Automatic stays in bankruptcy stop debt collection immediately

Declaring bankruptcy is the ultimate last-ditch solution to debt. But when you have few other options, bankruptcy -- and the automatic stay that comes with it -- can be a financial lifesaver. 

An automatic stay is one of the primary advantages in declaring bankruptcy, whether it's Chapter 7 or Chapter 13. "For most people, it's the biggest reason to file bankruptcy because it stops foreclosure or repossession," says bankruptcy attorney Theodore W. Connolly, co-author of "The Road Out of Debt: Bankruptcy and Other Solutions to Your Financial Problems."

"The automatic stay is the cornerstone of the bankruptcy process," agrees Tara Twomey, attorney with the National Consumer Law Center and project director of the National Consumer Bankruptcy Rights Center. "My guess is most people wouldn't file if not for the automatic stay." 

How automatic stays help bankrupt consumers

How it works
The stay goes into effect the moment you file a petition for bankruptcy -- no judicial action is required. A court order is not involved, yet an automatic stay has the effect of one.

It requires all collection actions to stop and shuts down any foreclosure, wage garnishment, eviction, demand for repayment or lawsuit in which the debtor is a defendant. If you haven't had a bankruptcy case dismissed in the past year, the stay remains in effect until the court decides your case -- usually three or four months. In some cases, payments made to creditors in the past 90 days will be called back and redistributed by the court. 

An automatic stay is not a permanent fix on its own, but a reprieve that can lead to a fix. "The automatic stay itself doesn't do anything but freeze everybody, like in a game of freeze tag," Twomey says. "This not only benefits the debtor but also creditors. You get an orderly distribution of anything that's available to creditors as opposed to a race to garnish most of the debtor's wages or seize their assets first."

"Once consumers leave bankruptcy, it's the discharge order that protects them from having to pay that debt further," Twomey says. "The automatic stay is the big freeze that allows everybody to figure out how to go forward." 

A stay really is automatic. You don't have to notify creditors, just hand their contacts over to the court so the bankruptcy clerk can send notice of the case. Any creditors who willfully violate an automatic stay will be fined and open to a lawsuit. You can recover actual and, in some cases, punitive damages, as well as attorney's fees.

If a creditor keeps calling after bankruptcy is filed, what should you say? Nothing. File a complaint with the court and let the court handle it. "If a creditor doesn't stop after a stay is issued, you want that in front of a court," says Connolly. "Nothing is going to make a judge angrier than that." 

Limits to automatic stays
Powerful stuff, but there are limits -- specifically, 28 exceptions declared by Congress. You won't get out of alimony or child support payments, for example, or fines from the prosecution of criminal actions. 

With unsecured debt such as the credit card and medical debt that drive most Chapter 7 bankruptcies, an automatic stay inevitably leads to permanent reprieve. Such debts are essentially wiped out the minute you file because the court will eventually discharge them.

But an automatic stay will not stop a mortgage lender from eventually foreclosing on your home under Chapter 7. Mortgage debt stays on the house even in bankruptcy, up to the value of the house, but a creditor can sometimes get the court to lift the automatic stay by filing a motion and providing good cause. 

For example, the bank may be granted an exception to the stay if it loses faith that you will ever be able to pay off the mortgage -- say, if you owe $500,000 on a house worth only $300,000. "If it's underwater, there's no value to the estate, the debtor doesn't have exemption in the property, then, of course, the court is going to allow that," says Connolly. "Because of your bankruptcy filing, you won't be liable for the unpaid balance of the mortgage after the lender sells or forecloses on your house though."

In Chapter 13, the automatic stay gives you a window to restructure your debts to keep your property. You will have to keep paying your mortgage, but may have a chance to make some changes to it if your lender agrees. Plus, you can pay any pre-petition defaults or delinquencies to your mortgage lender spread out over the term of the plan. 

Curbing abuses
Automatic stays are potent, but don't expect to rely on them repeatedly. "People are always trying to game the bankruptcy process in order to buy themselves time with the automatic stay," Connolly says. "That's why restrictions were put in place to prevent people from abusing the system." 

If you've had a bankruptcy case dismissed within the past year, the automatic stay only lasts 30 days. If you've had two cases dismissed in a year, you won't get any stay.

For the first-time bankruptcy filer, however, an automatic stay is a right that could just get you back on the road to financial recovery.

See related: Your map through Chapter 7 and 13 bankruptcy, Steps to rebuild credit after bankruptcy, 10 tips for dealing with debt collectors, collection

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Updated: 01-18-2018