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Community Corner

Bankruptcy Myths Debunked

If you are considering bankruptcy, don't make these mistakes.

In these tough economic times, people at all levels of the economic ladder are considering bankruptcy.

Bankruptcy takes planning for two reasons: (1) you want to emerge from bankruptcy in the most beneficial financial position; and (2) you want to make sure you actually complete the bankruptcy process. We are debunking some common bankruptcy myths so you can ponder when and whether you should file for bankruptcy.

This article concerns Chapter 7 and Chapter 13 bankruptcy proceedings. A Chapter 7 can be defined in its most simplistic form as where you are discharged of most of your debts, but the bankruptcy trustee takes most of your non-exempt property and sells it. A Chapter 13 can be defined most simplistically as a proceeding where you are generally allowed to keep your property; however, you are going to be required to pay a majority of creditors off over a period of three to five years. 

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The bankruptcy trustee is a person in bankruptcy court who is in charge of all of the property you own when you file, and the trustee has an obligation to increase that property for the benefit of the creditors you own.

Now, on to some common bankruptcy myths:

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1. If I transfer my property to my family and friends, I can get it back when I am done with bankruptcy. 

If you are transferring your property to family or friends, you may be exposing them to a lawsuit in your bankruptcy proceeding. Property includes anything you own, including money, cars, stocks, furniture or business interests. If you transfer property to anyone, the bankruptcy trustee can go after the person for the property or value of the property for at least four years from when you transferred the property. If you file for bankruptcy in 2011, any transfers from 2007 are still subject to scrutiny. 

If you absolutely have to sell your property, make sure you sell it for fair market value. In other words, selling your 2011 Mercedes to your brother for $1,000 is a bad idea, but selling your 2011 Mercedes for its Kelley Blue Book value is another story. 

2. I should use my credit card’s entire available balance right before bankruptcy since it will be discharged anyway. 

Almost everyone thinks that credit card debt is completely dischargeable (it goes away) after bankruptcy. There are several circumstances where you may be responsible for your credit card debt after your bankruptcy proceeding is over. If you are using your credit cards when you have no intent or ability to pay the balance, if you make balance transfers, or if you are purchasing luxury items with your credit cards, you may still be responsible to the credit card company for the balance. This applies to both Chapter 7 and Chapter 13 bankruptcy proceedings. This means that even after bankruptcy, you may still be responsible for your credit card debt.

So the fundamental message is to stop using your credit cards. If you feel that you have no way out of using credit cards to live your daily life, please consult a bankruptcy attorney.

3. I might be able to avoid bankruptcy if I just cash in my IRA and 401(k) plans. 

This is like playing Russian Roulette. You had better be certain you can solve all your financial problems before you cash in your IRA and 401(k) plans.  

Your IRA and 401(k) are among one of your most protected assets in a bankruptcy proceeding. In almost all circumstances, if you emerge with nothing else in bankruptcy, your retirement account will be fine. Your 401(k) is exempt from the bankruptcy estate — you get to keep it after bankruptcy. Your basic IRA is exempt up to $1 million. 

In other words, if you take nothing else from this article, leave your 401(k) and IRA alone! Don’t touch them. Hands off. Seriously.

4. I am going to stop paying my mortgage and other secured creditors since I am going into bankruptcy anyway. 

This is a complicated issue. In general, it is a bad idea to stop paying your secured creditors, such as your mortgage and car loans, because your debt to these types of creditors will continue even after bankruptcy. In a Chapter 7, generally the debt will survive bankruptcy, the creditor can take the secured property, or you will have to “reaffirm” the debt to keep the property and pay according to the original terms of the secured contract.

In a Chapter 13, generally you have to pay the back-due amount through your plan and then continue paying the amounts due in the future.

Second-most important thing you should take from this article: If you want to keep your house, car or other secured property, you need to plan ahead and speak with a bankruptcy attorney. These issues on secured property are far more complicated that what we have space for. After all, the U.S. Congress wrote the bankruptcy code. 

5. I am tired of paying my ex-spouse child support and/or alimony. If I file for bankruptcy, then those obligations go away. 

No, no, no! The magic of bankruptcy court will not make these obligations mysteriously go away. Regardless of whether you file for a Chapter 7 or a Chapter 13, you will still be required to pay your child support and/or alimony obligations.

It gets worse. If you file for a Chapter 13, and if you are not current on your alimony or child support obligations, you will not receive a discharge from any of your debts we discussed in this article. This means you just paid a filing fee, paid an attorney to represent you, spent countless hours filling out paperwork, and you are in the same position as you were before bankruptcy.  

If you paying your child support or alimony obligations are a problem, a bankruptcy attorney cannot help you. Consult your family law attorney or beg for mercy from your ex-spouse. 

Rachel S. Green is a bankruptcy attorney who now directs the bankruptcy division at J.T. Simons, P.A.

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