorney about it.  A good attorney is a problem solver. There may be legal steps he can take to solve the problem.

One more important reason to speak with your attorney: it is a Federal offense to file false bankruptcy papers.  A person who fails to disclose a valuable asset is liable to fines and prison.

What is a trustee? I know what a trusty is but not a trustee.

Answer: The trustee works for the bankruptcy system.  His job is to make sure that creditors are treated fairly. He will look at the papers filed in a person’s case to see if there is anything that can be sold for the benefit of the creditors.

About four weeks after your case is filed, you and your attorney will go to a meeting with the trustee. This is called the creditors meeting. It is called this because creditors have the right to come and ask questions. Very, very seldom do creditors show up in the typical non-business case.

Without exception, the trustees treat people respectfully. They have seen enough hardship to know what you are going through. He will put you under oath, and while he looks at your papers, he will ask you questions. He might ask what your home is worth, or whether you put an addition on it or whether you sold any land in the last few years. If you have something that is not protected, like a timeshare, he will ask you what it is worth. If it has some value, he will tell you to turn it over to him. Most meetings are over soon. The trustee wishes you luck and you are done.

Suppose I own Sitting Bull’s Model 1866 .44 caliber Winchester carbine. It’s a family heirloom. I want to leave it to my son, but I am filing for bankruptcy. Can’t I give it to him now?

Answer: First, call the Smithsonian and tell them theirs is a fake.  Better yet, look for the “made in China” stamp on yours. My point is: most people overestimate the value of their possessions. If you think you have something of real value, get a written appraisal from a reputable person.

If it’s the real deal, your troubles are over. Get Sotheby’s to auction it, pay your debts and retire.

If it’s something less but still valuable, talk to your attorney.  There may be options. Here is one: the rifle is worth $10,000 (it belonged to Sitting Bull’s pastry chef) and your debts total $30,000. Use Chapter 13 (the payment plan kind of case) to pay your creditors what the thing is worth without giving it up: $277 for 36 months. You keep the rifle; the creditors get 33% of what they’re owed, and the balance is eliminated.  This is a very simplified example, but that’s the general idea.

Finally, it’s illegal to give away valuables just to keep from losing them in bankruptcy. People go to prison for hiding valuables in a bankruptcy case. Tell your attorney about it. A good attorney is a problem solver not just a filler-out of forms.

Will Bankruptcy Protection Eliminate all my Debts?

Does bankruptcy protection really eliminate debts? Forever?

Answer: Forever.

What if I change my mind about a debt? Suppose I really want to pay Dr. Black because he set my cat’s broken leg. Can I do it?

Answer: After your case is closed, you are free to pay a debt that was in your case, but it would be purely voluntary.

What kinds of debts can be eliminated?

Answer: Most kinds of debts:

  • credit card
  • medical bills
  • utility bills
  • personal loans
  • store charge accounts
  • checking account overdraft loans
  • checking account overdraft fees
  • business debts
  • many kinds of lawsuits
  • judgments
  • wage garnishments
  • balance due after a vehicle was repossessed
  • balance due after foreclosure
  • income tax debts if they are old enough and meet other requirements
  • overpayments of unemployment benefits
  • some kinds of potential claims

What kind of debts can’t be eliminated?

Answer: The kinds that shouldn’t be eliminated. The most common is child support. Another is student loans. Other kinds include debts resulting from drunk driving, most federal, state and local taxes, criminal fines and restitution orders, debts left out of the bankruptcy, debts resulting from fraud, embezzlement or larceny, debts resulting from willful and malicious injury and others.

The legal term for eliminated debt is “discharged.” A debt eliminated by bankruptcy protection is a discharged debt.

What is a discharge order?

Answer: It is the order that eliminates the debts. It is an order of a Federal court, signed by a Federal judge. It is a very serious thing.

What if I’m disabled? Does it change which of my debts can be discharged?

Answer: Student loans of a disabled person can be eliminated, but doing so adds another step to the process. You have to prove in court that the disability prevents you from earning enough to pay them.

Can someone still try to collect one of my old debts?

Answer: No one–no one–is allowed to pressure you in any way, shape or form to pay a debt that has been eliminated.  It is a violation of Federal law to try to collect an eliminated debt. A person who tries it can and should be sued.

If you get statements, invoices, calls or any kind of request for payment, the collector is violating the Discharge Order. Even a polite letter is illegal. Not even a candygram on perfumed paper is allowed.

What can I do if a creditor tries to collect one of my discharged debts?

Answer: Plenty.  Anyone who tries to collect a discharged debt is disobeying the order of a Federal judge and is in contempt of Federal court. The attorney who handled your case can go back into U.S. Bankruptcy Court, file a lawsuit and if he prevails, the creditor may have to pay damages as well as your legal fees.