Should I File for Bankruptcy?

Should I File for Bankruptcy?

You lost your job and were living on credit cards to make ends meet.  You suffer from medical bills.  You are separated/divorced from your spouse.  These are real life issues that have made you wonder whether to file for bankruptcy.  This is a very personal decision.

Considering Bankruptcy Checklist

If several of the following apply in your situation, you might consider bankruptcy:

• Your salary is garnished or your bank account is attached
• Most of your bills are credit card bills, hospital or doctor's bills, etc.
• Your bills is more than you could reasonably pay over three years
• Collection agencies are calling you at home and/or at work
• Your payments are more than 30 days behind 
• You are being sued by creditors
• You owe income taxes that you are currently unable to pay
• You have few assets
• You have little or no savings
• You have had property repossessed (such as a car)
• Your mortgage lender has threatened or started foreclosure proceedings against your home.

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Chapter 7 Bankruptcy: Debtor Beware of Losing Your Tax Refunds!

When filing a chapter 7 bankruptcy, the goal is to allow you to have a "fresh start".  A fresh start means that we, as a society, want you to have a car to get to work.  Keep your tools so that you can continue to work in your trade.  Keep clothes, household goods, and other items so that you are not from starting from scratch.

A "fresh start" is essentially artful terminology that guides you as to whether a you will be allowed to keep possessions in a bankruptcy.  One asset that is the subject of many trustees is the tax refund.  You might be one of those individuals that gets a large tax refund.  Trustees in a chapter 7 cases, the administrators of the bankruptcy case, look for large tax refunds that can take and distribute to your creditors.

In a chapter 7 bankruptcy, there are two tracks of exemptions to protect your assets from being sold to creditors.  One track is the home equity track.  You can protect from $75,000 to $150,000 of equity in your home.  This is a great exemption that protects a lot of money if you have worked hard to build equity in your home.  If this path is taken, you will likely have to surrender your tax refund if you have not spent your tax refund before you file bankruptcy.  This mainly effects debtors from late in a tax year through May of the following year.  Late in a tax year, you have built up a nice savings with your employer that that a trustee will look at with an envious eye.

If you have not built up equity in your home, you can use the approximate $20,000 "wild card" exemption to protect your tax refund.  $20,000 is not nearly the same protection as the home exemption, but it can come in handy to protect to a $8,000 tax refund that I have seen from some debtors.

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How Much Debt Before I Should File Bankruptcy?

$5,000?  $50,000?  $500,000?  How much debt do you need to have before it makes sense to file bankruptcy?

There is No Magical Amount!  

There is no particular debt limit that you must have in order to file a Chapter 7 bankruptcy.  It really depends upon what is going on in your life.  Life is not simple.  Some clients find themselves with good income, but are suddenly single parents with little disposable income.  Other clients are living on only social security income and have little debt.

A Little Debt....

I once had a client who have wanted to file a bankruptcy with only $4000 debt. In virtually all situations, this is not enough debt to justify filing bankruptcy.  However, a perfect world storm caused this case to be filed. First, income was almost non-existent.  Usually, this is not a problem once the creditor realizes the issue and will settle the debt for less than what is owed and what the client can afford to pay.  In this case, however, the creditor was stubborn, which made it stupid.  It wanted to be paid 100% and continued to proceed with a lawsuit, hoping to obtain a a judgment and a 25% wage garnishment.    No amount of persuading the creditor to take less worked.

Or, A lot of Debt ....  

I have had other clients who had $400,000 worth of debt and were fighting against filing a Chapter 7 and getting a fresh start.

The Key:  Can You Make A Dent in Your Bills if You Attacked It for 6 Months?

You have to determine whether or not you feel you can either pay your debt back over time or whether or not you need a fresh start to be able to survive.

I like the 6 month rule.  If you attacked your debt for six months, could you leave a dent?  Or, would you hardly leave a dent, instead you are just simply paying minimum payments, primarily paying interest.  If you don’t see your debt going down, then bankruptcy is probably a good solution for you to get out of debt once and for all and get back on your feet.  If, on the other hand, you feel you have the ability to make a significant dent in the debt, I think you should first try this approach.

Photo Credit: Alan Cleaver at Flickr