how bankruptcy helps.
“Bankruptcy” is not a punishment, an indictment, or a public shaming. It’s not a moral judgment that someone spent too much money, or that anyone has failed at anything.
Bankruptcy is simply a tool.
Bankruptcy might not be the right tool for your specific situation, which is why it’s important to find an attorney who will help you explore all the possible alternatives. But like any tool, when it’s used for the purpose it’s designed for, by someone who understands how to use it, bankruptcy can have a number of benefits.
1. Eliminating or Reducing “Garden-Variety” Debt
When most people hear the word “bankruptcy,” this is probably the number-one benefit that comes to mind. Folks who are eligible can file a Chapter 7 bankruptcy and obtain a discharge of many “unsecured, non-priority debts” — which is just legalese for debts (a) without collateral, and (b) to which Congress has not granted special status. I prefer to call them “garden-variety debts.” This category includes credit cards, payday loans, personal loans, medical bills, and various other unpaid bills. It also includes “deficiencies,” which are the unsatisfied portions of auto loans and other secured debts that are leftover after the collateral was repossessed and sold. Some are surprised to learn that older tax debts can be dischargeable, though there are sometimes exceptions when the applicable tax return was not timely filed.
Certain kinds of debts are either never dischargeable or dischargeable only in limited circumstances. For student loans to be discharged, a consumer must demonstrate an “undue hardship,” which is a difficult legal burden to meet. And Congress has granted special, non-dischargeable status to some debts, including recent tax debts and domestic support obligations such as child support, maintenance, and alimony.
What many people don’t realize is that a Chapter 13 bankruptcy can also result in a discharge of all or some garden-variety debts. Chapter 13 involves making monthly payments to the Chapter 13 trustee for a set amount of time, but just because payments are being made does not necessarily mean one is paying all of their debts. While some Chapter 13 filers are required to pay 100% of their garden-variety debts, many need pay only a smaller percentage of those debts, and some Chapter 13 filers are not required to pay any of their garden-variety debts at all. Whatever garden-variety debt is not paid through a Chapter 13 plan is discharged when the plan is successfully completed.
2. The Automatic Stay
The automatic stay is what stops debt collection calls and letters as well as nastier debt collection activities like lawsuits, garnishments, and frozen bank accounts. In the vast majority of bankruptcy cases, the automatic stay takes effect the instant that the first bankruptcy papers are filed with the federal bankruptcy court — though, practically, creditors and debt collectors will keep trying to collect until they know about the bankruptcy.
There are exceptions when the automatic stay does not take effect immediately when the case is filed. And there are certain activities that could be considered forms of debt collection that the automatic stay does not prohibit. Still, for most consumers the automatic stay is a powerful tool and one of the main benefits of filing for bankruptcy. Any creditor or debt collector who violates the automatic stay could face sanctions from the federal bankruptcy court and possibly be held liable for damages suffered by the consumer.
3. Stopping Debt Collection Lawsuits
Creditors and debt buyers have learned how to turn the legal system into an arm of their debt collection operations. Sometimes there are viable defenses to debt collection lawsuits. But even when there is no legal defense, the automatic stay immediately stops a debt collection lawsuit in its tracks. The creditor generally can’t continue prosecuting the lawsuit or obtain a judgment until the automatic stay ends or the bankruptcy court grants a special exception.
When you first file for bankruptcy, the debt collection lawsuit is only frozen; what ultimately happens to the lawsuit depends on what happens in the bankruptcy. If the underlying debt is discharged in a Chapter 7, or discharged or paid in a Chapter 13, then the creditor can’t continue the lawsuit. But if the bankruptcy does not resolve the debt — for example, if the Chapter 13 is dismissed before the debt is discharged or paid — then the creditor can resume the lawsuit after the automatic stay ends.
4. Stopping Wage Garnishments
Most private debt collectors cannot garnish your paycheck until they have sued you and obtained a judgment against you — though there are exceptions. Even after a creditor has obtained a judgment and started garnishing your wages, it’s not too late to file for bankruptcy. The automatic stay immediately stops the ongoing garnishment. And if the underlying debt is discharged or paid during the bankruptcy, the garnishment cannot resume after the bankruptcy ends.
Sometimes, it’s possible to obtain a refund of some or all wages garnished in the 90 days before filing bankruptcy. To be clear, a refund is not automatic or guaranteed, and whether garnished wages can be recovered depends on the facts of the case. If the creditor refuses to return recoverable wages, a separate lawsuit within the bankruptcy case, called an “adversary proceeding,” may be necessary to get them back.
While it’s never too late to stop an ongoing garnishment, there could be other consequences from a judgment — for example, judgment liens on real property — that are not so easily fixed by a bankruptcy. For this reason, it’s best to talk to a lawyer as soon as possible after being served with a summons and complaint.
5. Stopping Repossessions
The automatic stay prohibits creditors from repossessing your car or any other personal property that is collateral for a debt. This means that filing bankruptcy usually stops the immediate threat of repossession. That said, in order to keep the car long-term, the auto loan must eventually be paid. For folks who are behind on car payments, often the best fit is a Chapter 13 bankruptcy, which makes it possible to adjust the car payments and pay off the auto loan through the Chapter 13 plan. Redeeming the car can be an option in a Chapter 7 bankruptcy, though it’s important to understand the limitations of redemption.
Even if your car has already been repossessed, there may be hope of getting it back. If the bankruptcy is filed and the automatic stay takes effect before the creditor has sold or otherwise disposed of the car, there can be a path toward getting the car back, though that is not necessarily automatic. State law generally requires creditors to wait a period of time before selling repossessed cars, but those waiting periods can be short. So if your car has already been repossessed, time is of the essence.
6. Stopping Foreclosures
Similar to repossessions, foreclosures can be halted by the automatic stay once a bankruptcy is filed. The bankruptcy should be filed before the foreclosure sale takes place. Bankruptcy alone cannot undo a foreclosure sale, unless there are defenses to the foreclosure under state law.
For consumers who are behind on their mortgage payments and are trying to keep their home long-term, Chapter 13 is generally the bankruptcy option. A Chapter 7 bankruptcy will postpone the foreclosure sale but will do nothing to cure the underlying problem with the mortgage.
And to be clear, a Chapter 13 is not a magic wand that instantly fixes the mortgage. In order to keep the house, the consumer must resume making the regular mortgage payments and must catch up with missed payments and any additional penalties and fees over the course of the Chapter 13 bankruptcy. This means that, while the bankruptcy is pending, the monthly cost of the mortgage will be higher than the regular monthly payment.
If missed mortgage payments are a problem, it’s best to talk to a lawyer right away, before the amount of arrears gets out of hand, and while there is still enough time to consider non-bankruptcy alternatives.
7. Turning the Power or Water Back On
Bankruptcy also protects consumers from termination of utility services such as water, electricity, and natural gas. If a public utility is on the verge of cutting off your service because of an unpaid bill, filing for bankruptcy can keep the lights on — or even turn them back on if service has already been terminated.
Again, while bankruptcy may avert the immediate emergency, additional steps may be required for utility service to continue. The Bankruptcy Code allows utilities to require “adequate assurance” — which very often will be an additional security deposit — within 20 days of filing. It’s important not to be caught off guard by this requirement and to have a plan for how to pay the additional deposit in the early days of the bankruptcy case.
8. Lowering Car Payments
As explained above, in order to keep a car or other personal property that is collateral for a debt, the secured debt must be paid. But in Chapter 13 bankruptcy, sometimes a Chapter 13 plan can reduce the secured amount of the debt to the fair market value of the collateral. Whether this is legally allowed depends on when and how the car loan was incurred and who incurred it. Lawyers call this maneuver “cram down.”
In addition to cram down, high interest rates on car loans and other secured debts can be reduced to a more reasonable rate. This is especially helpful to those victimized by high-interest title loans.
Because of these two procedures, some consumers find that their total monthly payment to the Chapter 13 Trustee — including what must be paid on the car — is actually less than the consumer’s regular monthly car payment before bankruptcy.
9. A Foundation for Rebuilding Your Credit
Credit reporting agencies are allowed to report bankruptcies for up to 10 years after filing under the Fair Credit Reporting Act (FCRA).
Unlike the length of time that a bankruptcy can be listed on a credit report, one’s credit score is not primarily a legal matter. Credit scores are numbers that private corporations generate based on their own algorithms. Because there are different scoring models and the formulas are proprietary, predicting exactly what someone’s credit score will be after filing bankruptcy is not something I can reliably do.
That said, there is good evidence that, on average, consumers who file bankruptcy tend to see significant increases in their credit scores within one year after filing. The Consumer Financial Protection Bureau has found this; economists at the Federal Reserve Bank of Philadelphia have found this; and private companies such as LendingTree have found similar patterns.
For some, filing for bankruptcy does cause an initial dip in credit scores. However, many people who file bankruptcy already have poor credit scores. For those people, filing bankruptcy is a practical first step toward rebuilding credit. In the long run, bankruptcy can be a better strategy than continuing to make minimum payments indefinitely without actually reducing their debt — or, even worse, missing payments.
10. A Step Toward Reinstating Driver’s Licenses or License Plates
A driver’s license can be suspended or revoked for many reasons. But if the reason it has been revoked is because of an unpaid debt, bankruptcy may provide a path toward reinstating the driver’s license.
Similarly, unpaid personal property taxes can be dealt with through a Chapter 13 bankruptcy. Consumers who had been prevented from renewing their license plates because of unpaid personal property taxes can often renew them soon after filing Chapter 13, while delinquent taxes are being paid through the Chapter 13 plan.