The decision to file for bankruptcy can be difficult. Most people would prefer to pay their debts if they had the means to do so. Unfortunately, this is often not feasible due to unforeseen circumstances. Many people are concerned about the effects filing for bankruptcy will have on their credit rating and do not realize that a successful discharge can often improve their credit score.
Personal bankruptcy typically falls under two chapters of the Bankruptcy Code:
A qualifying Chapter 7 filing typically means that all unsecured debt is eliminated. The person filing the case, called the “debtor”, is entitled to a clean slate at the conclusion of the case. Examples of unsecured debts which are fully dischargeable include credit cards, unpaid medical expenses, monies due on leases and even judgments arising out of lawsuits. Examples of the kind of debts which would not typically be dischargeable include child support, spousal support, student loans and taxes.
Qualification for Chapter 7 depends on what is known as the “Means Test”. The Means Test compares the debtor’s Current Monthly Income (CMI) with that of the median income for that locale. If the debtor’s income in the last six months, when annualized, is less than the median income, there is no presumption of abuse under the Bankruptcy Code and the debts are presumably dischargeable. If the debtor’s CMI is greater, a complex analysis of the debtor’s income and expenses is required to determine whether the debtor qualifies for Chapter 7. If the debtor does not qualify for Chapter 7, they may be eligible for relief under Chapter 13.
Many clients are concerned that they will lose their home or car by filing under Chapter 7. The reality is that, in most cases, auto loans and mortgages can be reaffirmed. This means that the client signs an agreement stating that he or she will continue to make monthly payments . The debtor is allowed to retain ownership of the asset subject to applicable exemptions.
Exemptions dictate the amount of equity a person may retain in any asset. Exemption amounts differ from state to state. The amount of the exemption will depend on the state in which the debtor has been domiciled for the majority of the last 730 days (2 years). For example, if a Florida resident debtor resided in Florida two years ago, Florida exemptions apply. If the Florida resident debtor resided in a different state two years ago, the exemptions allowed in that state would apply.
The above example is a simplified version of the analysis required to determine applicable exemptions. A debtor should consult with a qualified attorney to determine which state’s exemptions apply.
A Chapter 13 bankruptcy might be described as a restructuring of unsecured debt. As in a Chapter 7 case, an analysis of the Means Test is required to determine the debtor’s Current Monthly Income (CMI), as well as the Disposable Monthly Income (DMI). DMI will determine the amount which must be paid to the Chapter 13 Trustee under the Chapter 13 Plan.
Payments to the Trustee under a Chapter 13 Plan, once approved, will be distributed on a pro-rata basis to all unsecured creditors. In other words, if a debtor owes more to one creditor than another, the creditor to which the highest balance is owed will receive a greater portion of the monthly distribution.
The Plan will remain in effect until all unsecured creditors are paid in full (if possible based on DMI) or for a period of 5 years, whichever is shorter. The creditors are repaid at 0% interest and any unpaid balance at the end of the plan will be discharged.
A Chapter 13 filing has some advantages over a Chapter 7 filing. A debtor is generally allowed to keep any non-exempt assets provided that the plan payments exceed the fair market value of the asset. In addition, it may be possible to “strip” second mortgages or liens on homestead property. For example, if there is a second mortgage or lien on a homestead property, and the fair market value of the home is less than the amount secured by the first mortgage, the second mortgage holder would receive no funds in the event of a foreclosure. Under these circumstances, a motion can be filed with the Bankruptcy Court to reclassify the second mortgage or lien as an unsecured debt. The lender would be repaid on a pro-rata basis with the remainder of the creditors and the unpaid balance would be discharged at the conclusion of the plan payments.