Only deadbeats, cheats and crooks file for bankruptcy, right? Nothing could be further from the truth, say the folks who deal with bankruptcy day to day
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Few people dream of one day filing for bankruptcy. However, it can be the best option for those at the end of their financial ropes — as long as they understand what they’re getting into.
“People are generally poorly informed about what bankruptcy can and cannot accomplish for them,” says Paul Staley, a bankruptcy lawyer and author of “The Bankruptcy Lifeline: What Your Creditors Hope You Don’t Know.” Before you seek to eliminate your debts, check out these myths and make sure you can distinguish fact from fiction.
Myth No. 1: You automatically become debt-free. Of the six types of bankruptcy under the U.S. Bankruptcy Code, the two most common among consumers are Chapter 7 and Chapter 13. If you file for Chapter 13 bankruptcy, your debts are restructured in a way where you enter into a repayment plan for three to five years. A bankruptcy trustee distributes the payments among your creditors. Your repayment period may or may not satisfy all your debts, but once it’s over, any remaining unsecured debt is discharged. With Chapter 7 bankruptcy, most debts can be eliminated, but there are exceptions, such as student loans, child support, alimony and some taxes.
Credit card bills and other debts acquired within 90 days of filing for bankruptcy may also not be eliminated if the court determines that you made purchases that you never intended to pay. “I have met with people who have incurred large amounts of debt in weeks running up to the date when they intended to file bankruptcy, some of them knowing all along that they were in deep financial trouble,” Staley says.
People are generally poorly informed about what bankruptcy can and cannot accomplish for them.
|— Paul Staley|
Author, bankruptcy attorney
However, the current status of your accounts should change after you’ve filed for bankruptcy. Discharged accounts should be marked as “included in bankruptcy” or similar language, says Ken Chaplin, senior vice president at TransUnion. If you get your credit report and find that an account that was discharged in your bankruptcy is currently showing up as “past due” or “unpaid,” contact your creditor to let them know the information is not up to date, Chaplin adds.
Myth No. 3. Your credit will be destroyed for the next seven years. In general, Chapter 7 bankruptcies remain on a credit report for up to 10 years and completed Chapter 13 bankruptcies remain for up to seven years, says Christina Goethe, a spokeswoman for FICO.
However, the delinquent accounts that are included in the bankruptcy may disappear off the credit report before the bankruptcy itself. As the individual accounts age and reach the seven-year limit, they’ll be deleted from the credit report, says Norm Magnuson, a spokesman for the Consumer Data Industry Association.
Don’t assume your credit score will skyrocket once the bankruptcy drops off your credit report. If you avoided using credit and simply resorted to cash after your bankruptcy, you could end up with no credit history, says Griffin.
That could be just as bad as having a bankruptcy on your credit report since lenders have no way to assess your creditworthiness. To avoid having this happen, keep an account open or apply for a secure credit card and maintain a positive payment history, Griffin says.
Myth No 4. Debt collectors can’t take your stuff. “The minute you file bankruptcy, something called the automatic stay applies to your case,” says Seymour Wasserstrum, a bankruptcy lawyer in Vineland, New Jersey. “That means creditors automatically must stop any contact with you whatsoever.” Once a debt is included in a bankruptcy, the debt collector cannot try to collect the debt.
However, that doesn’t mean they can’t come after certain belongings. According to the federal Consumer Financial Protection Bureau, lenders may in some cases have the right to repossess collateral that wasn’t paid for, such as a car, after bankruptcy.
Myth No. 5. Your bankruptcy will stop all attempts to collect. If a debt is discharged in bankruptcy, you no longer have a legal obligation to pay it, but that doesn’t mean a creditor won’t try to get you to pay up. Sometimes creditors sell debts to debt buyers who don’t know that the debts have been discharged. In other cases, a creditor may simply continue to try to recoup the money. Whatever the reason, not only are you not obligated to pay, but you can hire a bankruptcy attorney or file a motion with the bankruptcy court to address the matter, says Wasserstrum.
I often hear from people who say, ‘I have friends who declared bankruptcy and three months later they got credit or bought a house.’ … [T]ypically, they’re not the kinds of credit you should want.
|— Rod Griffin|
Experian director of public information
Myth No. 6. After bankruptcy you can’t get credit. Some people believe that you can’t get approved for credit after filing for bankruptcy, but many people do, in fact, get approved for credit cards, car loans and even mortgages. However, all that glitters is not gold. “I often hear from people who say, ‘I have friends who declared bankruptcy and three months later they got credit or bought a house,'” says Griffin. “You may get offers right away, but typically they have very high fees and very high interest rates — they’re not the kinds of credit you should want.”
Myth No. 7. Bankruptcy affects everyone’s credit the same way. The impact of a bankruptcy on an individual’s credit score depends on that person’s entire credit profile, says FICO’s Goethe. “For example, someone who had spotless credit and a very high FICO score could expect a huge drop in their score. On the other hand, someone with many negative items already listed on their credit report might only see a modest drop in their score.” The number of accounts included in the bankruptcy could also affect the score, Goethe adds. “The more accounts included in the bankruptcy filing, the more of an impact on the score.”
Myth No. 8. You’ll lose the shirt off your back. Some people think filing for bankruptcy means they’ll lose everything, but each state has its own bankruptcy exemption law that designates which possessions a debtor can keep. These can include anything from a home to clothing to retirement accounts.
While not the best move for everybody, bankruptcy could give you the opportunity to catch your financial breath. Just make sure you are armed with the truth, rather than myths.