The Expenses Step of the Chapter 7 “Means Test”

If your income is higher than “median income,” you may still file a Chapter 7 case by going through the expenses step of the means test.

 

The Easy, Income Step of the Means Test

The last couple of blog posts have covered the first step of the means test, the income step. It says that if your “income”—as that term is uniquely defined in this law—is no more than the published median amount for your state of residence and for your size of family, you can skip the rest of the means test, and you generally qualify for a Chapter 7 “straight bankruptcy” case. You don’t have to go through the rest of the means test.

The Admittedly Complicated, Expenses Step of the Means Test

If on the other hand your “income” is greater than the median income amount applicable to your state and family size, then you have to go through the detailed expenses step to see whether you can participate in a Chapter 7 case.

The Challenge of the Means Test

The concept behind the means test is pretty straightforward: people who have the means to pay a meaningful amount to their creditors over a reasonable period of time should be required to do so. But putting that concept into law resulted in an amazingly complicated set of rules.

These expense rules are detailed and rigid because Congress was trying to be objective. The assumption was debtors would just inflate their anticipated expenses to show that they had no money left over for their creditors—no “means” to pay them anything.

One of the complications is that the allowed expenses include some based on your stated actual expense amounts, while others are based on standard amounts. The standard amounts are based on Internal Revenue Service tables of expenses, but some of those standards are national, some vary by state, and some even vary among specific metropolitan areas within a state. There are even some expenses which are partly standard and partly actual (certain components of transportation expenses).

There are also rules about when to allow and how to determine the allowed amounts for secured debt payments (vehicle, mortgage) and for “priority debts” (income taxes, accrued child support).

If You Have Disposable Income

After all that, if after subtracting all the allowed expenses from your “income” you have some money left over, whether you can be in Chapter 7 depends on the amount of that money and how that compares to the amount of your debts:

  1. If the amount left over—the “monthly disposable income”—is no more than $125, then you still pass the means test and qualify for Chapter 7.
  2. If your “monthly disposable income” is between $125 and $208, then apply the following formula: multiply that amount by 60, and compare that to the total amount of your regular (not “priority”) unsecured debts. If the multiplied total is less than 25% of those debts, then you still pass the means test and qualify for Chapter 7.
  3. If after applying the above formula you can pay 25% or more of those debts, OR if your “monthly disposable income” is more than $208, then you do NOT pass the means test, UNLESS you can show “special circumstances,” such as “a serious medical condition or a call or order to active duty in the Armed Forces.”

THAT’s Complicated!

True enough. So you certainly want to have an attorney who fully understands these often confounding rules and how they are being interpreted by the local bankruptcy judges and the pertinent appeals courts.

If you don’t pass the means test you will instead likely end up in a 3-to-5-year Chapter 13 case. Not only would that mean getting full relief from your debts years later than under Chapter 7, with a similar delay in rebuilding your credit, you may well also end up paying thousands, or even tens of thousands, more dollars to your creditors. It’s definitely worth going through the effort to find a competent bankruptcy attorney to help you, whenever possible, find a way to pass the means test. 

 

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Taking Advantage of the Rigidity of the Chapter 7 “Means Test”

Because of how precisely the amount of your “income” is calculated, filing bankruptcy just a day or two later can make all the difference.

 

Passing the “Means Test”

Our last blog post was about most people passing the “means test” by making no more than the median income for their state and family size. We also made clear that “income” for this purpose has a very broad meaning, by including non-taxable received from irregular sources such as child and spousal support payments, insurance settlements, cash gifts from relatives, and unemployment benefits. Also, we showed how time-sensitive the “means test” definition of “income” is in that it is based on the amount of money received during precisely the 6 FULL CALENDAR months before the date of filing. This means that your “income” can shift by waiting just a month or two, or even by waiting just a few days until the turn of the month (since that changes which 6 months of income is at issue).

Why is the Definition of “Income” for the “Means Test” So Rigid?

One of the much-touted goals of the last major amendments to the bankruptcy law in 2005 was to prevent people from filing Chapter 7 who were considered not deserving. The most direct means to that end was to try to force more people to pay a portion of their debts through Chapter 13 “adjustment of debts” instead of writing them off Chapter 7 “straight bankruptcy.”

The primary tool intended to accomplish this is the “means test,” Its rationale was that instead of allowing judges to decide who was abusing the bankruptcy system, a rigid financial test would determine who had the “means” to pay a meaningful amount to their creditors in a Chapter 13 case, and therefore could not file a Chapter 7 case.

The Unintended Consequences of the “Means Test”

The last blog post explained the first part of the means test: comparing the income and money you received from virtually all sources during the six full calendar months before filing bankruptcy to a standard median income amount for your state and your family size. If your income is at or under the applicable median income, then you generally get to file a Chapter 7 case. If your income is higher than the median amount, you may still be able to file a Chapter 7 case but you have to jump through a whole bunch of extra hoops to do so. Having income below the median income amount makes qualifying for Chapter 7 much simpler and less risky.

Filing your case a day earlier or later can matter so much because of the means test’s fixation on the six prior full calendar months, AND because you include ALL income during that precise period (other than social security). 

So if you receive some irregular chunk of money, that can push you over your applicable median income amount, and jeopardize your ability to qualify for Chapter 7.  

An Example

It does not necessarily take a large irregular chunk of money to make this difference, especially if your income without that is already close to the median income amount. An income tax refund, some catch-up child support payments, or an insurance settlement or reimbursement could be enough. 

Imagine having received $3,000 from one of these sources on October 15 of last year. Your only other income is from your job, where make a $42,000 salary, or $3,500 gross per month. Let’s assume the median annual income for your state and family size is $45,000.

So imagine that now in the early part of April 2014, your Chapter 7 bankruptcy paperwork is ready to file, and you would like to get it filed to get protection from your aggressive creditors. If your case is filed on or before April 30, then the last six full calendar month period would be from October 1, 2013 through March 31, 2014. That period includes that $3,000 extra money you received in mid-October. Your work income of 6 times $3,500 equals $21,000, plus the extra $3,000 received, totals $24,000 received during that 6-month period. Multiply that by 2 for the annual amount—$48,000. Since that’s larger than the applicable $45,000 median income, you would have failed the income portion of the “means test.”

But if you just wait to file until May 1, then the applicable 6-month period jumps forward by one full month to the period from November 1 of last year through April 30 of this year. Now that new period no longer includes the $3,000 you received in mid-October. So now your income during the 6-month period is $21,000, multiplied by 2 is $42,000. This results in your income being less than the $45,000 median income amount. You’ve now passed the “means test,” and qualified for Chapter 7. 

 

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The Easiest Way to Pass the Chapter 7 “Means Test”

Most people considering Chapter 7 “straight bankruptcy” have low enough income to qualify.  Find out if you do.

 

The “Means” Part of the “Means Test”

When Congress passed the last major set of changes to the bankruptcy laws nine years ago, it explicitly said that wanted to make it harder for some people to file Chapter 7.  The idea was that those who have the means to pay a significant amount of their debts should do so. Specifically, those who can pay a certain amount to their creditors within a three-to-five-year Chapter 13 payment plan ought to do so, instead of just being able to write off all their debts in a Chapter 7 case.

How the Law Determines Whether You Have Too Much “Means”

The “means test” measures people’s “means” in a peculiar, two-part way, the first part based on income, the second part based on expenses.

The income part is relatively straightforward; the expense part involves an amazingly complicated formula of allowed expenses.

The good news is that if your income is low enough on the income part of the “means test,” then you’re done: you’ve passed the test and can skip the rest of the test. The other good news is that most people who want to file a Chapter 7 case DO have low enough income so that they do pass the “means test” based simply on their income.

Is YOUR Income Low Enough to Pass the “Means Test”?

Your income is low enough if it is no higher than the published “median income” for a household of your size in your state. You can look at your “median income” on this website (for bankruptcy cases filed on or after April 1, 2014).

A Peculiar Definition of “Income”

Here’s what you need to know to compare your “income” (as used for this purpose) to the “median income” applicable to your state and family size:

1. Determine the exact amount of “income” you received during the SIX FULL calendar months before your bankruptcy case is filed. It’s easiest to explain this by example: if your Chapter 7 case is filed on March 25, 2014, count every dollar you received during the six-month period from September1, 2013 through February 28, 2014. After coming up with that six-month total, divide it by six for the monthly average.

2.When adding up your “income” include all that you’ve acquired from all sources during that six-month period of time, including unconventional sources like child and spousal support payments, insurance settlements, unemployment benefits, and bonuses. But EXCLUDE any income from Social Security.

3. Multiply your six-month average monthly income by 12 for your annual income. Compare that amount to the published median income for your state and your size of family in the link provided above. (Make sure you’re using the current table.)

Conclusion

If your “income”—calculated in the precise way detailed here—is no more than the median income for your state and family size, then you have passed the “means test” and can file a Chapter 7 case.

But if your income is higher than that, you may still be able to pass the “means test” and file a Chapter 7 case. That’s covered in the next blog post.  

 

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Why You Should or Should Not Worry about Creditors Objecting in Your Bankruptcy Case

FACT: In bankruptcy, creditors seldom fight the write-off of their debts. Why not? And when DO they tend to fight?

 

Debts That Creditors Must Object To

This blog post is NOT about the kinds of debts that simply can’t be discharged (legally written off), and don’t need the creditor to object for that to happen. Examples of those are child and spousal support obligations, recent income taxes debts, and criminal fines. Those survive bankruptcy without any effect on them.

Instead this is about ordinary debts and the ability of any creditor to raise certain limited kinds of objections to the discharge of its debt.

Your Fears

As you consider whether or not to file bankruptcy, you might be wondering whether doing so would be effective—whether you will succeed in discharging your debts so you no longer have to pay them. And you might also wonder whether it would be emotionally difficult—whether the creditors would give you a bad time and try to make you feel guilty for not paying your debts.

As indicated at the beginning of this blog post, creditors will very seldom raise objections to discharging their debts. So your bankruptcy case will likely result in the discharge of all the debts you expect to discharge, usually without even hearing from most or all of your creditors about it. So your bankruptcy will in most cases be effective and not contentious.

Why Objections Aren’t Usually Raised

But if creditors have a right to object, why don’t they do so? If they can make trouble for you, why don’t they?

Simply because doing so is very seldom worth their trouble.

Why not?

1. Creditors seldom have the factual basis on which to object.

The legal grounds for creditors to object to the discharge of their debts are quite narrow. They need to present evidence that you incurred the debt through fraud or misrepresentation, by theft or embezzlement, by your intentional injury to a person’s body or property, or through some other similar bad act. The biggest reason that creditors don’t raise objections to the discharge of their debts is that they seldom have grounds to do so.

2. It takes money for creditors to object, money they may well not recoup.

Creditors sometimes do have factual grounds to object, for example in relatively common situations such as bounced checks or the use of credit without the intent to repay (just before filing bankruptcy). But even in these situations, creditors often don’t object because they decide it’s not worth the risk that they would just spend more money on objecting without doing any good. They often don’t want to risk spending more money to pay for their staff and for attorney fees only to have the bankruptcy judge decide that the required grounds for objection have not been met.

3. The risk that the creditor would have to pay your attorney fees.

One of the reasons why sensible creditors decide not to object unless they are very confident that they have the grounds to do so is that they risk being ordered to pay your attorney’s fees for defending against their objection. That would happen if the judge decided that “the position of the creditor was not substantially justified.” So if creditors are not very confident of their argument, they could be dissuaded further by the risk of having to pay your costs fighting the objection.

So that’s why most creditors just write off the debt and you hear nothing from them during your bankruptcy case.

When Creditors Tend to Object

Creditors do object sometimes, often involving one of the following two situations:

1. Using leverage against you.

If a creditor thinks it has a sensible case against you, it could raise an objection knowing that you are not willing or able to pay a lot of attorney fees to fight it. The creditor knows that even if you have a good defense to its accusations so that you could well win if the matter went all the way to trial, it would cost you a lot to get to that point. So they raise the objection in hopes of inducing you to enter into a settlement quickly.

2. A Personal Grudge

If a creditor is very angry at you for some reason, he, she, or it might be looking for an excuse to harm you or cause you problems. Ex-spouses and ex-business partners are the most common creditors of this sort, but sometimes more conventional creditors find some reason to pick on you. Irrationality is unpredictable, so it sometime drives an objection even when there are little or no factual grounds for it.

The Creditors’ Firm Deadline to Object

Creditors have a very limited time to raise objections: their deadline is only 60 days after the Meeting of Creditors (so around 3 months after your bankruptcy case is filed).

So, talk with your attorney if you have any concerns along these lines. And then if whatever assurances he or she gives you doesn’t stop you from worrying about this, you’ll at least know that you won’t have long to worry before the creditors’ right to object expires. 

 

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When Chapter 7 “Straight Bankruptcy” is Not So Straightforward

How can you tell if your Chapter 7 case will be straightforward? Avoid 4 problems.

 

Most Chapter 7 cases ARE straightforward. Your bankruptcy documents are prepared by your attorney and filed at court, about a month later you go to a simple 10-minute hearing with your attorney, and then two more months later your debts are discharged—written off. There’s a lot going on behind the scenes but that’s usually the gist of it.

But some cases ARE more complicated. How can you tell if your case will likely be straightforward or instead will be one of the relatively few more complicated ones?

The four main problem areas are: 1) income, 2) assets, 3) creditor challenges, and 4) trustee challenges.

1) Income

Most people filing under Chapter 7 have less income than the median income amounts for their state and family size. That enables them to easily pass the “means test.” But if instead you made or received too much money during the precise period of 6 full calendar months before your case is filed, you can be disqualified from Chapter 7. Or you may have to jump through some more complicated steps to establish that you are not “abusing” Chapter 7. Otherwise you could be forced into a 3-to-5 year Chapter 13 case or your case could be dismissed—thrown out of court. These results can sometimes be avoided with careful timing of your case, or even by making change to your income before filing.

2) Assets

Under Chapter 7 if you have an asset which is not protected (“exempt”), the Chapter 7 trustee can take and sell that asset, and pay the proceeds to the creditors. You may be willing to surrender a particular asset you don’t need in return for the discharge of your debts. That could especially be true if the trustee would use those proceeds in part to pay a debt that you want and need to be paid anyway, such as back payments of child support or income taxes. Or you may want to pay off the trustee through monthly payments in return for the privilege of keeping that asset. In these “asset” scenarios, there are complications not present in the more common “no asset” cases.

3) Creditor Challenges to the Dischargeability of a Debt

Creditors have a limited right to raise objections to the discharge of their individual debts. This is limited to grounds such as fraud, misrepresentation, theft, intentional injury to person or property, and similar bad acts. With most of these, the creditor must raise such objections to dischargeability within about three months of the filing of your Chapter 7 case—precisely 60 days after your “Meeting of Creditors.” Once that deadline passes your creditors can no longer complain, assuming that they received notice of your bankruptcy case.

4) Trustee Challenges to the Discharge of All Debts

In rare circumstances, such as if you do not disclose all your assets or fail to answer other questions accurately, either in writing or orally at the trustee’s Meeting of Creditors, or if you don’t cooperate with the trustee’s review of your financial circumstances, you could possibly lose the right to discharge any of your debts. The bankruptcy system largely relies on the honesty and accuracy of debtors. So it is quite harsh towards those who abuse the system through deceit.

No Surprises

Most of the time, Chapter 7s are straightforward. The most important thing you can do towards that end is to be completely honest and thorough with your attorney during your meetings and through the information and documents you provide. That way you will find out if there are likely to be any complications, and if so whether they can be avoided, or, if not, how they can be addressed in the best way possible. 

 

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Choose between Your Prior and Present State’s Property Exemptions When You Have Timing Flexibility

If you moved to your present state less than two years ago, when you file bankruptcy can affect how much of your property is protected.

 

Even though bankruptcy is a federal procedure, the state where you are “domiciled” can greatly affect how much of your property you can protect in bankruptcy. In a Chapter 7 “straight bankruptcy” case, this can determine whether you have to surrender any of your property to the bankruptcy trustee. In a Chapter 13 “adjustment of debts” case, this can determine how much you need to pay to your creditors during your payment plan.

Property Exemptions Can Be Very Different State to State

The property exemption laws of one state can be radically different from those of another state, even if that state is right next door.

Take the example of the exemptions available to a person who lives in Mobile, on the southern tip of Alabama, and those available to someone who lives an hour drive to the east in Pensacola, on the Florida Panhandle.

First one similarity: both Alabama and Florida, like a majority of the states, require their residents to use their state property exemptions instead of a federal set of exemptions in the Bankruptcy Code. So a long-time resident of Mobile must use the Alabama exemptions in her bankruptcy filing, while a long-time resident of Pensacola must use the Florida exemptions.

These two states’ homestead exemptions—the amount of value in your home that you can protect from creditors—are a stark example how exemptions can be radically different. Alabama has one of the least generous homestead exemption amounts—$5,000 in value or equity, or $10,000 for a couple—while Florida has one of the most generous—unlimited value or equity. Simply put, if a person owned a $150,000 free and clear home in Mobile (or one with that much equity) and filed a Chapter 7 case, the Chapter 7 trustee would take that home, sell it to pay creditors, and give the person the $5,000 exemption amount (and possibly any left over after paying the creditors in full). That same valued house in Pensacola (or one with that much equity) would be completely protected, the trustee could not touch it, and the creditors would get nothing from it.

(Note that if you “acquired” your present homestead within 1,215 days (about 40 months) before filing bankruptcy—and the equity for it did not come from a prior principal residence in that same state—then your homestead exemption is limited to a maximum of $155,675, even if your present state’s exemption is more generous. (See Section 522(p) of the Bankruptcy Code.) The point of this law is to discourage people from moving to and buying a house in a state with a high or unlimited homestead exemption in order to shield their assets from bankruptcy.)

Choosing between Your Prior and Present States’ Exemptions

You may have an opportunity to take advantage of the difference in exemptions between your prior and present state because of the bankruptcy law that determines which state’s laws you must use. If you have lived in your present state for the last 730 days (2 times 365 days), then the property exemptions which will apply to your bankruptcy case are the ones allowed in your state. However, if you moved during these last 730 days from another state, then the exemptions of your prior state will apply.

(To be picky, you follow the law of the state where you had your domicile—generally, where you were living—“during the 180 days immediately preceding the 730-day period.” See Section 522(b)(3)(A) of the Bankruptcy Code for all the gory details.)

So if you moved from another state to your present state in less than two years, and you file a bankruptcy before the 730-day period expires, than you must use the exemptions of your prior state. But if you wait until immediately after that 730-day period expires, you must use the exemptions of your present state.

Find Out If the Different States’ Exemptions Matter to You

It is definitely possible that all of your property is protected by the exemptions available in EITHER state. The contrast in homestead exemptions above between Alabama and Florida is an extreme one. Most people who file bankruptcy do NOT lose any of their property. So the first thing you need to do if you have moved in the last two years from another state and are in financial trouble is talk to a local bankruptcy attorney. Find out if you have any assets which would be protected better by either of your two states. And if so, see if it is worthwhile in your particular situation to pick when you file your bankruptcy case based on which state’s exemptions are better for you. You certainly don’t want to be in the situation when you find out too late that you could have protected your property better by filing a few months or even a few days earlier. 

 

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Why You Should Not Allow a Creditor to Get a Default Judgment against You

Not responding to a lawsuit by a creditor can harm you in more ways than you think.

 

Three Different Sets of Reasons

Judgments can harm you in three distinct ways:

1) Give the creditor powerful collection tools against you to collect the debt.

2) Force you into filing bankruptcy when it’s not to your best advantage.

3) Makes it harder sometimes to discharge (write off) the debt later in bankruptcy.  

Today’s blog addresses the first one of these. The other two will be covered in my next blogs.

The Temptation to Let a Lawsuit Turn into a Default Judgment

Most lawsuits filed by creditors and collection agencies to collect debts result in judgments against the people being sued. That’s because the main allegations in most of these lawsuits simple argue that the debt at issue is legally owed. And that’s usually not in dispute. So the people being sued understandably figure that there’s no point in responding to allegations that appear to be true.

Practically speaking, most of the time the people being sued are at the end of their financial rope. So they believe that they can’t afford to hire an attorney to find out what their options are, or the consequences of doing nothing.

What ARE the Consequences of Doing Nothing?

You may know that a judgment gives a creditor the right to garnish your wages and bank accounts. You may believe that you can prevent such garnishments from happening to you by keeping your money out of bank accounts and by being paid other than a regular wage or salary (although even those are not practical options for most people).  Perhaps, but the “judgment creditor” usually has other rights against you once it gets that judgment.

The laws differ state by state, but generally a judgment becomes a lien against any real estate you own, or will own in the future. Depending on the facts and applicable law, the creditor may then be able to foreclose on that real estate to get its debt paid. Think about not only property under only your own name, but also your rights to property held jointly with a spouse, parent, or through a trust or estate.

An aggressive creditor usually has other tools available. In most states it can get a judge to order you to go to court to answer questions under oath about what you own so that the creditor can find out what it can take from you. The creditor may be able to get a court order sending a sheriff’s deputy to your home or business to seize some of your possessions for payment of the debt. If someone owes you any money (or anything else), that person can be ordered to pay that debt to the creditor instead of to you.

Similarly, if you own a business, the creditor can force your customers to pay it instead of you. This can be devastating both to your cash flow and to your business reputation. Your business could even be subjected to a “till tap”: a sheriff’s deputy arriving at your place of business to take money directly out of the cash register to pay towards the judgment debt.

Will These Happen to You?

We don’t want to give the impression that these kinds of aggressive collection procedures are used in most cases, or will necessarily be used in yours. Some of these are unusual, taking a fair amount of extra work and fees for the creditor or its attorney, and so likely won’t happen in most simple collection cases. The point is that once creditors have a judgment against you, they have many powerful options against you. We meet all the time with distressed new clients who have been shocked at how creditors with judgments against them have been able to financially hurt them.

Why See an Attorney If You Have No Defense to the Debt?

Flying blind is scary and dangerous. Getting sued and not knowing the potential consequences of just letting the creditor win is like flying blind. Besides potentially finding out about possible defenses to the lawsuit, consulting an attorney gives you the opportunity to consider your broader financial situation, and your options for addressing it. A lawsuit by a creditor is usually a symptom of a broader problem. By consulting with a knowledgeable attorney, you may learn about potential solutions to both the lawsuit AND the rest of your financial problems.

 

Please visit our website again for the next two blogs about the other very important reasons why you should not allow a creditor to take a default judgment against you. 

 

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Which is Better for Saving Your Home, Chapter 7 or 13?

Although either type of consumer bankruptcy will temporarily stop a foreclosure of your home, which is better for you in the long run?

 

The Simplistic Answer

If you are behind on your mortgage, and definitely want to keep your home, then the simple guideline is: file a Chapter 7 “straight bankruptcy” case if that allows you to catch up on your arrears as fast as you need to, otherwise file a Chapter 13 “adjustment of debts” to give you more time.

A Truly Unique Decision

Many considerations can come into play in deciding whether a Chapter 7 or 13 is better for you overall. Even if we focus only on considerations related to saving your house, the decision still turns on your unique circumstances.

For example, following up on the “simplistic answer” stated above, a vague rule of thumb is that mortgage holders will tend to allow Chapter 7 debtors who are behind on their mortgage about a year to catch up. The mortgage holders will generally negotiate a “forbearance agreement” with large enough monthly catch-up payments (beyond the regular monthly mortgage payment amount) to bring the account current in a year or so.

But some specific mortgage holders may have a policy of allowing a longer or shorter period, and some may lengthen or shorten the length based on the particular facts.

The situation can be complicated by the reality that a Chapter 7 filing may make you eligible for a mortgage modification, but you may well not know until after you’ve filed the bankruptcy case and applied for the modification.

Another twist is that Chapter 13 allows for the potential “stripping” of a second mortgage, which Chapter 7 does not. If so, then even if you might have been able to cure the mortgage arrearage fast enough to pull off a Chapter 7 case, the tens of thousands of dollars saved through the “stripping” would very likely make Chapter 13 the better option.

Might Chapter 7 Be Enough?

So would—in your unique situation—a Chapter 7 buy you enough time, or would you instead need the much stronger medicine of Chapter 13?

Chapter 13 deservedly is known as being the home-saving bankruptcy option. But here are some examples where Chapter 7 may be enough to save your home:

  • you have a sale pending on your house but you’ve run out of time with a scheduled foreclosure;
  • you have some money coming to cure the arrearage but again have run out of time;
  • you are very close to getting a mortgage modification approved, or are more likely get it approved after discharging you debts in bankruptcy; or
  • you have decided to surrender the house but need a little more time to get into another home.

Chapter 13 Is Great If You Need It

Admittedly, these are relatively rare situations. Much more common is if your income went down through unemployment or a lower paying job, so that keeping up with the home mortgage payments became impossible. And then you regained that income, or maybe not all of it, and now owe a huge amount of missed mortgage payments, late charges and other fees. It does not take long for that arrearage amount to become so large that there’s no way that you could catch up on it within a year or so.

So Chapter 13 can give you as much as five years to catch up.

It can also buy you much more time to sell your home, until you are in a better time of year for home sales, have reached a point in your family’s life when moving makes more sense, or maybe even want to wait a couple of years for the home’s value to rise.

Chapter 13 can also be much better at dealing with other house-related debts, such as property taxes, second mortgages, and income tax, support or homeowners’ association liens.

Conclusion

There is much that goes into the decision whether to file a Chapter 7 or Chapter 13 case. This blog should convince you that, while both have advantages, you really need an experienced bankruptcy attorney to help you make the right choice for your unique circumstances. 

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Choosing Between Filing Chapter 7 and 13–Easy or Not?

Chapter 7 and 13 are very different debt-fighting tools. But that doesn’t necessarily mean it’s obvious which is right for you.

 

The Not Always So Easy Choice

Once it is clear that you need bankruptcy relief, picking the right Chapter to file can be simple. Your circumstances may all point towards one option or the other. But sometimes it can be a very delicate choice, with advantages and disadvantages that have to be carefully weighed.

And sometimes what at first seems to have been an obvious choice is not once all of the facts of your case are put on the table. Appearances can be deceiving. Your situation can turn out to have a twist or two that turns your case towards the Chapter you weren’t expecting. 

The unexpected twist is usually either a surprising advantage to filing under the Chapter you had not intended to file, or a surprising disadvantage to filing under the Chapter you had intended to file.

The First Impression IS Often Right

To be clear, when my clients first come in to see me, many have a good idea whether they want to file a Chapter 7 or a 13.  There is lots of information available about this, including on this website. So lots of my clients come in having done some homework. Or at least they’ve heard something about the two Chapters and have an impression which makes sense to them. And much of the time, their initial impression ends up being the right choice. 

But it Can Also be Wrong

Initial notions about what kind of bankruptcy you should file are often wrong because of advantages and disadvantages you had no idea about which end up being game-changers.

The simple fact is that bankruptcy law can be maddeningly complicated. Although the main differences between Chapter 7 and Chapter 13 can be summarized in a few sentences, there are in fact dozens of more subtle but often crucial differences. Many of them do not matter in most situations, but sometimes one or two of those differences can swing the decision strongly in a new direction. Without a thorough review of your case by an experienced bankruptcy attorney, you CAN end up filing under the wrong Chapter, and ending up paying the consequences for many years.

An Illustration

Let’s say you have a home you’ve been struggling to hold onto for the last year or two, but by now have pretty much decided it wasn’t worth doing so any more. You’re seriously behind on both the first and the second mortgages. Like so many other people, the home is worth a lot less than you owe. In fact, let’s say you owe on the first mortgage a little more than what the home is worth, plus another $75,000 on the second mortgage, so the home is “under water” by that amount. Although for the last couple of years you’ve been hoping that the market value will start heading back up, but it’s just held steady. You and your family would definitely like to stay there, buy you absolutely can’t pay both mortgages. Besides it makes little economic sense to keep struggling to hang onto property worth $75,000 less than what you owe. So you’ve decided it’s time to give up on the home, and just file a Chapter 7 bankruptcy.

But then you meet with your bankruptcy attorney and find out some surprising good news. Because your home is worth less than the balance on the first mortgage, through a Chapter 13 case you can “strip” the second mortgage off the title of your home. You no longer have to make the monthly payments on it, making keeping your home all of a sudden hundreds of dollars cheaper each month.  In return for paying into your Chapter 13 Plan a designated amount each month based on your budget, and doing so for the three-to-five year length of your Chapter 13 case, you can keep your home usually by paying very little—and sometimes nothing—on that $75,000 second mortgage. At the end of your case, whatever amount is left unpaid on that second mortgages would be “discharged”—legally written-off—so you own the home without that mortgage. You are debt-free, other than your first mortgage. 

This “stripping” of the second mortgage is NOT available under the Chapter 7 that you initially thought you should file. The ability to keep your home by significantly lowering its monthly cost to you and bringing the debt against it much closer to its value could well swing your choice towards filing Chapter 13, contrary to your initial intention.

Meet with Your Attorney with an Open Mind

This is just one example of countless ways that the Chapter you initially thought was the right one might not be. So be sure to keep an open mind about your options when you first consult with your attorney. Do tell him or her your goals, and say why you think one Chapter sounds better to you than the other. In the end, after laying out your story and hearing the attorney’s advice, it is ultimately your choice. But do yourself a favor and be flexible, because you might possibly get better news than you expected when you first walked in.

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More Good Examples of How Bankruptcy Really Helps Even When You Can’t Write Off Every Debt

Three more very practical ways that bankruptcy works to let you take control of your debts, even those that can’t be written off.


Two blogs ago I gave six reasons why it’s worth looking into bankruptcy even when you can’t discharge (write off) one or more of your debts. Today here are the final three of those reasons, each one paired with a concrete example illustrating it.

Reason #4: Taking control over the amount of the monthly payments.

The taxing authorities, support enforcement agencies, and student loan creditors have extraordinary power to take your money and your assets if you fall behind in paying them. Because of that tremendous leverage, you normally have no choice but to play by their rules about how much to pay them each month. Chapter 13 largely throws their rules out the window.

Let’s say you owe $15,000 to the IRS—including interest and penalties—from the 2010 and 2011 tax years, resulting from a business that failed. You’ve now got a steady job but one that gives you very little to pay the IRS after taking care of your very basic living expenses. The IRS is requiring you to pay that debt, plus ongoing interest and penalties, within 3 years. And it calculates the amount you must pay it monthly without any regard for your other debts, or for your actual living expenses. Even if you did not have unexpected expenses during those 3 years, paying the required amount would be extremely difficult. But if your vehicle needed a major repair or you had a medical problem, keeping up those payments would become absolutely impossible.  But the IRS gives you no choice.

In a Chapter 13 case, on the other hand, the repayment period would stretch out to as long as five years, which lowers the monthly payment amount. And instead of a rigid mandatory monthly payment going to the IRS, how it is paid in Chapter 13 is much more flexible. For example, if in your situation money was very tight now but you could more each month later—for example, after paying off a vehicle loan—you would likely be allowed to make very low or even no payments to the IRS at the beginning, as long as its debt was paid in full by the end. Also, you would be allowed to budget for vehicle maintenance and repairs, and medical costs, and other reasonable expenses, usually much more than the IRS would allow. And if you had unexpected vehicle, medical, or other necessary expenses beyond their budgeted amounts, Chapter 13 has a mechanism for adjusting the original payment schedule. Throughout all this, you’d be protected from the IRS.

 Reason #5: Stopping the addition of interest, penalties, and other costs.

Under the above facts, if you were not in a Chapter 13 case, the IRS would be continuously adding interest and penalties. So that much less of your monthly payment goes to reduce the $15,000 owed, significantly increasing the amount you need to pay each month to take care of the whole debt in the required 3 years.

In Chapter 13, in contrast, unless the IRS has imposed a tax lien, no additional interest is added from the minute the case is filed. No additional penalties get added. So not only do you have more time to pay off the tax debt, and much more flexibility, you have also have significantly less to pay before you finish off that debt.

Reason #6: Focusing on paying off the debt that you can’t discharge by discharging those you can.

This may be obvious but can’t be overemphasized: often the most important and direct benefit of bankruptcy is its ability to clear away most of your debt burden so that you can put your financial energies into the one that remain.

Back to our example of the $15,000 IRS debt, let’s say the person also owes $20,000 in credit cards, $5,000 in medical bills, and a $6,000 deficiency balance on a repossessed vehicle. Discharging these other debts would both free up some of your money for the IRS and avoid the risk that those other creditors could jeopardize your payments to the IRS.   Entering into a mandatory monthly payment arrangement with the IRS when at any moment you could be hit with another creditor’s lawsuit and garnishment is a recipe for failure.

Instead, a Chapter 7 case would very likely discharge all of the credit card, medical and old vehicle loan debts. With then gone you would have a more sensible chance getting through an IRS payment arrangement.

In a Chapter 13 case, you may be required to pay a portion of the credit card, medical and vehicle debts, but in return you get the benefits of getting long-term protection from the IRS, a freeze on interest and penalties, and more flexible payments.

So whether Chapter 7 or Chapter 13 is better for you depends on the facts of your case. Either way, you would pay less or nothing to your other creditors so that you could take care of the IRS. Either way, you would much more likely succeed in becoming tax free and debt free, and would get there much quicker.

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