Updated April 5, 2019: No one likes to think about debt and bankruptcy, but if your money problems have gotten out of control, filing for bankruptcy may be one of your last resorts.
Your debts may become unmanageable if you’ve been unemployed and can’t get out from under mounting expenses, or if a divorce, chronic health problem or other personal issue has impacted your finances.
If attempts at budgeting or working out arrangements with creditors haven’t produced a solution and you’re on the brink of becoming destitute, declaring bankruptcy can eliminate most of your debts and allow you to start over.
Bankruptcy gets rid of most forms of unsecured debt that isn’t protected or backed up with an asset or piece of collateral. Bankruptcy can usually dismiss:
Credit card debt
Overdue bills turned over to collection agencies
But if you’re considering filing for bankruptcy, there are some instances where bankruptcy won’t erase your debt:
Although it affects more than 40 million Americans, you won’t be able to get rid of your student loan debt; both federal and private loans are exempt from Chapter 7 bankruptcy. However, there are some instances where you may be able to get your student debt discharged in a bankruptcy court proceeding.
You’d need to prove that you’ve suffered an undue hardship, like a disability that prevents you from working to earn money and make your loan repayments. But you’ll also need to prove that you’ve made every attempt possible to pay down your debt, and that doing so has prevented you from maintaining a minimal standard of living.
Another undue hardship could be that you were exposed to unfair or deceptive practices from your school, and that the debt you incurred is unfair. One example could be your school shutting down while you’re enrolled without reimbursing your tuition, leaving you with a load of loans to repay and no degree. In other cases, students are lured to attend fake schools, or schools that lie about their practices to attract paying students. However, proving some of these hardships to a bankruptcy court can be difficult.
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In some cases, if you have unpaid income taxes three or more years prior to the date of your bankruptcy filing, you may be able to have the debts discharged. (Here are five ways to make doing taxes less painful.) But with more recent income tax obligations you might be out of luck. Like student loan debt there are a few cases in which you may be able to convince the judge, but those are the exception, not the rule. To get them considered for discharge, you’ll need to complete a very complicated test to prove it. You’re also on the hook for other business- or sales-related taxes, too.
Generally, any debt secured with some form of collateral, like a mortgage, auto loan, or expensive purchase you’ve financed, like a piece of jewelry or major appliance, can’t be discharged in bankruptcy.
These items you purchased and were paying off still belong to your lender, so you’ll need to give them back or find a way to keep making your payments.
Child or spousal support or alimony payments aren’t eligible for bankruptcy discharge. It’s considered a legal domestic support obligation as part of one’s divorce proceedings, and won’t hold up in a bankruptcy claim.
If you’re divorced and your divorce agreement specified that you’re responsible for your ex’s legal fees, credit card debt or other forms of debt, you won’t be able to discharge those in bankruptcy, either. One exclusion is debts related to dividing marital property; depending on the state you live in, certain debts may be considered in bankruptcy. (Avoid the money mistakes that lead to divorce.)
Claiming bankruptcy also won’t save you from paying any debts you owe the U.S. government, like penalties, fines or other fees. Like student loan debt or taxes, you’ll still be responsible for any outstanding debts or restitutions owed to federal, state or local governmental entities incurred pre-bankruptcy.
If you owe the courts or other people any money stemming from a criminal act or malicious conduct, you can’t have it discharged through Chapter 7.
This may include white collar crimes like fraud, false representation or pretenses, embezzlement or larceny, or more serious acts such as damages you owe to victims if you were at fault for causing someone else’s death, such as vehicular manslaughter while driving under the influence or operating a boat or aircraft while intoxicated.
If you’ve filed for bankruptcy and figure, "Now I’ll just go on a spending bonanza since it’ll all be forgiven anyway," think again. Any credit card debt — or any debt, actually — that you incur post-bankruptcy filing won’t count towards your claim.
If you’ve previously filed Chapter 7 and had debts that weren’t discharged, they won’t be discharged this time around, either, so don’t waste the time, effort or money trying. You can’t fool the courts; they’ll have records of your past case.
The only thing better than getting debt discharged in bankruptcy is finding out it never belonged to you in the first place.
When you’re taking account of all your debt you’d like to include in your filing, make sure it’s all yours. Reporting errors where negative information from a person with the same name as you (or from a family member or ex-spouse) appears on your history, or identity theft, are common ways to incur debt that doesn’t belong to you. Monitor your debts carefully and make sure they’re all actually yours.
Forget to list all your debts in your bankruptcy case? The ones that qualify for discharge won’t be considered, and you can’t go back to retroactively revise your list. Since you’re required to include all your debts you owe, the court won’t know what you’ve left out and will assume that if anything is missing you chose to leave it out.
So if you have legitimately dischargeable debts, like medical expenses or a pile of overdue bills in collections, be sure to list them or you’ll miss the bankruptcy boat.
Dischargeable debts, nondischargeable debts — what about avoiding bankruptcy altogether? Follow these alternative avenues before going down Bankruptcy Street:
Negotiate with your creditors: Can you strike a deal with your creditors and reach new payment agreements before declaring bankruptcy? If it’s a credit card provider, that could mean arranging for a new, lower interest rate, even temporarily. If it’s a mortgage or auto loan carrier, it may be asking for a revised payment plan schedule for a select period of time. And your student loans? They won’t count towards bankruptcy, but it could be the debt that’s sending you toward bankruptcy. Seeking out deferment, forbearance, a refinance or loan consolidation are some ideal options. Aiming to settle any debts may be the lifeline you’re seeking to avoid not just bankruptcy, but debt altogether.
Sell assets or property: Your things have sentimental value, but those that have monetary value, if you’re willing to part with them, can be sold to pay off some of your debts and keep bankruptcy at bay. If you’re in debt over your new car payment, do you have a second vehicle you can sell to raise some cash? Antiques, heirlooms or other items you can put a price on? Take to eBay, CraigsList or private sellers (i.e. a jeweler in search of vintage items) to muster up some money towards your debt.
Tighten up your budget: Bankruptcy is the result of insurmountable debt. Insurmountable debt is too often the result of poor money management. By crafting a better budget for your finances, stave off debt and don’t let the prospect of bankruptcy ever enter the picture. Take account of your monthly income and expenses and ensure that you’re not spending more than you earn. Use budgeting apps to fine tune your budget, and find ways to cut back on expenses. And if those expenses include overdue debt, use a practical way to start paying it off, like the snowball method.
Seek financial help from others. Going into debt to pay your debt sounds like the textbook definition of using one credit card to pay off another, but not in this case. You may want to ask friends or family if they’d be willing to lend you the money to pay down some of your debt. As you prepare your budget in the bullet above, factor how much you may need to borrow; having these figures at hand can make the difference in convincing the person you’re asking that you’re serious about conquering your debt. If they agree, work out how much they can afford to let you borrow, and most important, how much you can afford to repay. There’s no shame in asking; if the worst they can say is "no," better to hear it from someone you trust than a bankruptcy judge denying discharge of your debts.
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Images: Catherine MacBride
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