Myths About Bankruptcy

12 Common Myths About Bankruptcy

Bankruptcy has a scary reputation based on a few tidbits of truth and lots of embellishment that you may have heard from a friend of a friend who knew someone who filed. It’s not nearly as frightening once you know the facts.

Here is a list of a dozen commonly held misconceptions about bankruptcy.

 

1. Everyone will know I’ve filed for bankruptcy relief.

Unless you’re a prominent person or a major corporation and the filing is picked up by the media, the chances are very good that the only people who will know about a filing are your creditors. While it is true that bankruptcy is a public legal proceeding, the number of cases filed is so numerous that very few publications have the space, the manpower or the inclination to run a list of all of them.

 

2. All debts are wiped out in Chapter 7 bankruptcy.

Not true. Certain types of debts cannot be discharged, or erased. They include child support, alimony, divorce related property settlements[1], government-issued or government-guaranteed student loans, recent income tax assessments, employer trust fund tax liabilities (unpaid employee withholding taxes), and debts incurred as a result of fraud, theft or embezzlement.

 

3. I’ll lose everything I own.

This is a misconception that keeps people who really should file for bankruptcy from making the decision to file when it would be in their best interest. Some people think that someone from the government will come to their home, take everything and sell it out from under them and they’ll be left to start over in a cardboard box. While property exemption statutes vary from state to state, each state has a law that protects the value of certain assets, such as your house, car (up to a certain value), money in qualified retirement plans, household goods, and clothing.

Most people will pass through bankruptcy and keep everything they started with. If you have a mortgage and a car loan, you can keep those in a Chapter 7 as long as you keep making the payments (the same as before you filed for bankruptcy relief).

 

4. I’ll never get credit again.

Quite the contrary. It won’t be long before you are getting credit card offers again. The offers will just be from sub-prime lenders that will charge outrageous interest rates and you should stay far away. However, the more time that elapses between your discharge date and an application for credit, and if your earnings are stable and you haven’t added more debt, the rates will become increasingly more reasonable.

I don’t advise that any of my clients run out and run up bills again, but if you need a car, you can go out and get credit. You don’t have to go to a loan shark to get credit, but you won’t get a loan at A+ rates either. A higher interest rate on a large purchase will have a significant impact on your payment, so if possible, make sure you get a car loan before you file a bankruptcy petition and plan on reaffirming the loan terms after you file.

If you have a credit card with a zero balance on the day you file for bankruptcy relief, you don’t have to list it as a creditor since you don’t owe any money on it. You may be able to keep that card even after the bankruptcy. But be forewarned, most of your credit accounts do periodic reviews of your credit report. Your zero balance credit card lender may discover that you have filed for bankruptcy relief and cancel your account anyway.

 

5. If you’re married, both spouses have to file for bankruptcy.

Not necessarily. It is not uncommon for one spouse to have a significant amount of debt in their name only. However, if spouses have debt they want to discharge that they’re both liable for, they should file together. Otherwise, the creditor will simply demand payment for the entire amount from the spouse who didn’t file.

 

6. It is really hard to file for bankruptcy.

It’s really not. Technically, and Congress requires that I tell you this, you don’t need an attorney. Like any court in our nation, the doors are open to all citizens, but I really don’t recommend that your go through this procedure without an attorney to guide and advise you, warn you of potential pitfalls, accurately prepare and file the bankruptcy statements and schedules and deal with your Trustee and your creditors.

 

7. Only deadbeats file for bankruptcy.

Far, far from the truth. Most people file for bankruptcy after a life-changing experience such as loss of a job, divorce or a serious illness. Many of my clients came to me after investing their money and talent in a business venture that failed. My clients have struggled to pay their bills for months, have liquidated otherwise exempt assets to pay their bills, have worked two and three jobs to pay their bills, have borrowed from friends and family to pay their bills, and have gone without essentials, but just keep falling farther and farther behind.

 

8. I don’t want to include certain creditors in my filing.

Not possible. You must list all of your creditors. Period. End of story. However, there is nothing stopping you from paying them back some day, even if the debt is discharged. After you receive a bankruptcy discharge, those creditors are forbidden by law to attempt any further collection activities. If your conscience won’t let you sleep nights because you didn’t pay your debts, there’s nothing in the bankruptcy code that prevents your from repaying them once you are back on your feet although you are no longer legally obligated to do so. But bankruptcy is an all-or-nothing deal, so you have to include all of your creditors on your petition.

 

9. Filing for bankruptcy will improve my credit score.

Not immediately, no, not at all, but over time it can improve your score. Next to a real estate foreclosure, a bankruptcy filing is the worst “negative” you can have on your credit score and like other negatives, it can stay on your report for up to ten years. However, say, for example, that if someone has a credit score below 600, substantial unsecured debt (e.g., credit card balances, medical debt) and a history of slow payments, collections or judgments, they may see a substantial increase after they receive a Chapter 7 discharge because their debt to income ratio improves dramatically after the discharge enters. Of course, they have to be careful moving forward and maintain a good history of positive credit behavior (on time payments, balances far below the credit limit or, better yet, paid in full every month), but there can be a substantial upswing on the credit in about 12 months after their case is filed.

 

10. You can’t get rid of back taxes through bankruptcy.

Generally speaking, this is true. However, to discharge income tax liability, all your returns need to be filed and the taxes owed need to be a least three years old, i.e., a liability from a return filed on or before April 15, 2005, will be dischargeable after April 15, 2008.

 

11. You can only file for bankruptcy once.

You can file for bankruptcy more than once, but the 2005 Bankruptcy Reform Act lengthened the required wait between filings. You can file for Chapter 7 relief once every eight years. You have to wait two years to repeat a Chapter 13 filing and four years between a Chapter 7 and a Chapter 13.

 

12. I can max out my credit cards and then file for bankruptcy OR none of my credit card debt can be discharged.

This is the polarity myth between two extremes. On one end are my clients who have been told that after the 2005 Bankruptcy Reform Act, credit card debt is excluded from the general discharge. Not true. Excessive credit card balances which are subject to exorbitant interest rates and over limit fees are the exact problem bankruptcy is designed to resolve. On the other end of the spectrum is the misconception that it is okay to run up your card balances right before filing. That is called fraud and could result in that debt becoming a non-dischargeable liability that you will carry for life. Don’t do it.

 


[1] Although debts arising from property settlements contained in a divorce decree ARE dischargeable in Chapter 13.