Setting the Record Straight About Whether You Can File a Chapter 7 “Straight Bankruptcy” Case

5 realities about whether you qualify under Chapter 7.

 

One of the biggest areas of confusion about bankruptcy is whether or not you qualify to file a Chapter 7 case.

If it’s the right tool for you, the odds are very high that you quality. The following five points get right to the heart of what you need to know.

1. Bad Publicity

Many people think that qualifying for “straight bankruptcy” is hard. Their attitudes range anywhere from a vague feeling to a firm conviction about this. From my countless conversations with new clients, I believe this impression is left over from a major overhaul of the Bankruptcy Code more than 7 years ago. That “reform,” which arose from a notion that too many bankruptcies were being filed, was indeed loudly trumpeted as promoting “Bankruptcy Abuse Prevention” by making it harder to file bankruptcy, especially under Chapter 7.

That quite clearly was in fact the intention of the law’s promoters. But for the vast majority of people for whom Chapter 7 is the best option, they continue to qualify for it.

2. The Confusing “Reform” Has Prolonged the Misinformation

The “Bankruptcy Abuse Prevention” Act dumped an astoundingly difficult to understand set of changes onto the Bankruptcy Code. In fact, parts are downright impossible to understand because they are directly contradicted by other parts. So bankruptcy judges and appeals judges all the way up to the U.S. Supreme Court have been scratching their heads trying to make sense of the insensible. Sorting out the layers of statutory contradictions and ambiguities through the court system takes many, many years. In the meantime, not surprisingly different courts looking at the exact same gibberish arrive at different rulings. If it’s difficult for high judges to make any sense of these laws, it’s only natural for ordinary people to have misimpressions about it. In this environment it’s easy to see how a concern about qualifying to file under this now not-so-new law still gets blown way out of proportion.

3. Most Can “Skip” the “Means Test”

Parts of the “means test”–the major mechanism now for qualifying under Chapter 7—are mind-numbingly confusing, but many people can avoid all that simply by virtue of their income. Without getting into the calculations here, basically if your “income” (as specially defined for this purpose) before filing was no more than the published median income amount for your state and size of family, then you qualify for Chapter 7 without needing to go through any more of the  “means test.”

Also, certain kinds of folks can skip the “means test” no matter the amount of their income, specifically present or recent business owners who have more business debt than consumer debt.

4. Passing the “Means Test” Can Be Easy

Even if you are a consumer debtor whose “income” IS higher than the applicable median income amount, through some creative but perfectly legitimate timing strategies you may well be able to lower your “income” to bring it under the applicable median amount.

And even if that’s not possible, you can often fly through the “means test” by subtracting appropriate expenses from your income to show you have either no “disposable income” or not enough to cause a problem. Either way, you qualify for Chapter 7.

5. Chapter 13 is Sometimes the Better Option

The purpose of the “means test” is to make people who have the “means” pay back some of their debts through a Chapter 13 case. In the relatively few times that a person does not qualify under Chapter 7 and so has to do a Chapter 13 case, usually the amount that must be paid in the Chapter 13 case to the creditors is much less than the total debt, making it not such a bad deal. Also, often when a person does not qualify under Chapter 7, Chapter 13 may have been the better choice anyway. It’s not unusual that a person who “just wants to file Chapter 7 and get it over with” learns that Chapter 13 comes with surprising advantages, making it the debtor’s first choice regardless whether the person would or would not pass the “means test.”

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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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Can You File Bankruptcy If You Are Not a U.S. Citizen?

The simple answer is yes, you may file bankruptcy in the United States regardless of your citizenship status.

 

Who May Be a “Debtor” in Bankruptcy Court?

The Bankruptcy Code places no citizenship limits on who may file bankruptcy. Section 109(a) states that “only a person that resides or has a domicile, a place of business, or property in the United States… may be a debtor… .” for filing bankruptcy.  “Person” is simply defined to include an “individual” (as well as a “partnership and corporation”). So there is no requirement about needing to be a citizen, or even to being legally in the country. So everyone, citizen or not, legal or not, can file bankruptcy.

Have a “Domicile… in the United States”

To have a “domicile” simply means being physically present in one location with the intention of making that place your present home. Generally the longer you has been in one place and the more you have put down roots—such as signing an apartment rental agreement, getting a state driver’s license—the easier to show that you’ve established a domicile.

Have “Property in the United States”

If you have any meaningful amount of property–a bank account or other kinds of financial accounts, a vehicle, personal possessions—that alone appears to be enough to qualify as a debtor.

Practical Requirements

The bankruptcy filing documents ask for a Social Security number, although the Bankruptcy Code does not explicitly require it. If you have a valid Social Security number appropriately issued by the Social Security Administration, use it. Otherwise, get an Individual Taxpayer Identification Number (“ITIN”) from the IRS, and use that. The “IRS issues ITINs to foreign nationals and others who have federal tax reporting or filing requirements and do not qualify for SSNs.”

You will also need to show proof of your identity at the Meeting of Creditors about a month after your case is filed. The reason for this is for the bankruptcy trustee to be able to verify that you—the person answering the questions under oath–is a real person, the one who filed the bankruptcy documents. This is intended to prevent identity frauds of the bankruptcy system. Proof of identity usually requires two documents: one showing your SSN or ITIN—such as the original Social Security card it that’s available, or some other paper received from the government or from an employer showing the number; plus 2) some form of photo identification—such as a driver’s license or passport. 

 

If you are not a citizen but meet these conditions, you can file for bankruptcy. 

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Chapter 7 Bankruptcy Only Buys You Limited Extra Time for Your Home, But It May Be Enough for What You Need

Are you facing a foreclosure sale, aren’t fighting it, but just need more time to move? Or you are on the brink of a sale and need just another month or two to close?

 

Chapter 13 is Often the Better Option for Holding onto Your Home

If you are seriously behind on your mortgage, and you want to keep the home, Chapter 13 is often the way to go. Or if you have a second mortgage, or a tax lien, or child/spousal support lien against your home, Chapter 13 can also be very helpful. It comes with a variety of legal tools that can make it possible to keep your home when it would otherwise be impossible or extremely difficult.

When Chapter 7 is Enough

But you may not need those extra legal tools of Chapter 13, either because you are surrendering the house soon anyway, or because you only need a modest amount of help to be able to keep the house. Chapter 13 can be great, but there’s no point to entering into a three-to-five year payment plan if a Chapter 7 “straight” bankruptcy would give you just the amount of help with your house that you need.

When You Are Surrendering Your House

If you are on the brink of a foreclosure sale, the filing of a Chapter 7 case stops that foreclosure just as quickly as would a Chapter 13 filing. If you just need to buy a relatively short amount of time—a matter of a few weeks or a couple months—Chapter 7 case could be enough.

This can be a sensible solution if you’ve decided to leave the house behind, but need a little more time to pull together the money to make the move. Or you may need a couple more months before your kids’ school year is over, or are waiting for your next housing to become available. In these situations, Chapter 7 could well be the ticket.

When You Are Selling Your House

If you are on the brink of closing a sale of your house, including a short sale, you can file a Chapter 7 case to stop an approaching foreclosure. This can buy some time, but be aware it can complicate things as well. Your bankruptcy trustee will then have some say about what happens to your property, although that should not be a problem if you have no equity or what you have is protected by the homestead exemption. A bankruptcy filing can spook your buyer, so you or your attorney should likely communicate what you are doing and give the appropriate reassurances.

Stopping Other Kinds of Foreclosures

A Chapter 7 filing stops not only foreclosures by your mortgage lender, but also by the county tax assessor for unpaid property taxes, by the IRS on tax liens, by ex-spouses on support liens, or creditors who sued you and got a judgment lien attached to your house. But remember again that this protection only lasts a few months, or even shorter if the creditor is aggressive. But in the right situation it may be enough time either to discharge (write off) the underlying debt—such as with a credit card debt resulting in a judgment lien—or to make payment arrangements with creditors on debts that do not get discharged—such as with the IRS or support enforcement.

Stopping Liens from Attaching to Your Home

Filing a Chapter 7 can also prevent—again at least temporarily—most kinds of liens from attaching to your home. If it is a debt that is going to be discharged in your Chapter 7 case, stopping the lien could make a difference of tens of thousands of dollars.

For example, if you had equity in your home and owed the IRS a substantial amount of income taxes from a number of years ago, the IRS could record a tax lien against your home. If you filed a Chapter 7 case before that were to happen, you may be able to discharge the tax debt (if it meets certain conditions) and be allowed to keep the equity in your home through the homestead exemption. But if you delayed filing the Chapter 7 case until after the IRS filed a tax lien, you would likely have to pay that debt out of the equity in the house (because the homestead exemption does not protect against tax liens).

How Much Time Does a Chapter 7 Buy?

The answer to this question is unfortunately unclear, mostly because it depends on how aggressively your mortgage lender reacts. If it is very aggressive, you may not gain more than a month or so. If it is not, you may gain the three or so months that it takes a simple Chapter 7 case to complete, or even more time. Your attorney may be able to give you a better idea based on the behavior of your creditor in previous cases. 

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Keep Your Vehicle with More Time to Catch Up and a Lower Monthly Payment

What can you do if you MUST keep your car or truck, but can’t afford the monthly payments?

Or if you fell behind and just can’t catch up?

Chapter 7

A regular bankruptcy”—Chapter 7—won’t usually help in these situations.

It would only help if writing off your other debts results in you able to do ALL of the following:

1) catch up on any missed payments within a month or two of filing the bankruptcy,

2) start making the regular monthly payment on time by the next due date, AND

3) consistently pay on time all the rest of the monthly payments on the contract.

Most vehicle loan lenders—especially the major national ones—are just not flexible about any of this. If you do not have the means to catch up on any missed payments fast enough, you will generally not be allowed to keep the vehicle. If during the Chapter 7 case itself you don’t make the regular monthly payments on time, the lender may well ask the bankruptcy court for permission to repossess your vehicle even before the case is completed. And even if you get past all that, some of these lenders are quicker to repossess if you are late with payments any time down the line.

As far as lowering the payments or changing any of the other terms of the contract, very few vehicle lenders will even consider doing that.

Chapter 13

So, if you can’t meet these payment hurdles, but you have no choice but to hang on to your vehicle to commute to your job or to meet other family responsibilities, the other kind of consumer bankruptcy, Chapter 13, is worth seriously considering.

It can help two ways:

1) almost always it can give you more time to catch up if you’re behind; and

2) under certain conditions a Chapter 13 case can also—through a “cram down”—reduce your monthly vehicle payments, likely lower your interest rate, and shrink the total amount you need to pay on the loan.

Lots More Time to “Cure the Arrearage”

Instead of being stuck with catching up on any missed payments in a matter of weeks (as under Chapter 7), Chapter 13 often gives you many months or even a few years to bring your account current. A portion of your plan payments would go towards your arrearage. Generally, as long as you consistently make your plan payments and your regular monthly vehicle payments (usually also included in the plan payment) on time, and keep up on your insurance, your lender has to allow you to do this. 

 “Cram Down”

Under some conditions, you will be able to keep your vehicle without needing to make up any missed payments. Through a “cram down,” the amount you must pay for your vehicle is reduced to the value of the vehicle. The interest rate is often reduced, the length of the loan is often extended, all of which usually result in a reduced monthly payment, often significantly so.

“Cram down” only makes sense when—as is very often but not always the case—your vehicle is worth less than what you owe on it.

Bankruptcy law only allows a “cram down” if you got your vehicle loan at least two and a half years before filing your Chapter 13 case—910 days, to be precise.

Conclusion

Chapter 13 provides some extremely valuable tools enabling you to keep your vehicle. This may or may not justify filing under Chapter 13 instead of Chapter 7, but it sure means that it’s an option worth exploring with your attorney.

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