Bankruptcy Won’t Erase All Debt. These Obligations Can’t Be Discharged

For some individuals, the solution for eliminating crushing debt is to file for bankruptcy.

While the catalyst for going that route differs from person to person, it’s worth knowing which obligations can and cannot be discharged in bankruptcy. For instance, just last week, the U.S. Supreme Court ruled in a 9-0 decision that an individual cannot discharge debt that arose due to the fraud of another person.

The number of personal bankruptcies has been on the rise, although the numbers remain relatively low. In January, nearly 30,000 individual filings were recorded, an increase of 20% from the previous year’s 25,000 filings, according to the American Bankruptcy Institute. However, the pandemic has had an impact on the filings as the government rolled out aid and programs, such as stimulus checks, enhanced unemployment benefits, and lenders allowing pauses on mortgage or rent payments, to ease the financial burden on households. This led to a drop in bankruptcy filings in 2021 and 2022.

Despite the decline in bankruptcy filings, household debt has remained a concern. According to the Federal Reserve Bank of New York, total household debt reached $16.9 trillion in the fourth quarter of 2022, with $11.9 trillion in mortgages, $1.6 trillion in student loans, $1.6 trillion in car loans, and more than $990 billion in credit card debt. However, delinquencies have remained low, indicating that most households are able to manage their debt obligations.

Although the pandemic has affected the economy and the financial stability of households, the government’s stimulus efforts and the low delinquency rates suggest that households have been able to weather the storm. Nonetheless, experts warn that the rising levels of debt and bankruptcy filings are cause for concern and indicate the need for continued support and financial education to help households manage their finances effectively.

Some Debts Cannot Be Wiped Out In Bankruptcy

When it comes to consumer debt, bankruptcy is an option for many types of loans, including credit card debt, personal loans, medical debt, mortgages, and auto loans.

However, one notable exception is student loan debt, which is notoriously difficult to discharge completely. To do so, a borrower must prove that they will never be able to pay back their loans and that repaying them would be an undue hardship. Other types of debt that cannot be erased in bankruptcy include child support and alimony.

Additionally, certain debts related to a court order during a divorce, such as covering a car lease payment for an ex-spouse, may also be off-limits. It’s essential to understand these exceptions before pursuing bankruptcy as a solution to debt.

Recent Debt May Be Considered Fraud

In addition, if you obtained the debt through fraudulent means, such as providing false information during the loan application process, you may not be able to eliminate it. If the lender can prove that you provided misleading or inaccurate information that you knew was incorrect, the debt may be considered non-dischargeable.

Moreover, if you use your credit card to spend beyond $800, excluding essential items, within 90 days before filing for bankruptcy, the law presumes it to be fraudulent. The same applies to cash advances above $1,100 from a single creditor taken out 70 days before filing for bankruptcy, according to the National Consumer Law Center.

Typically, taxes that you owe cannot be eliminated in bankruptcy, except for those that are older than the last three years of tax returns. Additionally, tax debts incurred through fraudulent means are always considered non-dischargeable.

Not Everyone Qualifies For Chapter 7 Bankruptcy

Bankruptcy can be filed in several ways, with Chapter 7 and Chapter 13 being the most common choices for individuals. Both options have filing fees of a few hundred dollars, and the cost of hiring an attorney can range from $1,200 to $3,500, depending on the location and complexity of the case.

The two options have some similarities, such as stopping collection activity like calls from creditors or debt collectors, wage garnishments, and lawsuits from creditors. However, there are also differences in who is eligible and how debt is treated in each option.

Chapter 7 is typically for those who cannot afford to repay their debt and have limited assets, with a means test determining their eligibility. It is the most frequently used option for individual bankruptcy, as it can quickly eliminate some forms of unsecured debt, such as credit card debt, medical bills, and personal loans. However, it may not prevent home foreclosure or car repossession in some cases.

On the other hand, Chapter 13 allows individuals three to five years to pay back certain debts while retaining assets like a house or car. It also stops creditors from garnishing wages or levying bank accounts. To qualify for Chapter 13, the individual must have enough income and debt below a specific limit, which currently stands at $2.75 million.

For individuals with debt above the limit, Chapter 11 is an option similar to Chapter 13 but less commonly used. It allows individuals to keep assets while paying back their debts over time.

Your Retirement Accounts Are Protected In Bankruptcy

The positive aspect is that your retirement assets such as 401(k) plans and individual retirement accounts, which are solely yours and to which you made contributions, are usually safeguarded in bankruptcy. This means that if you file for bankruptcy, the assets in these retirement accounts cannot be seized by creditors to repay your debts. However, it is worth noting that inherited IRAs are not protected in the same way.

There is, however, an exception to this general rule, which applies to both traditional and Roth IRAs. Only a certain amount per person, currently around $1.51 million, is safe from creditors. If the amount in the IRA exceeds this threshold, then the excess could potentially be used to pay off your creditors. This is unless the judge decides otherwise.

It is essential to remember that retirement accounts are a vital source of financial security for your future, so it’s crucial to avoid using them to pay off your debts. It is advisable to seek expert legal advice and guidance before making any decisions that could impact your retirement savings.

Your Credit Will Take A Hit, But Also Will Rebound

One major drawback of declaring bankruptcy is its negative impact on your credit score, which may already be struggling if you have missed payments or defaulted on loans. The bankruptcy filing stays on your credit report for up to a decade, although the effect lessens over time and your score can gradually improve.

No matter which type of bankruptcy you choose, you must be prepared to provide extensive financial information to the court. This includes details about your income, assets, debts, and expenses, as well as recent tax returns and bank statements.

It is important to note that many bankruptcy lawyers offer free initial consultations, so you can discuss your financial situation and explore other options for dealing with your debts. They may suggest alternatives to bankruptcy, such as debt consolidation, credit counseling, or negotiating with your creditors to arrange a payment plan. It is important to consider all of your options and seek professional guidance before deciding on the best course of action for your situation.

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