Is Consumer Debt driving you into Bankruptcy
For individuals whose debts are primarily “consumer debts,” as opposed to business entities or persons whose debts are primarily related to business dealings, there are essentially two types of bankruptcy filings. They are commonly referred to as Chapter 7 and Chapter 13. I’ll first provide a very brief overview of each and then discuss how one determines which is available or preferable. Please keep in mind that a fully comprehensive explanation of the intricacies of each type of filing will take much time and many pages, and because each person’s circumstances are unique, there simply is no way to deal with all considerations that may be necessary to reach the best result for each person. This is why you need to consult with an experienced and knowledgeable attorney if you believe that filing for relief under the U.S. Bankruptcy Code is right for your particular set of circumstances.
Chapter 7 is a “liquidation” type of case. When one files for relief under Chapter 7 (relief from your creditors and debts), a trustee is appointed to determine whether the debtor (the person filing) has any unencumbered assets that may be liquidated (a fancy word turned into cash). Most often, there are no unencumbered assets, but if there are, those assets are subject to being sold so that there is money to distribute to creditors. This aspect of the case prompts many prospective clients to ask whether their home or car will be sold. Generally speaking the answer is no. This is true because most people have mortgage loans or vehicle financing liens that encumber the property to the value of the outstanding loan balance. A debtor is also allowed to exempt a certain amount of value of almost all types of property. For example, if you and your spouse jointly own a home in Illinois valued at $150,000 with a $120,000 balance on your mortgage loan, that leaves only $30,000 in equity, which is the maximum unencumbered value. However, each of you has a $15,000 exemption under Illinois law, meaning that the total equity of $30,000 can be claimed as exempt thereby leaving nothing for a Chapter 7 trustee to liquidate. In other words, as long as you are up to date on your mortgage payments, the house will remain yours.
Chapter 13 involves a plan for repaying a portion of your pre-bankruptcy debts. Prior to 2005, a Chapter 13 plan was formulated by subtracting a debtor’s monthly expenses from his monthly income after allowed deductions (taxes, etc.). The difference or “disposable income” was paid monthly to an appointed trustee for distribution to creditors under the terms of the plan as proposed by the debtor. In 2005, Congress changed many of the Bankruptcy laws, and since then a Chapter 13 plan payment is determined by resort to a rather complicated and even convoluted calculation which relies primarily on IRS standard allowances. I’m personally not a big fan of this system, but it remains the law and therefore applicable to most, but not all, Chapter 13 cases. A chapter 13 plan generally runs between three and five years, after which the debtor receives his discharge of the balance of most pre-filing debts.
The year 2005 plays a big role in much of this discussion as prior thereto, a person was free to choose between the two types of bankruptcy filings. For example, a person may be able to save a home from foreclosure through a Chapter 13 plan, but generally cannot do so through Chapter 7. There are other valid reasons to pick and choose, but that option is for the most part no longer on the table. The many changes in 2005 included the requirement that persons “qualify” to file under Chapter 7, and if unable to do so are required to file under Chapter 13. This prompted many, including experienced attorneys, to believe that would mark the effective end of consumer-based bankruptcy cases. That has not been the case in my experience, however.
The qualification process as it now exists resorts to a rather complex set of calculations, which again relies on the seemingly arbitrary IRS figures for various allowances based upon where a person lives and how many household members there are. The official form used to make the determination can be found by clicking here. The IRS allowance information necessary to complete the form can be found by clicking here. The first consideration is annual income. In Illinois, for a family of three, the median annual income allowance is currently $68,721. If you are under this threshold, you may file under Chapter 7, period. But if over that level of income, you must go through the rest of the calculations to determine whether you qualify. The IRS allowances themselves are not very generous, but for people who have mortgage loans and other types of secured debt payments, those are actually deductible from monthly income to get to the bottom line.
Since 2005, I have had only handful of clients that could not qualify under Chapter 7, although it has happened. For those who cannot qualify, the same calculations used to determine eligibility are used to determine Chapter 13 plan length and payments amount. As you can see, it’s just not as simple as it once was, which is why you simply must have the advice of a competent attorney when contemplating bankruptcy relief.