Bankruptcy Mythbusting #1

Myth:  If I file for bankruptcy, I will lose my [fill in the blank].

Fact:  People are afraid that they will lose something - whether it's their home, their car, or their tax refund.  That's simply not true.  The purpose of bankruptcy is not to strip you of all your worldly possessions and leave you out on the streets with the shirt on your back.  Nor does bankruptcy mean a free-for-all for your creditors to come into your home and seize anything of value.

Nevertheless, in a small percentage of cases, people do lose something in bankruptcy, and that's how these rumors get started.  People think that because they know it happened in one case, it therefore happens in all cases.  While this is false, it is fair to ask - when does someone risk losing something in bankruptcy?

There are only two ways you can lose property in bankruptcy.

First, is through foreclosure / repossession.  Bankruptcy eliminates debt, but it does not eliminate liens.  Therefore, secured creditors with liens on stuff you own can still exercise their rights to recover their collateral of their debt is not paid.  Therefore, if you are delinquent on your mortgage or car payment and file for bankruptcy, your mortgage lender or auto finance company can still take possession of your house or car.

Of course, the same is true, even if you don't file for bankruptcy.  The role bankruptcy plays in the foreclosure and repossession process is twofold.  One, bankruptcy could trigger these proceedings if the lender hadn't started them yet.  In my experience, lenders don't start foreclosure or repossession proceedings until the customer is - on average - two months delinquent on their bill.  So, I caution my clients who are even only one month behind on their secured debt payments to catch-up before filing for bankruptcy.  Two, the bankruptcy does temporarily stall foreclosure and repossession by way of the automatic stay.  Before the creditor can proceed with taking their collateral, they must either file a motion with the court to be excepted from the stay, or they must wait for the bankruptcy case to be discharged and closed.

The second way to lose property is by having property that exceeds your allowed exemptions.  While you are not expected to be left out on the streets wearing a barrel, you're not allowed to sit on the proverbial gold mine while your creditors get the shaft, either.  Therefore, each debtor in bankruptcy is entitled to "exemptions" which protect equity in assets from trustee seizure.  If your assets fit within your allowed exemptions, you keep everything, your creditors get nothing, and your case is referred to as a "no asset case".  If the equity in some of your assets exceeds your allowed exemptions, exposed assets could be seized by the trustee and sold for the benefit of unsecured creditors - referred to as an "asset case".

The exemptions you get to choose from vary, depending on which state you file in.  Some states are more generous than others.  Wisconsin residents may choose between state exemptions and federal exemptions - both sets of which are fairly generous.  Consequently, very few debtors filing in Wisconsin have asset cases, and those that do usually do not have very much non-exempt property.  Some other states have more favorable exemptions, and others have less favorable exemptions - leading to lower and higher rates of asset cases, respectively.

Some people have heard a myth that they can protect a certain "x" dollar amount of property because someone quoted to them a particular exemption.  What's important to understand is that the federal exemptions, and each state set of exemptions, contain several different types of exemptions for different types of property.  For example, when using federal exemptions, you have an exemption to protect real estate, another exemption for vehicles, another for household items, another for retirement accounts...  Well, I could go on and on - there are literally several dozen exemptions.  Some of these have dollar limits.  Others, like the ones for retirement accounts, have no dollar limit.  Most can only be used for specific types of property.  Others, like the "wildcard" exemption, can be used on any asset that doesn't have its own specific exemption (like cash, bank account balances, tax refunds) and assets that are not completely protected by their own exemption (a vehicle with $4k in equity would need a combination of the motor vehicle exemption and a little wildcard exemption to top it off).

If I haven't yet driven home the idea that whether you lose property is fact-specific and varies on a case-by-case basis, then let me point out that everything I've just said assumes you are filing for Chapter 7 Bankruptcy.

Even if your attorney determines that you might lose an asset due to non-exempt equity, or to foreclosure / repossession, you may be able to avoid losing anything by filing for Chapter 13 Bankruptcy.  As I like to say, Chapter 13 Bankruptcy can fix any problem that pops up in Chapter 7 Bankruptcy.

In Chapter 13, you can cure arrears on a secured loan over the life of the plan.  So for example, say that you are six months behind on your mortgage payments and facing imminent foreclosure.  You can file Chapter 13 before the foreclosure process is complete, and propose to pay the arrears over the life of the plan.  The bankruptcy filing stops the foreclosure process, and if you complete the Chapter 13 plan successfully, your mortgage will have been brought current by the time you exit.

Similarly, Chapter 13 can alleviate the problem of non-exempt equity.  Let's say you have $5k in exposed equity.  In Chapter 7, the trustee can seize the asset, sell it, pay you the amount you were able to exempt, and use the remaining $5k to pay to unsecured creditors.  In Chapter 13, you pay the trustee (spread out over the life of a 3-5 year plan) an amount identical to what the trustee would have gotten in Chapter 7.  The creditors are made as whole as they would have been in Chapter 7, and in exchange, you keep all of your property.

Of course, Chapter 13 only works if you can afford to do whatever you're trying to accomplish.  For example, low income debtors who are 8-12 months behind on their mortgage might not be able to afford the necessary plan payment - even over a 5 year plan - to bring the mortgage current.  It's a way to say that bankruptcy is not for everyone, and what happens in your case is extremely fact-specific to your particular circumstances.

The good news is that an experienced bankruptcy attorney can look over the facts of your case and predict fairly accurately what you can expect in both a Chapter 7 and Chapter 13 environment before you make any commitments.

Want to find out what bankruptcy could mean for you?  Call (920) 490-6160 now to schedule a free consultation.  I can determine whether your assets might be vulnerable to foreclosure, repossession, or seizure by trustee, plus more.