Debt Settlement Blog

Whether you’re up to your neck in loans, out of work or stretching one small paycheck to meet ever-growing obligations, nearly everyone occasionally flirts with the idea of ditching their debt.

While the reasons to file for bankruptcy vary, statistically speaking, 33 percent of debtors cite job or income loss as one of the reasons or even the number one reason they filed, says John Ulzheimer, vice president of the After Bankruptcy Foundation, a nonprofit organization that helps people recover from bankruptcy. Another 37 percent cite medical and job-related reasons and 24 percent cite medical-only reasons for filing.

But the reality of bankruptcy is that it’s a complicated legal procedure that will trash your credit rating.

Reforms in 2005
And, bankruptcy laws are now even more complicated thanks to new reforms that went into effect Oct. 17, 2005. The changes in the laws make it harder to qualify for bankruptcy and even exclude some people from filing Chapter 7 altogether.

The new reforms require that a person filing for bankruptcy must get credit counseling from a government-approved credit counseling agency. The debtor must go to counseling within 180 days before filing for bankruptcy. There are some exceptions, such as the lack of qualified agencies to provide counseling and certain emergencies.

What’s more, before any debt can be discharged under Chapter 13, debtors have to take a government-approved financial management education program. If debtors fail to complete the course, debts will not be discharged.

After these programs are completed, a person may file for bankruptcy. Most people opt for either Chapter 7 or Chapter 13. While rules vary widely from state to state, here’s a general rundown on each, along with the new stipulations:

Chapter 7
Commonly known as liquidation, Chapter 7 usually takes four to six months from the date of filing to the final discharge. You can file only once in six years. This form of bankruptcy basically allows filers to give up assets in exchange for discharge of their debts. This is frequently the option for people who have few or no assets, often little or no income, and a lot of debt.

“You would use a Chapter 7 if you don’t have assets of value that the trustee would try to sell,” says David Greer, a partner with Williams Mullen in the real estate section, whose practice covers bankruptcy.

New rules affect eligibility
Some new bankruptcy rules will make it harder to qualify for Chapter 7:

Debtors must pass the “means test,” meaning when they file, their income must be less than the median income in their state. If a debtor’s income is above the state’s median and the person can afford to pay $100 per month toward paying off debt, then the filer will be forced to file under Chapter 13.

Whether someone can afford to pay $100 per month is based on a formula that includes monthly income, expenses, and total amount of debt. Check your monthly income against your state’s median income.

Ulzheimer says the means test will punish those who make too much money. Some people who need to file for Chapter 7 (and thus discharge most of their debts) won’t be able to. By forcing people to file for Chapter 13, filers will end up paying more money — not just to creditors, but to the person managing the payments.

Documentation needed
Good so far? Stay on your toes. Failure to provide the following documents within 45 days after the petition has been filed results in automatic dismissal of the case. However, debtors can apply for a 45-day extension.

What you can keep
Chapter 7 stops most garnishments, although it depends on why you’re being garnished. What you will be allowed to keep will depend largely on your state laws. Some states allow you to keep all of the equity in your home, while others exempt a certain amount. In some places, individuals may keep their household goods. Some states, such as Virginia, allow filers to keep wedding and engagement rings. “Well over 90 percent are considered no-asset cases,” says Henry J. Sommer, president of the National Association of Consumer Bankruptcy Attorneys and editor in chief of “Collier on Bankruptcy.”

If you manage to hang onto a home or car after a Chapter 7, you must keep up payments if you want to keep the property. Since Chapter 7 is obviously an option of last resort, check carefully to see what assets you can keep and what you stand to lose before you even consider filing.

At filing, the individual provides a list of all assets and obligations. A bankruptcy trustee goes over the list and decides whether to sell any unprotected assets to pay outstanding debts. Creditors can object on several grounds, including sudden disappearance of assets and lies in the bankruptcy filing.

Some debts not forgiven
While you may able to keep some assets, you also keep some debt. Certain debts, no matter what state you live in, cannot be discharged. For instance, any debt owed to a single creditor totaling more than $500 for luxury items bought within 90 days of filing are non-dischargeable; cash advances of $750 within 70 days are also non-dischargeable.

Chapter 7 also won’t stop or even postpone some debt collections and lawsuits. New bankruptcy laws have dropped the following “automatic stays” of bankruptcy:

What’s good about Chapter 7?
According to the Administrative Office of the United States Courts, individual debtors walk away from most debts in 99 percent of Chapter 7 cases, with the exception of cases that are converted or dismissed.

“Financially, it’s easier to recover under Chapter 7 because you can walk away virtually debt-free,” says Ulzheimer. However, from a credit-scoring perspective, this option will be more damaging than a Chapter 13 filing because it will stay on your credit report for 10 years. Chapter 13 will take seven years to fall off your credit report.

The impact will vary depending on how recently the bankruptcy occurred and how many debts were discharged.

“The more accounts, the more impact,” says Ulzheimer. As the bankruptcy gets older, even though it remains on the report, the “impact will diminish,” says Ulzheimer.

Chapter 13
Also known as debt adjustment, Chapter 13 allows individuals, not corporations, to temporarily halt foreclosures and collection actions while they draft and execute a plan to repay some or all of the debts over a three- to five-year period.

One of the biggest benefits for Chapter 13 filers is that the amount you’re going to have to pay on that debt will depend not on how much you owe but on how much you have — your regular income, hence the nickname “wage earner’s plan.”

“In many cases, if you are behind on your mortgage or your car loan, and you don’t think you can catch up quickly, you file a Chapter 13,” says Sommer, author of “Consumer Bankruptcy: The Complete Guide to Chapter 7 and Chapter 13 Personal Bankruptcy.” “That’s probably the No. 1 reason people file Chapter 13.”

This type of bankruptcy lets you reschedule and extend secured debts over the life of your Chapter 13 plan.

Types of debt
Chapter 13 differentiates between three types of debt:

With a Chapter 13 bankruptcy, you must be under the allowed debt limits. As of April 2005, it’s $307,675 of unsecured debts — such as credit card debt and medical bills, not tied to an asset — and and $922,975 of secured debt — those tied to an asset that can be repossessed or foreclosed upon, such as a house or car. The limits change April 1 each year.

Debt owed to a single creditor totaling more than $500 for luxury items bought within 90 days of filing are non-dischargeable; cash advances of $750 within 70 days are also non-dischargeable.

New, tougher laws
Once again, however, new bankruptcy laws will toughen a debtor’s ability to qualify.

For instance, if a debtor’s income is greater than the state median income, they have to establish a five-year repayment plan where they have to pay a certain amount of money to creditors. This amount is based on a strict allowed expenses-to-income formula. The allowed expenses — not actual expenses — are set each year by the IRS collections department. On the anniversary date of a confirmed plan, they must file a new statement of income and expenses.

Before you file, you must also provide a copy of your latest tax return at least seven days before the meeting of creditors. Those filing under Chapter 13 have to be current on tax returns for the previous four years.

Chapter 13 documentation
Like debtors filing for Chapter 7, failure to provide the following documents within 45 days after the petition has been filed results in automatic dismissal of the case. However, debtors can apply for a 45-day extension.

Assets harder to hold
To retain a home, filers have to keep making their monthly payments. But the amount that was past due at filing can be included in the bankruptcy debts, and paid over the life of the bankruptcy plan.

Under the new reforms, it will be harder for debtors filing Chapter 13 to keep a vehicle. Those who plan to keep their vehicle have to pay the full loan amount, rather than just its current value as previously allowed. This new rule applies to all car loans less than two and a half years old as of the filing date.

Who gets paid when
Re-payment priorities for people and companies (creditors) that are owed money have also changed. In other words, who’s getting their money first is no longer the same: Under the new bankruptcy laws, people who are owed unpaid child support and alimony take priority over any other creditor.

Chapter 13 won’t stop or even postpone some debt collections and lawsuits. New bankruptcy laws have dropped the following “automatic stays” of bankruptcy:

Debtors cannot confirm a bankruptcy plan or obtain a discharge of debts if their domestic support obligations are not paid according to its terms.

More debts not forgiven
Be advised. Debts from the following items will not be discharged under Chapter 13 :

The repayment plan must be approved by the bankruptcy court and the trustee, and creditors are allowed to object. Sometimes individuals file for Chapter 13 only to find out they must convert it to a Chapter 7.

If the plan passes muster with the court, then all disposable income is given to the trustee, who keeps a percentage as a fee and parcels out the rest to the creditors in accordance with the plan. You’re only prevented from re-filing for Chapter 13 for six months.

What’s good about Chapter 13?
Chapter 13 allows debtors a chance to halt foreclosure proceedings on their homes. While they must still make mortgage payments on time, they can pay off delinquent mortgage payments and ultimately keep their homes, according to the Administrative Office of the United States Courts.

What’s more, even though it lingers longer, Chapter 13 is kinder on the credit score than a total liquidation, says Ulzheimer. Creditors will see that the debtor is making an effort to pay off the debts. Unfortunately, it will be harder to obtain new credit because creditors will know you already have to pay off other creditors. With Chapter 7, they know you’re not paying off those debts, he says.

One final note: At the end of any bankruptcy, you might receive a 1099 form from creditors listing your discharged debt as unreported income. If the IRS asks, supply the documentation that shows the 1099 form resulted from a bankruptcy.

“Chapter 20″
There is no Chapter 20 in the bankruptcy code. Instead the term refers to filing a Chapter 7 followed by a Chapter 13 (the sum of which is 20), says James R. Beaman, a Tucson-based attorney and co-author of “The Complete Idiot’s Guide to Surviving Bankruptcy.” The purpose of the second filing: to get rid of debts that are not dischargeable under Chapter 7.

This type of action is “pretty rare,” says Sommer. More common is that individuals get into debt again within six years of a Chapter 7 and end up filing a Chapter 13. There are stricter limits to filing a case after a prior case under the new law.

For instance, a discharge will not be granted in Chapter 13 if the debtor obtained a discharge through Chapter 7, 11 or 12 within four years prior to the date of filing the new case, or if a debtor filed a Chapter 13 case within two years of the pending case.

Get a good attorney
In the event that you still want to file for bankruptcy, you need an experienced lawyer who specializes in bankruptcy to navigate the federal laws, state laws and tax consequences. Steer clear of petition preparers, typing services or paralegals, says Sommer. And if you are even considering filing on your own, remember the old adage: A man who represents himself has a fool for both an attorney and a client.

“It’s a very bad idea,” says Sommer. “Chances are, mistakes would be made that would cost you more than paying an attorney.”

Under the new stipulations, lawyers must make a “reasonable inquiry to verify that the information contained” in petitions and schedules are correct. The signature of the lawyer on the petition will certify that the information in the schedules filed is correct. Lawyers face financial responsibility for court costs and creditor’s attorneys’ fees if the debtor’s statements about property and finances prove to be false or incomplete.