5 bankruptcy myths busted
Only deadbeats, cheats and crooks file for bankruptcy, right? Wrong.
Only deadbeats, cheats and crooks file for bankruptcy, right? Nothing could be further from the truth, say the folks who deal with individuals seeking bankruptcy relief on a day-to-day basis.
More than 182,000 Chapter 7 bankruptcy filings were recorded during the first three months of 2013, making it by far the most common type of bankruptcy procedure used by individuals. Falsehoods about the people who file are rampant, however, from who pursues it and why, to what the implications are for those who proceed.
No one is better equipped than bankruptcy lawyers to set the record straight about the legal process that allows people to cancel certain debts. We spoke to bankruptcy lawyers from around the country about the way it really works and the people who turn to bankruptcy for protection. Here are the most persistent myths they'd like to shatter -- once and for all.
1. Most filers are deliberate deadbeats
The first bit of nonsense concerns the personality characteristics and attitudes of Chapter 7 filers. "The widespread misconception is that people who need to file were irresponsible with their finances," says lawyer John Hargrave, whose firm is located in Barrington, N.J. Another, he says, is that they can pay their creditors back if they really want. They're just lazy.
Not so, say the pros. "Debtors rarely consider bankruptcy if they can afford their bills," says Michael Duffy, a lawyer practicing in Philadelphia. "More often they can't afford their bills, but we still look for a nonbankruptcy alternative out of necessity or look at different chapters of bankruptcy." Why? Because they feel a strong sense of responsibility to pay.
Dallas lawyer Herman Lusky agrees, explaining that the overwhelming number of consumers who file have tried everything to work out their debt problems, sometimes even to their detriment. "Many exhausted their exempt property -- such as IRAs and 401(k)s -- prior to filing, thereby creating additional tax problems for them."
Still, bankrupt folk are somehow different from the rest of us, right? Wrong again, says lawyer Jeena Cho, from San Francisco. "They're everyday people like you and me." Her clients come from all walks of life: "Single, married, divorced and widowed. Careers range from accountants, bankers, cashiers, dentists, firemen, bookkeepers, hairstylists, teachers, doctors, Realtors and, yes, even lawyers."
Bankruptcy will ruin your credit
This myth is almost comical. Filers typically haven't paid their debts in months, have accounts in collections and have been sued and owe judgments. In short, says Glendale, Calif., lawyer Lauren Rode, "If you are contemplating bankruptcy, your credit score is probably already shot."
But won't the bankruptcy make it even worse? The opposite, Rode says. "Filing a bankruptcy actually increases your credit score overnight if it is already low." She has proof: Rode's firm has a program allowing it to pull a client's FICO scores both before and after it discharges their debt. "Usually their pre-filing score is in the high 500s, and their post-filing score is in the low 600s," says Rode. "It immediately increases by about 30 to 50 points."
As for the credit report itself (and not just the score), a Chapter 7 bankruptcy will be listed on it for 10 years from the filing date. While credit score numbers may rise, anyone who pulls the report and sees the notation is free to form an opinion -- positive, negative or neutral.
Filing a bankruptcy actually increases your credit score overnight if it is already low. Usually their pre-filing score is in the high 500s, and their post-filing score is in the low 600s. It immediately increases by about 30 to 50 points.
Attorney, Glendale, Calif.
So how often is the bankruptcy notation considered dreadful? Not as often as rumored. According to Klamath Falls, Ore., attorney Karen Oaks, borrowing opportunities rise after a debt discharge. "They soon have good enough credit to get a new vehicle," says Oaks. "I usually get thank-you notes from people!"
3. You'll lose all your property
Perhaps it's the old cartoons where bankrupt people are left wearing nothing but a barrel with straps that keeps the "don't file, you'll lose everything!" myth alive. However, say the lawyers, filers tend to keep the majority (if not all) of their possessions.
"Most property, including the debtor's home and vehicles, are exempt and the debtor doesn't lose anything," says Russell DeMott, a lawyer from Summerville, S.C. "In fact, over 95 percent of consumer Chapter 7 filings are 'no asset' cases where none of the debtor's property is sold."
It's important is to understand your state's exemption rules before you file. The type of property and amount of cash you get to keep varies by state, so know know the rules in your area. "For example," says Rode, "California allows $5,100 of equity in a car, all of your household goods and furnishings, all your apparel and about $26,000 of a wild card that can be applied to cash, checking accounts, stocks, additional cars, boats and anything else."
You may also be worrying over nothing, if that's all you have. Since most who file do so long after they've tried hard to satisfy their creditors, they've already sold or given up the bulk of their assets.
4. You'll lose none of your property
Conversely, another myth that lawyers want to banish is that they have more power than they really do. Some people think a wily bankruptcy attorney can protect all of their assets, from the yacht to the mansion.
In reality, though, if you have a lot, chances are you'll lose a lot in a Chapter 7. Property that isn't protected by an exemption is at risk. If you own something unnecessary and expensive, such as a personal boat, and it's all paid off, the creditor can demand that it be sold and the proceeds applied to the debt.
As for those who file and still seem to enjoy the finer things in life, know that appearances can be deceiving. The reason some seem to escape a bankruptcy with all of their luxury goods intact is because they don't actually own them. The stuff is either leased, rented or heavily leveraged.
Don't even entertain the idea of hiding assets to prevent their seizure, either. Creditors can be excellent detectives. "Your attorney will assess everything you own and if that's not done properly, there's trouble," says Rode. "A client I had owned rental property in New Mexico that he didn't tell me about. He almost lost it. We had to convert the Chapter 7 into a Chapter 13 at the last minute." (Similar to a Chapter 11 bankruptcy, which is typically for businesses, a Chapter 13 lets individuals pay their debts though the court, allowing them to keep their possessions.)
5. Only the destitute are eligible for bankruptcy
You may have heard Chapter 7 is only for impoverished people, and it's not possible to file if you make decent money.
Again, the lawyers object. Earning more than your state's median income does not automatically make you ineligible. "I get quite a few people who are above the median income limits and they think they won't qualify for a Chapter 7," says Hoeing. "But the majority of the time they do."
It's correct that if your income is greater than the median income for a household your size in your state you have to pass a "means test" to qualify for a Chapter 7 bankruptcy. Essentially, if you have enough cash left over after subtracting expenses from income to satisfy your creditors, you'll be denied. Much depends on your expenditures, however, and in many cases, they are legitimately overwhelming. A good lawyer will prove the need.
"I had a high income man who needed to file for bankruptcy but was so afraid he couldn't," says Oaks. On the surface, his $130,000 salary seemed enough to pay his bills, but he was in debt for legitimate reasons. He had prostate cancer and his medication was $3,400 every three months. That plus child support and a second mortgage put him behind. So while her client earned far more than most in his state, his circumstances made him eligible for a discharge.
And that's the important truth, stress this wide range of attorneys: You don't have to be un- or under-employed to file. It just has to make sense.
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