Filing Chapter 7 Bankruptcy: Do I Qualify?
Getting hopelessly upside-down in our financial lives can happen to the best of us. (Ask the current occupant of the White House.) But when your debts far outweigh your ability to pay and insolvency looms like a sledgehammer, it’s good to know there’s an approved cure for your hopelessness.
Yes, we’re talking about bankruptcy, specifically Chapter 7 bankruptcy.
Chapter 7, also known as “straight bankruptcy” or “liquidation bankruptcy,” is probably what most people imagine when they think of bankruptcy at all, but there are qualifying standards that mean not everyone can take advantage of it. The standard is called a “means test” and it’s used to limit the number of people who file for Chapter 7 bankruptcy.
Many times, if a consumer fails the means test for Chapter 7 bankruptcy, they still are eligible to file Chapter 13 bankruptcy instead.
Why File for Chapter 7 Bankruptcy?
The most obvious reason for filing for Chapter 7 bankruptcy is that there is a really good chance you will have most of your unsecured debts — including credit cards, personal loans and medical debt — discharged, or forgiven.
The American Bankruptcy Institute said that in 2016 there were 499,909 Chapter 7 filings and 95.5% of them succeeded.
Some filers are required to sell off certain assets, such as an expensive car or jewelry, but that tends to be the exception rather than the rule. Most of the stuff people own is either worthless or they still owe money on it.
So, chances are, you’ll keep your family room sectional and the big-screen HDTV on the wall opposite. However, that sweet 1968 Corvette you hide in the garage probably is going on the auction block. In the future, you’ll own a low-budget, used car.
It all comes down to property that is considered exempt (home, car used for work, retirement savings, etc.) and nonexempt (second home/car, art, jewelry), a condition that varies from state to state. Your lawyer should be an expert in this area.
Chapter 7 is designed not merely to get a drowning creditor back onto dry land, but also to make certain he (or she) has sufficiently firm footing to make a new start. Bankruptcy isn’t
worth the parchment it’s written on if the filer gets relief, but still can’t meet day-by-day necessities.
In truth, having the courage to take the painful, enduring hit bankruptcy exacts is not the sign of a loser. Done properly, it’s practically heroic.
On the upside, before a bankruptcy case can be filed, most individual debtors must participate in a session with an approved credit counselor. This is a good thing. A quality credit counselor might be able to recommend one or more strategies such as debt consolidation or a debt management plan that could help you avoid filing for bankruptcy at all.
However, if even your credit counselor agrees that bankruptcy is the best solution for your financial woes, then you know, at least, you are on the right path.
The question then becomes: Do you qualify for Chapter 7 bankruptcy? Dire as you think your situation is, you don’t simply get to choose. There are some hoops to jump through.
Even then, certain daunting obligations such as student loans, alimony, child support, IRS debt and fines, can’t be dismissed in bankruptcy.
How Do I Qualify for Chapter 7 Bankruptcy?
Brace yourself. Better yet, seriously consider hiring a bankruptcy lawyer.
Theoretically, you can do this yourself, but you’re about to plunge into a daunting pool of federal forms designed to help calculate your eligibility. Trying to do this yourself is a severe test of your patience and knowledge of bankruptcy laws.
Among the forms are part of the “means test” mentioned above. There is a form to figure your Current Monthly Income (Official Form 122A-1) and a Statement of Exemption from Presumption of Abuse (Official Form 122A-1Supp), plus other mind-numbing documents designed to demonstrate the full extent of your financial plight.
In lay person’s terms, the bankruptcy “means test” weeds out many — but not all — high-income earners from using Chapter 7. With certain exceptions, people with big incomes suffering serious cashflow problems, must seek reorganizational relief through Chapter 13.
That said, you don’t have to be flat broke to qualify for Chapter 7. High earners still may squeeze through if they have reasonable expenses for mortgages, cars, tax liabilities, and certain other expenses, such as alimony or child support, child care, certain education expenses, and even charitable contributions.
What Is a Means Test?
So, the means test. It’s a measure of your financial situation to be sure you meet qualifying standards for Chapter 7 bankruptcy. It was added to the bankruptcy laws in 2005 as a way to prevent consumers from abusing Chapter 7 bankruptcy laws.
To begin at the beginning, you must determine where your income fits compared to the median income in your state. If it’s lower than the median income for a household of your size in your state, you’re in. You have qualified to file for Chapter 7.
Conversely, if your income is higher than the median for a household in your state, you have complicated work left to do. The key question posed by bankruptcy laws: Do you have enough income above allowed monthly expenses to pay off some portion of your unsecured debts?
And that brings us back to the bankruptcy forms, which you can find here: http://www.uscourts.gov/forms/bankruptcy-forms.
Beyond that, even if you technically qualify for Chapter 7, the court will scrutinize two additional forms — Schedule I: Your Income and Schedule J: Your Expenses — with an eye, again, to determining whether you have enough to pay a portion to your creditors. If so, the court might convert your Chapter 7 application to a Chapter 13 reorganization.
Think you’re ready, then? Not so fast.
Before tackling such a life-altering task, it’s a good idea to lay out the up and down sides. To understand how those columns might add up, it’s useful to have a handle on exactly what’s in them. Here we go:
Chapter 7 Bankruptcy Pros and Cons
- Con: Bankruptcy is the ultimate hit on your credit rating. It is your legal confession that, at one time, you could not manage debt. And it sticks with you for a while. A Chapter 7 bankruptcy can remain on your credit report for up to 10 years.
- Pro: You’ve known you were going to get whacked one way or the other, right? Missed payments, defaults, repossessions and lawsuits are no picnic for your credit history, either. Chapter 7 is a way to begin climbing out, and the process, from filing to the final judgment is comparatively speedy: only about three to six months.
- Con: You may have to sacrifice property that is not exempt. This could extend to certain luxury items, or even priceless family heirlooms.
- Pro: State exemptions generally exempt most of your possessions from liquidation. After you file for Chapter 7, you will keep your salary (except for certain court-mandated deductions mentioned above like IRS garnishments, alimony, child support, etc.) and property you buy.
- Con: Say goodbye to your credit cards. So long, Capital One miles. Farewell, Marriott Rewards points. What’s in your wallet immediately after Chapter 7? Cash, an ATM card, and personal identification.
- Pro: It may be possible to obtain new lines of credit as soon as a year out from filing, but be ready to pay staggering interest rates.
- Con: If you don’t have a mortgage, bankruptcy will make it extremely difficult to obtain one.
- Pro: Some specialty lenders will take on so-called “bad risks,” an unfortunate term that fails to account for the integrity of someone who has taken the bold step of setting right his financial woes.
- Con: You must be confident of the path forward. Completing the Chapter 7 process means you’re barred from seeking Chapter 7 relief again for at least six years, dating from when you last filed for bankruptcy.
- Pro: Chapter 13 bankruptcy (again, for reorganization of debts) is not restrained by timetables, although each filing goes on your credit history.
- Con: This bears repeating: Bankruptcy will not get you off the hook for alimony and/or child support. You also still have to pay off your student loans, IRS debt and fines. Sorry.
- Pro: Bankruptcy may make it easier to meet your court-ordered obligations. Also, bankruptcy wards off aggressive collection actions.
- Con: You’re going to have to tell your tale of woe about how you got into your financial fix to a judge or bankruptcy trustee.
- Pro: Think your story is bad? They’ve heard worse.
- Con: Every bankruptcy is different. You might emerge from Chapter 7 still obligated to pay certain debts, such as a mortgage lien.
Alternatives to Chapter 7 Bankruptcy
Again, Chapter 7 is a bitter pill with a lingering aftertaste. If you can avoid it, you should. If bankruptcy is in your future, Chapter 13, described earlier, is a less debilitating alternative.
In exchange for agreeing to repay some or all of your unsecured debt, you protect your otherwise nonexempt possessions and, if you are a homeowner making mortgage payments, are able to stave off foreclosure proceedings while you arrange catch-up payments.
Maybe bankruptcy isn’t inevitable, though. Perhaps you could land a debt-consolidation loan. Perhaps you could negotiate a debt-settlement plan with your creditors. A good place to begin is with a credit-counseling organization, which can go to bat for you against those who whom you owe money.
Do you have assets to sell? A second home, vacant property, a second car? These would be at risk in a Chapter 7 bankruptcy anyway. Liquidating them to pay off debt outside a bankruptcy proceeding could preserve your credit rating.
What’s your home’s equity situation? If you’re on schedule with your payments, perhaps you could refinance, pay off your creditors, and end up with a single, lower, mostly tax-deductible monthly payment. If you’re behind, but you’re still flush with equity, negotiate with your lender on a plan that would make them, and you, happy.
Finally, have a heart-to-heart with your budget. Maybe it’s time you made genuine sacrifices in your lifestyle. Again, here a debt counseling service can provide insight and relief beyond mere dollars.
We’ve kicked around a few terms above. We should flesh them out a bit.
Bankruptcy Code: The federal law that governs the bankruptcy process. The code is divided into chapters; each chapter is divided into sections.
Chapter 7: The most common form of bankruptcy. It’s also widely known as “straight bankruptcy” or “liquidation bankruptcy.”
Chapter 13: This form of bankruptcy protects the filer from collections while his finances are analyzed and a 3-5 year repayment plan is structured, then executed.
Trustee: The court-appointed liaison who oversees your case. The trustee’s job includes, potentially, taking your nonexempt property, selling it, and distributing the proceeds to your creditors.
Exempt property: Depending on your state, what you are allowed to withhold from being seized and sold by the trustee.
Those are just for openers. An exhaustive list of bankruptcy terms is available via the United States Courts here: http://www.uscourts.gov/educational-resources/educational-activities/bankruptcy-basics-glossary
Meeting of Creditors
Included in the bankruptcy process is a mandatory “first meeting of creditors.” Once the case is filed, the trustee can pose questions to the petitioner, under oath, about assets and liabilities. As the title suggests, representatives of the creditors also can use this meeting to question the debtor. In fact, however, they rarely appear, relying on the trustee to get to the nub of things.
The only exceptions tend to be those carrying the note on your car (since that is a mobile asset, they want to be reassured about your intentions), and — you knew this was coning — the IRS, which always has a keen interest in reminding filers they can’t get out from under Uncle Sam.