Common Bankruptcy Myths

  1. “I have to qualify for bankruptcy.”

    • False. Anyone can qualify for bankruptcy.

      The real question is under which chapter you qualify. Under the new law, which went into effect in October, 2005, you qualify for a simpler, quicker Chapter 7 bankruptcy if your household income is below the median for your state, or you pass a “Means Test” to see if you have minimal disposable income as determined by bankruptcy law.

      Otherwise, you will have to file a Chapter 13 bankruptcy in which you make some contribution of your income (based upon your ability to pay) for a period of three to five years. However, you will obtain a discharge of your debts in both chapters.

  2. “I will never again have credit if I file for bankruptcy.”

    • False. There are two aspects to the consequences of filing for a bankruptcy: 1) The amount of time it takes to rebuild your credit and, 2) The amount of time it stays on your credit report. A bankruptcy will stay on your credit report for ten years. However, the national average time to recover credit is eighteen months.

      The fact of bankruptcy is not a bar to obtaining credit. There is no law prohibiting a person from obtaining credit after bankruptcy. (In fact, you will probably get new applications in the mail from lenders eager for a customer with renewed debt capacity).

      After bankruptcy, creditors evaluate you on how you have managed your finances after the bankruptcy, that is:

      • Have you paid your new debts on time since the filing?
      • How much debt do you have now after the filing?
        After the bankruptcy, generally you will be debt-free, so you are in a better position to handle new debt.

      Note, however, that you need to consider whether new credit is that important to you. If you did not manage it well the first time, going back to financing your life with debt is not the answer.

  3. “I will not be able to have credit for ten (or seven) years.”

    • False. This is commonly confused with Myth #2. People confuse the amount of time the bankruptcy is on the credit report with how long on average it takes to recover credit.

  4. “I will lose everything I own in bankruptcy, including my home and my car.”

    • False. There are exemptions in every state, commonly known as poor debtor’s laws that allow you to keep the bare necessities. There are also federal bankruptcy code exemptions that can be used if state law allows it.

      In addition to the exemptions allowed by law, the value of most property tends to depreciate over time. If the value of the property is less than the debt, the court-appointed administrator of your case (known as a trustee) will not want it and you get to keep it. In a Chapter 13 case you may keep any property that is not protected by the exemptions so long as you pay its value in your plan.

  5. “I need to have a minimum amount of debt to qualify for bankruptcy.”

    • False. What really matters is whether you can afford to pay off the debts you have in your specific situation. A debt load of $5,000 may be overwhelming if the disposable income you have available will not pay it all off in a reasonable amount of time.

      Take a look at the disclosures on your credit cards that have been required by the new federal credit card law, and see how long it will take you to pay off your balance paying the minimum. Also try the debt calculator at "What Will It Take to Pay Off My Balance?".

  6. “I am a bad person if I file for bankruptcy.”

    • False. Remember that bankruptcy is a form of relief and not a punishment. Filing for bankruptcy does not make you a bad person. It was passed by policy-makers as the law of the land for the specific purpose of giving people an opportunity to get a “fresh start” financially.

      The law does not require, and you will not be asked to explain how you got into this situation. The law recognizes things happen such as lay-offs, under-employment, illness, divorce or just plain bad financial decisions. Don’t beat yourself up. Stuff just happens.

  7. “If I file for bankruptcy it will affect my spouse.”

    • False. Under the law, you are only liable for the debts for which you signed. If your spouse did not sign on the debt, then he or she is not responsible for it. The exception are debts where both of you signed and hence are jointly and severally liable (that is, the creditor can hold either of you or both responsible). In that case, you, or both of you, can just continue to pay.

  8. “Everyone will know I filed for bankruptcy.”

    • False. Bankruptcy records are public information. However, unless you are a celebrity and someone specifically searches for you, it does not come to light.

  9. “I am making the minimum payments on my credit cards and my credit score is good. I don’t need to file bankruptcy.”

    • It depends. Don’t fool yourself. See the links at #5 above. If you’re just paying the minimum and not paying down debt, think about whether you want to be a financial slave for the rest of your life and never getting ahead.

  10. “Taxes cannot be wiped out in bankruptcy.”
    • False. Income taxes can be discharged under the following conditions:
      • The taxes relate to a tax year more than three years old.
      • Tax returns were filed by the debtor more than two years before the bankruptcy filing.
      • The IRS or a state tax agency has “assessed” the tax (noted in its records that the tax debt is fixed in amount and due and payable) more than 240 days before the bankruptcy filing.

  11. “I need to have US citizenship to file for bankruptcy.”

    • False. The relevant requirement for filing for bankruptcy is that you either reside, are domiciled, or have your principal place of business, or most of your property located in the district of the federal court in which you file during most of the prior six months.

  12. “I can choose which debts or property I put into the bankruptcy.”

    • False. You have to list all of your debts. Bankruptcy is not designed to favor just the debtor. There is a balance between the rights of debtors and creditors. It would not be fair to the creditors if you got to pick and choose which debts you could list. If you purposely omit debts or property, you may face a dismissal of your case and possibly criminal charges.

      Note that for some debts, you may state your intention to reaffirm the debt, that is, that you want to maintain personal liability. The creditor, at his discretion, can usually give you new contract where you agree to keep the debt, subject to court approval. You are always free to voluntarily re-pay, if you wish.

      Regarding your property, your attorney will work with you to do proper planning to protect it or file under the right chapter so you can keep it.

  13. “If I file for bankruptcy creditors can still take my earnings even after I file my case.”

    • False. In a Chapter 7 bankruptcy, any wages you earn after the bankruptcy filing are yours to keep. The only exception is an inheritance you come into within six months after the filing.

      In a Chapter 13 bankruptcy, because you are entering a payment plan over a specified period of time, part of your earnings will be applied to your debts.

      However, the amount applied to your debts depends on your income and must be a reasonable amount that is affordable to you.

  14. “I will not be able to get rid of most of my debts.”

    • False. Most debts are dischargeable with a few exceptions. All unsecured debt is usually dischargeable, such as credit cards, medical bills, unsecured loans, etc. There are exceptions to this, such as certain types of taxes, domestic support obligations, etc.

      Secured debts are also dischargeable, and you cannot be sued on them after the bankruptcy. However, since the agreement you signed giving the lender rights to the property as collateral survive the bankruptcy, to keep the property, you must either continue to pay, exercise your rights to redeem (make a lump sum payment of the value of the property to release in full the creditor’s lien), or reaffirm if the creditor requires it.

  15. “I will be repaying all my debts in Chapter 13.”

    • False. Your payment in Chapter 13 is generally based upon what you propose to do in your plan and what you can afford to pay. For example, let’s say you propose to pay your mortgage arrears of $18,000 in 60 months. Not counting the trustee’s commission for administering the plan, that would amount to a payment of at least $300/month. However, if given your income and expenses you could comfortably pay $400/month, then that is what you would be expected to pay to get a plan confirmed by the court. If you have $6,000 in credit card debt, the $100 excess over the $300 would pay the credit cards at 100% -- hence you would be repaying all your debts, in this example. If however, your credit cards total $3,000, the distribution would be only 50%. This plan still meets all the requirements for confirmation. Rarely does a plan provide for 100% payment. It only happens when the debtor happens to have sufficient disposable income that it works out that way.