People in financial trouble sometimes ask, “Should I file for bankruptcy?” Unfortunately, bankruptcy is not a one-size-fits-all shirt. Instead, the response is almost always: “It depends.”
For many people, bankruptcy is an amorphous concept, known only from stories or movies. Therefore, people are often uncertain of the process and ramifications of filing for bankruptcy.
Bankruptcy is based on federal law, but some parts of it are affected by state law and local rules, which makes it unique to every city and state. It’s also individual to each person or family based on different circumstances. That’s why even many lawyers are unfamiliar with the nuances of filing for bankruptcy.
Take, for example, a situation involving two families. Both are double-income families, each with two kids. Their household income is about the same, they both have two cars and a home with a mortgage. Although it sounds as if they might have similar bankruptcy filings, it’s wrong to assume so without taking a deeper look at the specifics of each family’s situation.
Family A has a special needs child who requires monthly expenses not covered by the family’s insurance. Family B’s primary income is a result of a teaching profession, which means pay only comes in for 10 of the 12 months a year. Those factors affect not only whether they file for bankruptcy, but how they do so.
Choosing a Bankruptcy Path
The term “bankruptcy” covers many different things. However, most consumer bankruptcies fall into one of two categories: Chapter 7 and Chapter 13.
In order to help people decide which path to take, it’s best to start with a three-prong analysis. The three prongs are purpose, income and assets.
Prong No. 1: Purpose. What is driving the need for financial help? Is the consumer behind on their house payments, car payments or other secured payments and need help getting caught up? Are they drowning in unsecured debt, such as credit cards or unsecured signature loans? Do they owe back taxes?
When I talk about purpose, I’m not talking about the cause of the financial trouble, but instead how bankruptcy can help. The purpose of bankruptcy is a driving force in deciding what chapter to file.
In cases involving only unsecured debts, consumers may be entitled to file either under Chapter 7 or Chapter 13. However, if someone is trying to save his or her home or car because they have fallen behind in payments, Chapter 7 is not a viable option.
Instead, Chapter 13 is a great way to get caught up on secured property, if the consumer has enough income to support making the payments. Bankruptcy attorneys frequently turn to Chapter 13 for people who have experienced a short-term loss of income, caused by job loss or medical leave.
Prong No. 2: Income. What is the household income? The household gross income from the past six months is used to determine if someone is above the median income for that size and geographic area.
Median family income is updated annually and is based on data published by the Census Bureau for each state and family size. Many variables affect this prong, but total disclosure of income and expenses is necessary for a bankruptcy attorney to guide people on whether a Chapter 7 or Chapter 13 filing is best. If a consumer’s household income is above the median income for that area, then further analysis is required to determine if Chapter 7 or Chapter 13 is available.
Prong No. 3: Assets. What does the consumer own and are there any liens against them?
Although bankruptcy is federal law, assets are one area that take on a local flavor. States can opt out of the exemptions provided by federal law and replace them with their own exemptions.
For example, North Carolina allows the exemption of some equity in a consumer’s home, one vehicle, some household goods and retirement accounts, among other things. The amount of equity a person has, along with whether they want to keep their home or vehicle, also guides whether to file Chapter 7 or Chapter 13.
So, when a client walks into your office and asks you if they should file for bankruptcy, remember that there is no easy answer.
- By Dennis Sargent
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