In general, paying off a creditor shortly before you file for bankruptcy is not a good idea. If you are filing for bankruptcy, you may be considering repaying certain debts before you file. Although paying off debts before filing bankruptcy may seem like the right thing to do, it is often not a good idea. In many cases, if you repay a debt within three months before filing longer if the debt was to a family member or close friend, the bankruptcy trustee can sue the creditor to get the money back.
Why Do Consumers Want to Repay Debts Before Filing Bankruptcy?
If you file for bankruptcy, at the end of your case you will receive a discharge. A discharge is a court order wiping out most or all of your debts some types of debts cannot be eliminated in bankruptcy. Sometimes a consumer doesn’t want a particular debt to be wiped out, and is tempted to pay it before filing bankruptcy. Some common situations where a consumer might want to pay off a debt before filing include:
• to ensure that a debt owed to a friend or close family member is not wiped out
• to protect a creditor that the consumer thinks has been fair
• to try to hide the bankruptcy filing from a bank, employer, or creditor
• to preserve a relationship with a medical provider, or
• to keep property, such as a car or home.
Many of the reasons that people want to repay debts are based on a misunderstanding of how bankruptcy works. For example, you might not automatically lose your home or car just by filing bankruptcy. And most credit card companies will become aware of your bankruptcy filing, even if you don’t have an outstanding debt with it and don’t list the debt in the bankruptcy. Paying debts off before filing bankruptcy can lead to problems once the case is filed.
Why Paying Debts off Before Filing Is a Really Bad Idea
Paying off a debt before filing your bankruptcy can cause problems for you and the person or business that you paid.
Paying Off a Debt Might Be a Preferential Transfer
When you file for bankruptcy, a bankruptcy trustee will be appointed. The trustee’s job is to fairly distribute your assets and property, if any, among your creditors. (You don’t have to give up all of your property during bankruptcy, learn what you can and cannot keep in bankruptcy.) The goal is to ensure that no one creditor has an unfair advantage over another. If you pay a creditor within a short period of time before your bankruptcy, the court may consider that payment to be a “preferential transfer.” Because you pay that one creditor 100% of the debt owed, and then have fewer assets left to repay other creditors through your bankruptcy, you have “preferred” that creditor over the others. If that happens, the trustee can try to get the money back through a claw back action.
How Far Back in Time Does the Court Look?
If you have made a preferential transfer to a creditor within the 90 days before you filed for bankruptcy, the trustee can file a claw back suit and try to obtain the funds from the paid creditor. If you repaid a close friend or family member, sometimes referred to as an “insider,” the time period that a court will consider extends to a year before you filed.
What Happens in a Claw back Suit?
In a claw back suit, the trustee brings a lawsuit against the creditor that you paid off in order to get the money back. A claw back suit can cause several problems with your bankruptcy.
• The result can be messy. The trustee may sue family members, employers, medical providers, and anyone else that you paid.
• It will likely delay your discharge since the court won’t enter a discharge until the claw back suit is complete.
• If the court finds that you paid a creditor in order to hide assets, it might deny your entire discharge. This happens most often when a consumer pays off close friends or family members.
What Debts Can You Pay Before Filing?
Not all pre-bankruptcy payments will be considered to be preferential transfers. You can make payments on debts if normally make such payments. The key is to not pay any more than you have been paying towards that debt. For example, if you regularly pay your physician $100 a month to repay a larger medical debt, you may continue to do so. You can continue to pay your regular car payment, mortgage, child support, or student loans. You can also pay credit card debt that you recently incurred to purchase regular necessities of life, such as gas or food.
Can I Pay Debts After My Bankruptcy Discharge?
If you want to ensure that a creditor gets paid, the best way to do this is after the bankruptcy. There is nothing that prevents you from paying off a creditor, even if its debt has been discharged in the bankruptcy. This is best done when you want to repay friends, family members, employers, or medical providers. However, many financial institutions and credit cards may refuse your payment after a bankruptcy discharge has been entered. No one wants to file bankruptcy. But when the bills become overwhelming, it becomes the best option for some. Bankruptcy can be a solution for those who are drowning in payments and can’t keep up. There are 2 kinds of bankruptcy for the average consumer: Chapter 7 and Chapter 13. In Chapter 7, most of your debts are completely wiped out, though this is reflected on your credit report for several years. In Chapter 13, you arrange a plan with your creditors to pay pennies on the dollar for your debt over the course of 3 to 5 years, and then whatever is left is dismissed.
Your Credit Report Will Be Impacted For Several Years
When you file for a Chapter 7 bankruptcy, it remains on your credit report for 10 years. With a Chapter 13, you pay it off sooner, so it only stays on your report for 7 years. This can make obtaining new credit really difficult. A few ways around this are reaffirming your car loan continuing to make payments on time can help rebuild your score. You can also get a secured card with your bank to help build credit a local credit union is usually your best bet for this. Don’t even think about opening any offers for credit cards you get in the mail when you file, though your mailbox will be full of them, and the idea of bankruptcy is to pay your balances down, not to let them keep adding up.
Your family might be affected
Did your parents help you co-sign your car loan, or a personal loan? If you’re making hefty payments and using bankruptcy to eliminate them, the burden of the loan will fall into their lap, which will impact their credit score and could impact their ability to get or eliminate credit. If you’re planning to file, definitely communicate your plans with them first. If you’re drowning in debt, they may be able to offer to help you first.
Moving might not be an option for a while
When you file for bankruptcy, your credit score will take a huge hit. Doing some savvy research and due diligence can help you restore your credit score within a few years, but keep in mind the bankruptcy will stay on your report for much longer. Until your score has recovered, mortgage lenders and landlords could view you as too risky and deny you housing as a result. Before you file, be sure you live somewhere you’re planning to stay for the next 3 to 4 years.
You’ll need to stop using credit
When you file for bankruptcy, a person called a trustee manages your case on behalf of your creditors. Some trustees can be more invested in the case than others, especially if they can collect assets from you for whom they earn commission. They’ll also decide if certain debts may not be discharged, especially debts you incurred within the previous 3 to 6 months you filed. If you’ve been racking up charges on a credit card or just took out a new loan, it’s likely you’ll still be on the hook for that if you file now. If you’re planning on filing, you need to stop using any kind of credit entirely for about 6 months before you file to ensure that as much debt as possible can be discharged.
Bankruptcy doesn’t mean you’re a bad person
All that said, if you’re thinking about filing for bankruptcy, don’t let the credit implications scare you. No one needs to know about your situation except you, your attorney (and yes, you should have one, as the paperwork can be overwhelming and confusing) and the court.
Chapter 7 Bankruptcy
Individuals and in some cases businesses, with few or no assets typically file Chapter 7 bankruptcy. It allows them to dispose of their unsecured debts, such as credit card balances and medical bills. Those with non-exempt assets, such as family heirlooms (collections with high valuations, such as coin or stamp collections); second homes; and cash, stocks, or bonds must liquidate the property to repay some or all of their unsecured debts. A person filing Chapter 7 bankruptcy is basically selling off their assets to clear their debt. People who have no valuable assets and only exempt property such as household goods, clothing, tools for their trades, and a personal vehicle worth up to a certain value may end up repaying no part of their unsecured debt.
Chapter 11 Bankruptcy
Businesses often file Chapter 11 bankruptcy, the goal of which is to reorganize, remain in business, and once again become profitable. Filing Chapter 11 bankruptcies allows a company to create plans for profitability, cut costs, and find new ways to increase revenue. Their preferred stockholders, if any, may still receive payments, though common stockholders will not.
Chapter 13 Bankruptcy
Individuals who make too much money to qualify for Chapter 7 bankruptcy may file under Chapter 13, also known as a wage earners plan. It allows individuals as well as businesses, with consistent income to create workable debt repayment plans. The repayment plans are commonly in instalments over the course of a three- to five-year period. In exchange for repaying their creditors, the courts allow these debtors to keep all of their property, including otherwise non-exempt property.
What to Do Before Filing Bankruptcy?
Before filing for bankruptcy, here are a few things you should do:
• Take a Credit Counselling course: This usually costs around $25 to $50; however, if you are unable to pay for a Credit Counselling course, you may be able to get the fee waived. The course will give you an overview of your debt relief options in and out of bankruptcy. If possible, take the course from an approved provider in your state, so you can use it to satisfy the required pre-bankruptcy credit counselling class. You won’t have to decide right away whether to file bankruptcy; the certificate of completion you will receive will be good for 6 months.
• Gather your financial documents, including your proof of income, bank statements, two years of taxes, lawsuit information for any cases filed against you, and a recent credit report. This will help you see the whole picture.
Advantages of filing for bankruptcy include:
• An automatic stay against creditors: Once you file, the court automatically issues this stay against any and all debt collection activity. It does not actually cancel your debt, but it suspends any debt collection proceedings until your bankruptcy case is complete or the stay is lifted. This means no more:
• Calls or letters from debt collectors
• Lawsuits on the debts
• Wage garnishments
• Home mortgage foreclosures
• Property repossession
If a creditor tries to collect a debt from you after the court grants your automatic stay, your attorney can bring a contempt of court action against them. This means the court can make them stop their collection attempts, fine them and/or make them pay you damages.
An automatic stay does NOT have the power to stop the following:
• Criminal proceedings
• Government tax audits
• The establishing, modifying or collecting of child support or alimony
• Establishment of paternity
• Co-debtors or co-signers
If you have already filed for bankruptcy once within the past year, you can petition the court for an extension of the first automatic stay. However, if you have filed two or more times during the past year, your automatic stay won’t go into effect without an explicit order from the court.
• Dischargeable debts: You may be able to discharge, or cancel, your responsibility to repay these debts. A dischargeable debt is one that can be eliminated by bankruptcy. These typically include credit card debt, medical and utility bills, and personal loans. Bankruptcy exemptions might allow you to maintain ownership of your property after bankruptcy. If you can “exempt” an asset, this means you don’t have to worry about it being seized in the bankruptcy. These exemptions play an important role in both Chapter 7 and 13 bankruptcies. Some exemptions protect up to a certain dollar amount of an asset; sometimes the exemption covers the entire value of an asset. Some exemptions apply to certain types of assets, like a motor vehicle or wedding ring, while others can be applied towards any property you own.
• Credit Score: Although worries about a tanked credit ranking delay many in filing for bankruptcy, and a bankruptcy filing remains on your record for 7-10 years, many debtors actually start improving their credit scores after they file for bankruptcy. Once a person’s dischargeable debts are cancelled, this allows them to move forward with a clean slate and begin rebuilding their credit. However, filing for bankruptcy at the wrong time or filing when you shouldn’t can make a bad financial situation worse. Filing too early can sometimes mean that a person loses property he or she would otherwise have been able to keep, or that they have to file a different type of bankruptcy that is not in their best interests (i.e., having to file a Chapter 13 instead of Chapter 7). Regardless, even when bankruptcy is a person’s best option, filing also has real, lasting effects on a person’s finances that should be considered before filing.
The potential disadvantages of bankruptcy include:
• Loss of credit cards: Many credit card companies automatically cancel any cards you hold when you file. You will probably receive numerous offers to apply for “unsecured” credit cards after filing. These can help you rebuild your credit, but usually require annual fees and high interest rates.
• Immediate impact on your credit score: Chapter 7 bankruptcy stays on a person’s credit report of 10 years in North Carolina, while a Chapter 13 remains for seven (7) years.
• Difficultly obtaining a mortgage or loan: A bankruptcy filing can make it difficult to get another loan or mortgage for many years.
• Loss of property and real estate: Sometimes not all personal property and real estate will fit under an exemption. This means the bankruptcy court could seize some of your property and sell it to pay your creditors.
• Denial of tax refunds: State, local and federal tax refunds can be denied because of bankruptcy.
• Job and housing stigma: Some potential employers and landlords ask questions about any recently-filed bankruptcies and this can negatively affect your chances for both.
• Non-Dischargeable debts: There are certain kinds of debt that cannot be discharged by bankruptcy. Non-dischargeable debts typically include alimony and child support, student loans, criminal restitution and fines, and any debts acquired through fraud.
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It’s not a matter of if, it’s a matter of when. Legal problems come to everyone. Whether it’s your son who gets in a car wreck, your uncle who loses his job and needs to file for bankruptcy, your sister’s brother who’s getting divorced, or a grandparent that passes away without a will -all of us have legal issues and questions that arise. So when you have a law question, call Ascent Law for your free consultation (801) 676-5506. We want to help you!
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West Jordan, Utah
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