Bankruptcy is a federal court process designed to eliminate debts or repay them under the protection of the bankruptcy court. For individuals, most people file either Chapter 7 or Chapter 13, because a court order can call an automatic stay, prohibiting most creditors from hounding you in order to collect what you owe. However, you should consider the costs, both financially and personally, before taking action. If you declare bankruptcy, renting an apartment or buying a house or a car will be extremely difficult because of your credit. In addition, future job opportunities could be compromised, perhaps leading to more financial issues. Many debtors assume that Chapter 7 bankruptcy is better than Chapter 13 bankruptcy because, Chapter 13 bankruptcy requires debtors to repay some debt, whereas Chapter 7 bankruptcy wipes out qualifying debt without a repayment plan. But it isn’t that simple.
For instance, Chapter 7 is quicker, many filers can keep all or most of their property, and filers don’t pay creditors through a three to five years Chapter 13 repayment plan. But not everyone qualifies to file for Chapter 7 bankruptcy and in some cases; Chapter 7 doesn’t provide the help the filer needs. Each bankruptcy chapter has unique tools that help solve distinct problems. For instance, a debtor who’d like to save a home from foreclosure will likely be better off filing for Chapter 13 bankruptcy because Chapter 7 bankruptcy doesn’t have a mechanism that will allow you to keep property when you’ve fallen behind on your payment. However, sometimes Chapter 13 bankruptcy is the only option because a debtor isn’t eligible for Chapter 7 bankruptcy.
Some debtors cannot file for Chapter 7 bankruptcy leaving Chapter 13 bankruptcy as the only option. You cannot file for Chapter 7 bankruptcy if both of the following are true:
• Your current monthly income over the six months before your filing date is more than the median income for a household of your size in your state.
• Your disposable income, after subtracting certain expenses and monthly payments for debts you would have to repay in Chapter 13 bankruptcy, exceeds certain limits set by law. These calculations are referred to as the means test. They determine whether you have the means to repay a certain amount of your debt through a Chapter 13 repayment plan. If you do, you flunk the test and are ineligible for Chapter 7 bankruptcy.
The means test can get fairly complex, and, to make matters worse, uses unique definitions of disposable income, current monthly income, expenses and other important terms, which sometimes operate to make your income seem higher, and your living expenses lower, than they are. Even if you are eligible for Chapter 7 bankruptcy, there are some situations when filing for Chapter 13 bankruptcy might be more advantageous than filing for Chapter 7 bankruptcy.
How the Automatic Stay Works
The automatic stay is an order that’s put in place as soon as you file for bankruptcy. All collection efforts to collect money you owe other than child support and alimony, including calls, letters, and other techniques, must come to an immediate halt. It stops almost anyone who is trying to collect from you.
A few things that a creditor cannot do once the stay is in place include:
• garnishing your wages (taking money out of your paycheck)
• levying on your bank account (instructing the bank to withdraw funds)
• foreclosing on your house
• repossessing your car, or
• Moving forward with a civil lawsuit requesting a money judgment.
In most cases, the automatic stay will protect you throughout your case. But not always. If you’ve filed more than one bankruptcy case within a year, you might not receive as much or any protection. Depending on the number of times you’ve filed during the previous year, the stay could be limited to 30 days (you filed one other matter) or might not apply at all (you filed two or more cases). If you find yourself with this problem and want the protection of the stay, you’ll have to file a motion asking the court to extend it or put it in place. The court will consider doing so if you explain why you filed the previous case and demonstrate that you aren’t gaming the system by repeatedly filing for bankruptcy. Also, it’s common for a creditor to file a motion to lift the automatic stay (a motion to remove the stay order) if, in a Chapter 13 case, you stop making your house payment and the creditor wants to move forward with a foreclosure. If the court grants the request, the judge will withdraw the stay order and allow the creditor to continue with collection efforts.
Advantages of Chapter 7 Bankruptcy
Chapter 7 bankruptcy is an efficient way to get out of debt quickly, and most people would prefer to file this chapter, if possible. Here’s how it works:
• It’s relatively quick: A typical Chapter 7 bankruptcy case takes three to six months to complete.
• No payment plan: Unlike Chapter 13 bankruptcy, a filer doesn’t pay into a three- to five-year repayment plan.
• Many, but not all debts get wiped out: The person filing emerges debt-free except for particular types of debts, such as student loans, recent taxes, and unpaid child support.
• You can protect property: Although you can lose property in Chapter 7 bankruptcy, many filers can keep everything that they own. Bankruptcy lets you keep most necessities, and, if you don’t have much in the way of luxury goods, the chances are that you’ll be able to exempt (protect) all or most of your property.
• You can keep a house or car in some situations. You can also keep your house or car as long as you’re current on the payments, can continue making payments after the bankruptcy case, and can exempt the amount of equity you have in the property.
Chapter 7 works very well for many people, especially those who:
• own little property
You’ll take the means test to see if your income qualifies for this chapter. If your income is below the average income for a family of the same size in your state, you’ll automatically qualify. If your income is higher than the median, you’ll have another opportunity to pass. However, if after subtracting allowed expenses, including payments for child support, tax debts, secured debts (such as a mortgage or car loan), you have income left over to make a significant payment to your creditors (called disposable income), you won’t qualify to file for Chapter 7 bankruptcy. Chapter 7 bankruptcy isn’t the best choice for everyone. Chapter 7 won’t help people whose debts won’t get wiped out (discharged), like certain income tax debt, student loans, and domestic support obligations. High-income filers find it hard to qualify. It’s also not a good fit for people who would lose substantial equity in a home or other property if they filed for Chapter 7 bankruptcy, or those facing foreclosure or repossession. For those individuals, Chapter 13 bankruptcy would likely be a better choice.
Disposable income is the amount that remains after subtracting allowed bankruptcy expenses from your monthly gross income. Your disposable income will determine whether you qualify to discharge (wipe out) debt in Chapter 7 or Chapter 13 bankruptcy. When you claim your deductions, you’ll be able to use the actual cost of some expenses. For others, such as the allowance for food, clothing, and housing, you’ll use the national and local standards.
Here’s a list of some of the deductions you’ll be allowed to take:
• food and clothing
• housing and utilities
• transportation costs
• involuntary payroll deductions
• life insurance
• court-ordered payments, such as family support
• certain education costs
• childcare expenses, and
• Health care costs.
In a Chapter 7 case, you’ll complete the Chapter 7 Means Test Calculation form. You’ll deduct allowed expenses to find your disposable monthly income. Next, you’ll multiply that amount by 60 months. If the figure exceeds the maximum amount currently allowed (which will be listed on the form), you won’t qualify for a discharge. Additionally, you might not qualify if your disposable income is sufficient to pay 25% or more of your unsecured, no priority debt (such as credit card balances, medical bills, and personal loans).
In a Chapter 13 matter, you’ll fill out the Chapter 13 Calculation of Your Disposable Income form. The amount that remains after deducting expenses is your monthly disposable income. You’ll pay that number to your unsecured, non-priority creditors each month over the course of your three- to five-year repayment plan. Because each case is different, determining whether you qualify for bankruptcy can be challenging. When in doubt, contact a knowledgeable bankruptcy attorney.
Here are a few other things filers find challenging about Chapter 13 bankruptcy:
• You must complete the entire three- to five-year repayment plan before any qualifying debt balances get wiped out (unless the court lets you off the hook early for hardship reasons).
• If you owe non-dischargeable past due taxes, or support arrearages, you’ll have to pay off the entire balance in your plan (many people don’t have sufficient income to do so).
• To keep a house or car, you’ll need to repay the arrearages over the course of your plan (while continuing to pay your regular monthly payment).
• Many people who file for Chapter 13 bankruptcy don’t complete their plans, so filers run a very real risk that their debts won’t be discharged.
Despite these potential problems, Chapter 13 bankruptcy is a good option for people who have a regular income to pay into a repayment plan, and who would otherwise lose their house to foreclosure or who need time to pay back tax or support arrearages.
The Chapter 7 Bankruptcy Process
You’ll fill out several forms listing your income, assets and debt. You have to list everything, or it might not be erased and may even be considered an act of fraud. You’ll then pay a fee to file a petition for bankruptcy court and a date will be set. The petition automatically prevents creditors from garnishing your wages or suing you. Your creditors will be informed and you’ll receive a court-appointed trustee to oversee the process. About a month after you file, you’ll attend a hearing in which creditors can view your debt and the trustee will arrange to sell off your nonexempt items. Depending on the state you live in, you could lose your second home, second car, stock or bond certificates, certificates of deposit, heirlooms and any valuable collections such as coins or stamps. After that, you will not have to pay dischargeable debt, which includes late rent and utility bills, credit cards, medical bills and documented loans from friends and family. By law, creditors cannot try to collect from the original debt. However, some non-dischargeable debts may still exist, and if creditors deem them fraudulent, you can still be approached by collection agencies. The petition creates a separate, taxable bankruptcy estate consisting of all assets that belonged to you before you filed. Your trustee is responsible for preparing and filing taxes attached to the estate, but you’re responsible for taxes not connected, such as income tax Remember, Chapter 7 stays on your credit for 10 years.
The Chapter 13 Bankruptcy Process
You’re only required to make one monthly payment to your trustee, who will distribute the funds to the various creditors. They are paid based on priority (tax authorities, child support/alimony and administration costs). Lenders are then paid, followed by credit card companies, medical providers, utilities and more. Just like Chapter 7, you’ll fill out the same papers, pay a fee and receive a court-appointed trustee. You have to submit a plan for repayment, which the court can either accept or reject. After you have filled out a form listing your assets and income and set up a confirmation hearing, your trustee will begin making payments to your creditors based on the court-approved repayment schedule. You’ll pay back your debts from your own income, and if some survive after your bankruptcy is closed, you have to keep paying back those debts. The petition does not create a separate taxable estate, so you’ll continue to pay taxes just like you did before you filed.
• Certain assets can be liquidated to pay off outstanding debts.
• Could be completed in as little as three or four months.
• Once complete, no further payments need to be made by the consumer.
• Stays on a credit report for 10 years.
• Income must be less than the median income in your state.
• You’ll receive a court-approved debt repayment plan. The amount you must repay depends on your income and the size of debt.
• There is no liquidation of assets, which means you keep everything, including your home and car, all while making regular payments.
• The entire process can take three to five years to complete.
• Stays on your credit report for seven years.
Requirements when Filing Chapter 7 or Chapter 13
If you’re considering either Chapter 7 or Chapter 13 bankruptcy, there are certain income requirements that must be met. Anyone contemplating Chapter 7 bankruptcy must go through what’s called a means test. This will assess whether you meet the necessary conditions to qualify. The first part of the Means Test is to figure out if your income is below the median income level in the state where you reside. If it is, then you pass and are eligible for Chapter 7 bankruptcy. However, if your income is above the median level, a deeper look into your disposable income is required. If your disposable income equals more than a predetermined amount, the courts will assume you have enough money to at least pay part of your debt and you won’t pass the means test. Anyone who fails the means test will be required to file for Chapter 13 bankruptcy protection.
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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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