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Bankruptcy myths-Arizona Bankruptcy Lawyer

There are several myths and misconceptions about bankruptcy floating around the internet.  Some of them are spread by creditors and companies trying to sell “debt settlement” services.  Others stem from common misunderstandings of the bankruptcy laws.  This article discusses and dispels the most common bankruptcy myths and misconceptions.

Myth 1: It is very difficult to qualify for bankruptcy

This is not true.  Congress changed the laws in 2005 to make it more difficult for individuals with higher income (but not for businesses) to qualify for Chapter 7 bankruptcy.  However, the overwhelming majority of people struggling with debt will still qualify for Chapter 7 bankruptcy.  Even people with higher income can usually qualify with the assistance of a competent bankruptcy attorney.  For those few that may not be able to qualify for Chapter 7 bankruptcy, other bankruptcy options are available, such as Chapter 13, or Chapter 11. 

Myth 2: You are required to have a minimum amount of debt to file for bankruptcy

There is no minimum amount of debt required to file for bankruptcy.  In fact, you can file for bankruptcy with only $1 in debt.  Obviously, this would not be advisable.  But the bottom line is that bankruptcy is an available debt resolution option regardless of how much debt you have.

Myth 3: You will lose all your property in bankruptcy

This is not true.  For most people, all of their property is protected under the federal and state exemption laws.  There are limits on how much property can be exempted.  For example, in Arizona, each person can only exempt one car with up to $6000 in equity.  So, those people that have a lot of valuable property may risk losing some of that property in Chapter 7 bankruptcy.  However, in such cases, Chapter 7 is likely not the right option, and another type of bankruptcy, such as Chapter 13, should be considered.  For more, read What Happens to My Property when I File for Bankruptcy?   

Myth 4: Your FICO credit score will be ruined forever

Not true.  Bankruptcy can actually help you improve your credit score.  To be sure, your FICO credit score will be impacted by bankruptcy. How much of an impact bankruptcy will have depends on what your credit score is before bankruptcy.  The lower your credit score before bankruptcy, the less of an impact bankruptcy will have.  If your credit score is very low, bankruptcy can actually increase it slightly, because bankruptcy will eliminate other debts that have an impact on your credit score.  In addition, after you are done with bankruptcy, it is easier to rebuild your credit, because you no longer have delinquent debts that continually drag down your score. 

The impact of the bankruptcy itself on your score will also diminish over time, especially if you establish positive credit history by regularly paying your debts after bankruptcy.  The bankruptcy will be completely eliminated from your credit report in at most ten years.

Myth 5: You will never be able to own anything after bankruptcy

This is obviously not true.  You can own anything you want after bankruptcy.  You are not restricted from buying houses, cars, jewelry, or anything else you want.  Even if you won the lottery after bankruptcy, that money would be yours to keep.  If you want to buy something on credit, that may be more difficult immediately after bankruptcy simply because of your credit score.  But the truth is if you are considering bankruptcy, your credit score is probably already poor, and you would have the same difficulties obtaining credit whether or not you filed for bankruptcy.  Bankruptcy can actually help you improve your credit score over the long term by eliminating debt from your credit report.

Myth 6: You will never be able to get a credit card or loan after bankruptcy

Not true.  Your ability to get credit improves as time passes, and as you reestablish a positive credit history.  Read How to Restore Your Credit After Bankruptcy in Arizona. How easy or difficult it is to get credit after bankruptcy also depends on the type of credit.  Credit cards tend to be the easiest to get.  In fact, many people get flooded with credit card offers immediately after bankruptcy.  The reason for this is simple: once you file for bankruptcy, most of your existing debt gets wiped out, and you generally cannot file for bankruptcy again for eight years. So lending you money is actually less risky. 

Car loans are more difficult to get, but there are many different sources for car loans. These include banks, credit unions, dedicated car lenders, and in-house dealership financing.  Some of these lenders will provide loans even if you are still in bankruptcy. 

Mortgages tend to be more difficult to obtain than car loans.  Mortgage underwriting guidelines always change. But, assuming you have sufficient income to qualify for a mortgage, you can oftentimes obtain a mortgage three to five years after bankruptcy.

Myth 7: Bankruptcy is an admission of financial failure and irresponsibility

Quite the opposite.  Bankruptcy is a financial tool designed to protect you from suffering financial failure.  People get into financial straits for all types of reasons out of their control.  It could be an unexpected illness, the loss of a job, or a divorce. 

Many people who file for bankruptcy first try for years to catch up on the debt created by one of these unexpected life events.  In most cases, instead of improving their situation, they end up making it worse.  For example, in order to catch up on credit card bills, you might withdraw money from a retirement account.  This will have severe consequences down the road when you want to retire, but have no retirement savings.  And if the credit card debt is high, then using your retirement to pay it down likely didn’t solve your financial problems. Instead, it simply pushed them off for a year or two.  Read The Basics of Financial Planning and Dealing with Debt

Long-term debt problems can negatively impact every aspect of your life, and can create a downward spiral, where one unresolved debt can create more and more debt issues.  Bankruptcy allows you to avoid these long-term effects by wiping out your debt and letting you get a fresh start.  In other words, bankruptcy is often the most responsible decision to make. By filing for bankruptcy, you are acknowledging a problem (i.e. unmanageable debt), and are taking steps to deal with it in a practical and responsible manner. 

In fact, businesses use bankruptcy all the time as a means to eliminate debt and restructure their affairs, so that they can continue operating.  If businesses view bankruptcy simply as a financial tool, then certainly an individual can do the same.  It is also worth noting that bankruptcy is provided for by the U.S. Constitution.  In other words, even the framers of the Constitution considered bankruptcy a legitimate and necessary tool for dealing with debt.

Myth 8: Married couples have to file for bankruptcy together

Married couples do not have to file for bankruptcy together.  One spouse can file without the other.  However, in many cases, it may be beneficial for both spouses to file together.  For more on this, read Should Spouses File for Joint Bankruptcy?

Myth 9: You must be behind on your bills to file for bankruptcy

You do not need to be behind on any bills to file for bankruptcy.  In fact, you can be current on all payments when you file for bankruptcy.  Generally speaking, once you decide to file for bankruptcy, it is advisable to stop payments on unsecured debt, like credit cards and medical bills.   The reason is that unsecured debt is normally eliminated in bankruptcy. So if you pay such debt shortly before bankruptcy, you are essentially throwing your money away. 

In addition, if you file for Chapter 7 bankruptcy, the bankruptcy trustee can undo the payments you made on unsecured debt within 90 days before the bankruptcy was filed.  So, in effect, the creditor to whom you made the payments also does not benefit from your payments.  However, being behind on your payments is not a condition for filing bankruptcy. If you happen to be current on your payments, you can still file for bankruptcy just like the person who is months behind on payments.

Myth 10: You will still have to pay your debt after bankruptcy

This is not true, with some exceptions.  There are certain types of debt that are not eliminated in bankruptcy.  Examples include domestic support obligations, certain taxes, and in most cases student loans.  So these debts would in fact need to be paid whether or not you file for bankruptcy.  However, if these are the only types of debt you have, then Chapter 7 bankruptcy may not be the right type of bankruptcy for you. Instead, you may benefit from a Chapter 13 bankruptcy, which allows you to spread out your payments over time.  For more, see Common Questions about Chapter 13 Bankruptcy.  Most other types of debt, including credit cards, medical bills, personal loans, payday loans, deficiencies on car loans, and similar, do get completely eliminated in bankruptcy.  So long as you get your discharge, you will not have to pay any of these debts after bankruptcy.

Myth 11: Bankruptcy eliminates all debt

This is not true also.  There are certain types of debt that are not eliminated in bankruptcy.  As noted above, this includes domestic support obligations, many tax debts, and usually student loans.  So these types of debt would still have to be paid even if you file for bankruptcy.

Myth 12: You can keep your car and house without paying for them

If you want to keep a car or house that is subject to a lien (e.g. a mortgage or a car loan), you will still have to pay the mortgage or the car loan.  Bankruptcy does not eliminate secured debts

That being said, Chapter 13 or Chapter 11 bankruptcy does give you options for modifying secured debt.  For example, if the amount owed on a car is higher than the value of the car, and you’ve had the car loan for at least 910 days (about two and a half years), then you can reduce the loan on the car down to the value of the car.  Chapter 13 and Chapter 11 also allow you to reduce the interest on car loans.  With respect to mortgages, both Chapter 13 and Chapter 11 allow for the modification of mortgages on rental property, and reduction of the mortgage balance down to the value of the property.  If you have multiple mortgages on your primary residence, it may be possible to eliminate the second and subsequent mortgages if they exceed the value of your house. For more on this topic, read Can I Keep My Car in Chapter 7 Bankruptcy?

Myth 13: You cannot discharge taxes in bankruptcy

This is not quite true.  Many taxes cannot be discharged.  However, income taxes can often be discharged, if they meet four requirements:

  1. the taxes must be at least three years old,
  2. the related tax return was filed at least two years ago,
  3. the taxes were assessed more than 240 days ago, and
  4. the taxpayer did not engage in any type of fraud or tax evasion.

There are several other conditions and qualifications that can affect these rules.  For example, the time periods may be extended if you have entered into an “offer in compromise” with the IRS.  On the other hand, the taxes may not be dischargeable at all if the IRS imposed liability before you filed your tax return.  Because determining if taxes are dischargeable is fairly complex, it normally requires the assistance of a good bankruptcy attorney.

Myth 14: You cannot discharge student loans in bankruptcy

This is generally true.  However, there are exceptions.  You can discharge a student loan if you can show that repaying the student loan will cause you undue hardship.  This requires establishing the following:

  1. that you cannot maintain, based on your current income and expenses, a ‘minimal’ standard of living for yourself and your dependents if forced to repay the loans,
  2. that the inability to repay the student loan will continue for a substantial portion of the loan repayment period, and
  3. that you have made good faith efforts to repay the loan.

Myth 15: You can pick and choose which debts to include in the bankruptcy

You cannot pick and choose which debts to include in your bankruptcy.  All of your debts have to be included.  Failure to list any debt can be conidered fraud, and can lead to a denial of your discharge, and in very extreme cases can lead to criminal penalties. 

However, it is common to want to pay a particular debt.  There may be many different reasons.  For example, it could be a debt owed to a relative, or it could be a debt owed to a doctor that you want to continue using.  While you cannot exclude any debts from the bankruptcy, you can choose to pay a particular debt after bankruptcy even though you have no legal obligation to do so. 

There are different ways to get this accomplished.  For example, if it’s a debt owed to a relative, you could simply pay it without any additional formalities.  If it’s a debt owed to a business or a commercial lender, the lender will probably not accept your payment unless you enter into a reaffirmation agreement.  Reaffirmation agreements carry significant risk, because they make you responsible for a debt that has been eliminated in bankruptcy.  Therefore, it is very important to obtain proper legal advice before entering into a reaffirmation agreement, and before paying off a debt that was eliminated in bankruptcy.  But the bottom line is that bankruptcy does not have to create familial strife, or prevent you from seeing your favorite doctor, and you can accomplish what you need without omitting the debt from your bankruptcy documents and without violating the bankruptcy laws.

Myth 16: You should max out your credit cards before filing bankruptcy

This is a bad idea, because incurring debt with the intention of not repaying it can be considered fraud, and could potentially make the credit card debt non-dischargeable.  So, generally, you want to avoid using your credit cards once you made the decision to file for bankruptcy. 

This doesn’t mean that every charge made on a credit card shortly before bankruptcy will be non-dischargeable.  First, if you put charges on a credit card before you made the decision to file for bankruptcy, then it may be difficult to prove that you had no intent of paying the charges when you incurred them.  Second, fraud in general is very difficult to prove. In most cases credit card companies will not even attempt to have your debt declared non-dischargeable, unless there are very obvious facts that indicate your intent not to pay—for example, if you retain a bankruptcy attorney, and then start actively using a credit card.

However, there are two circumstances where credit card charges or other loans are presumed to be non-dischargeable:

  • If, within 90 days before bankruptcy, you have charges for “luxury goods” with a single creditor totaling more than $725. “Luxury goods” does not include goods or services necessary for your or your dependents’ support.  So, if you have charges for groceries, gas, utilities, and the like, they would not fall into the “luxury goods” category.  But if you buy a new TV, or buy plane tickets for a vacation, that would likely be considered “luxury goods.”
  • If, within 90 days before bankruptcy, you take out cash advances with a single creditor totaling more than $1000.

If you have such charges within the previous 90 days, then it may make sense to wait before filing for bankruptcy. Read 7 Mistakes to Avoid When Filing for Bankruptcy in Arizona.

Myth 17: You can pay back friends or relatives before filing bankruptcy

This is also a bad idea.  Any payments to friends or relatives within one year before the bankruptcy are considered a “preference.”  In Chapter 7 bankruptcy, this means that the trustee can get the money back from the friend or relative that you paid.  In Chapter 13, you will have to count the amount of the payment as your asset, and you will have to pay that amount to your creditors in your Chapter 13 plan.

There is an exception to this rule.  If you pay a friend or relative for something you receive at the same time, and the value of what you receive and what you pay is about the same, then such a payment does not create a “preference.”  So, for example, if you rent a house from your relative, and you pay him monthly rent that is equivalent to the house’s market rent, then your regular rent payments should not create any issues.  Similarly, if you buy a car from your friend, and you pay her the market value of the car at the time you bought it, this is also acceptable.

It is important to note that this exception only applies if you pay at around the same time that you receive the item or service.  So, for another example, if you are renting a house from a friend, but haven’t paid the rent for a year, and then catch up on your backrent shortly before filing for bankruptcy, then most or all of that payment will be considered a “preference,” and will either be taken back by the trustee in Chapter 7, or may require increased payments to your creditors in Chapter 13.

Myth 18: You’ll lose your job if you file for bankruptcy

The Bankruptcy Code prohibits both governmental agencies and private employers from firing or discriminating against you just because you filed for bankruptcy.  Of course, most private employers can fire you for any reason, or for no reason at all, so it may be hard to determine why an employer fires you if that does in fact happen.  However, most employers will comply with the law.  

Some jobs have financial responsibility requirements.  Common examples include jobs handling other people’s money, such as brokers or investment advisors, and jobs requiring a security clearance, such as many jobs with federal military contractors like Raytheon.  When it comes to one of these jobs, then the employer could consider unpaid debt in making employment decisions.  Whether or not bankruptcy will help you retain one of these jobs will depend on the employer.  Many employers that require security clearance will revoke the clearance and thus terminate an employee who has significant unpaid debt, but will allow the employee to retain the clearance and his job if the employee files for bankruptcy.  If you are in one of these jobs, it is best to check with your employer’s HR department on how bankruptcy will affect your employment.   

Myth 19: Everyone will know you filed for bankruptcy

This is generally not true.  Bankruptcy filings are public record.  So if someone wanted to search to see if you filed for bankruptcy, they could do so.  However, your bankruptcy filing is not something that is widely disseminated. Most people who are not involved in your bankruptcy and do not actively search for it, will never know that you filed unless you tell them.

Myth 20: You can only file for bankruptcy once

Not true.  There are limits on how often you can file for bankruptcy, which vary based on what kind of bankruptcy you filed previously and what kind of bankruptcy you are filing now. 

If you previously filed a Chapter 7 bankruptcy, you can file another Chapter 7 bankruptcy eight years after the first filing, or you can file a Chapter 13 bankruptcy six years after the first filing.  If you previously filed a Chapter 13 bankruptcy, you can file another Chapter 13 bankruptcy two years after the first filing, or you can file a Chapter 7 bankruptcy four years after the first filing. 

These limits only apply if you received a discharge in your prior case.  If you did not receive a discharge, then you can file a second case in at most 180 days after the dismissal of the earlier case, and potentially much sooner.  The bottom line is that if you need to, you can file for bankruptcy more than once.

Myth 21: Debt consolidation is better than bankruptcy

This may be true in some circumstances, but usually is not.  The biggest difference between debt consolidation and bankruptcy is that with debt consolidation, you still have to pay the debt.  All debt consolidation does is roll all or most of your debts into a single payment, and possibly stretches out your payments.  If you do not have the means to pay your debt, debt consolidation is not likely to do you much good.  In addition, debt consolidation requires cooperation of your creditors.  It is not uncommon for a person to be in a debt consolidation program for months or even years, only to find out than one or more of the creditors are not willing to work with the debt consolidation company, and then have to file for bankruptcy anyway.  For more on debt consolidation, read Debt Settlement vs Bankruptcy: Pros and Cons.

Myth 22: Paying off your debt is a better option

This may be true in the abstract, but for most people struggling with debt, it is most definitely not true.  In other words, if you have no problems paying your debt, then certainly paying the debt would be a better option.  But, for many people who are considering bankruptcy, paying the debt is simply not an option. 

Myth 23: Bankruptcy will solve all your financial problems

This is also not true.  Bankruptcy will help you eliminate existing debt.  However, if you financial situation is such that your expenses regularly exceed your income, bankruptcy will not help you solve that problem, and you will continue incurring more debt after bankruptcy.  So, it is important to understand what led to your debt problems in the first place.  If the reason is that you spend beyond your means, then you will need to modify your spending habits in order to get a long-term benefit from the bankruptcy.  This may mean that you need to limit your discretionary spending, like eating out.  Or it may require a more drastic adjustment, such as reducing your car expenses by surrendering a car with a high monthly payment and getting another car with a lower payment.  Bankruptcy is very effective in helping you get rid of an unwanted vehicle with a burdensome payment.

 If, on the other hand, you spend frugally, but your income is just not sufficient to cover your basic expenses, then a long-term solution will require an increase in your income.  This can sometimes sound like an insurmountable obstacle, especially if you have struggled with employment for a long time.  But there are numerous non-profit and public employment assistance programs available to assist people who are unemployed or underemployed.  An example is the Tucson Urban League, located in Tucson, Arizona (tucsonurbanleague.org), which provides employment assistance and vocational training programs.  Similar programs are available in virtually every urban area.

Posted in Arizona Personal Bankruptcy Information.

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