Choosing the right type of bankruptcy for you

In 2010, more than 1.5 million Americans filed for bankruptcy protection - a 9% increase over the previous year and the highest rate of filings since the new bankruptcy laws went into effect in 2005. The states with the highest rates of bankruptcy remained in the Southwest, primarily California, Nevada and Arizona.High rates of unemployment coupled with soaring credit card debt and a slow rebounding housing market have been cited as the primary contributing factors for the record bankruptcy rates across the country. As the economy slowly begins to recover, the overall number of bankruptcy filings are expected to decrease in 2012 or 2013. For individuals whose recovery does not come fast enough, bankruptcy may be their best option for returning to financial stability in 2011. Consumers bankruptcy comes in two basic forms, chapter 7 and chapter 13. Chapter 7 bankruptcy gives debtors an opportunity to discharge (erase) their debts and to start rebuilding their credit with a clean slate. In exchange for this opportunity, the debtor may have to sell, or liquidate, some of his or her personal belongings. During a chapter 7 filing, the bankruptcy trustee will collect any nonexempt property owned by the debtor and liquidate it in order to repay some of the debt owed to the creditors. However, in most cases, debtors filing for chapter 7 will not lose any of their personal property, including their family home and car. Under federal and state law, certain types of property are exempt from liquidation in a chapter 7 bankruptcy. For example, California has a generous homestead exemption that allows debtors to exempt up to $150,000 in equity in their primary residence. To keep the house, however, the homeowner must continue to stay current on the mortgage payment, before, during and after the chapter 7 filing. Other types of property that are exempt from liquidation include the family car, certain household items including clothing and furniture, jewelry and tools of the debtor's trade. After any non-exempt property has been liquidated, the bankruptcy judge will discharge any remaining debts, including credit card debts, auto loans and medical bills. Under the 2005 changes to federal bankruptcy law, those who wish to file for chapter 7 are required to meet a means test first in order to file. The means test takes into account the amount of disposable monthly income a debtor has versus the overall amount of his or her debt. If the debtor has sufficient disposable income to pay the debts, then he or she will not be able to file for chapter 7 bankruptcy, but still may be eligible to file for chapter 13. Chapter 13 bankruptcies, also known as "wage earners" bankruptcy, gives debtors who have a steady income the opportunity to repay some of their debts under a structured repayment plan. The repayment period runs from three to five years. Secured debts, like mortgages and car loans, generally make-up most of the payments in the repayment plan. Typically, debtors pay little to nothing of their unsecured debts, including credit card bills. After successfully completing the repayment plan, the bankruptcy judge will discharge any remaining unsecured debts. Just like in a chapter 7, once a debt has been discharged in bankruptcy, the creditor cannot make any attempts to collect any remaining amounts from the debtor. Another important - and little known - advantage of chapter 13 bankruptcy is the possibility of having a second mortgage discharged. In a chapter 13 bankruptcy, debtors who have more than one lien against their homes may be able to have the junior liens discharged (also referred to as "lien stripping") if their house has been appraised for less than the first mortgage. For example, if a house is appraised for $300,000 and the remaining amount owed on the first mortgage is $320,000 and there is a second mortgage for $100,000, the homeowner can petition the court to discharge the second mortgage as part of their chapter 13 bankruptcy filing. If the bankruptcy judge finds that the current fair market value of the home is at or lower than the amount of the first mortgage, then the judge will convert any junior liens, including second mortgages, to unsecured creditors. The reason for this is that there is insufficient value in the home to secure the second mortgage. So long as the debtor successfully completes the chapter 13 repayment plan, the junior liens against the house will be discharged along with any other amounts owed to unsecured creditors. Before filing for bankruptcy, it is important for debtors to understand that not all types of debt are eligible for discharge in bankruptcy. These debts include back taxes, student loans, child support and criminal fines. Debtors who attempt to discharge these types of debts might expose themselves to a lawsuit called adversary proceedings. This complicates bankruptcy proceedings and significantly increases the costs to the debtors. Bankruptcy laws are complex and difficult to understand. It is recommended that you deal only with an attorney experienced in handling bankruptcy filings to help you get through the process as quickly and efficiently as possible. The purpose of this column is to provide general information on the law, which is subject to change. It is not legal advice. Consult a lawyer if you have a specific legal problem.

********** Published: February 24, 2011 - Volume 9 - Issue 45