10 bankruptcy myths

Like most big, bad scary things, Bankruptcy has a reputation based on a few tidbits of truth and lots of embellishment. And like most creepy crawlies, it’s not nearly as frightening once you know the truth.

With a mind toward declawing the monster, here are 10 misconceptions about bankruptcy:

1. Everyone will know I’ve filed for bankruptcy

Only agencies with access to Federal Court files and certain creditors will know.  Creditors having been discharged will certainly know but what difference does that make?  If you apply for credit following discharge these creditors will notice because Bankruptcy remains on your credit for 10 years under Chapter 7 of the Bankruptcy Code but only remains for 7 years under Chapter 13.

While it’s true that bankruptcy filings are a part of public records, the numbers of people filing are so numerous, very few publications have the space, the manpower or the inclination to list filers. Therefore, it is very unlikely that record of filing will be found anywhere but in the court file.  

  1. All debts are extinguished in bankruptcy

While true that certain types of debts cannot be discharged, most debts are. Expectedly, debts such as child support and alimony, as well as student loans, criminal restitution and debts incurred as the result of fraud and some taxes are excluded from being discharged.  Therefore, if you file your taxes on time, refrain from criminal activity and pay your support, taxes on time, you can waive bye bye to the rest including some taxes.

  1. I’ll lose everything I have

This is so clearly false it is laughable.  It is counter-intuitive to think that someone seeking to get back on their feet will lose all they own. The law provides ample exemptions to shelter assets most people can live with such as homes, cars,   (as long as you don’t drive a Bentley), household goods and furnishings as well as qualified retirement plans.  

However, there are a few exceptions such as property that exceeds allowable exemptions, (such as a Bentley owned free and clear).  However, given that mortgages and banks have first dibbs on houses and cars, there is usually little if any equity to worry about protecting.  The misconception that people stand to loose everything they own keeps people who really should file for bankruptcy from doing it, says Chris Viale, chief operating officer of Massachusetts-based Cambridge Credit Counseling Corp.  They think the government will sell everything they have and they’ll have to start over in a cardboard box,” Viale says: “For most people, they’ll pass through a bankruptcy case and keep everything they have,” says John Hargrave, a bankruptcy trustee in New Jersey. If you have a mortgage or a car loan, you can keep those as long as you keep making the payments (like the rest of us).

  1. I’ll never get credit again 

Quite the contrary, it won’t be long before you’re getting offers from credit issuers again. Be patient though because the first offers will be from subprime lenders that will charge very high interest rates. This is because you will have an unproven track record.  You can improve your chances for getting good offers by applying for store credit cards and pay the balances off each month when they fall due.  In a few years, you will be FHA qualified for a mortgage or refinance.  There are innumerable companies that will provide credit to you,” says California bankruptcy attorney and trustee Howard Ehrenberg. “I don’t advise any of my clients to run out and run up the bills again, but if someone does need an automobile, they can go and will be able to get credit. You don’t have to go underground or something to get money.”

  1. Only deadbeats file for bankruptcy

Most people file for bankruptcy after a life-changing experience, such as a divorce, the loss of a job or a serious illness. They’ve struggled to pay their bills for months and just keep falling further behind.  A bankruptcy filing can “right size a household budget by eliminating debt and surrendering unneeded assets” Take this from me as I’ve seen hundreds of families benefit by tossing off automobiles whose liens double the value of the car especially if the car is difficult to maintain and is always in the garage for repairs.

  1. I don’t want to include certain creditors in my filing because it’s important to me to pay them back someday and if the debt is discharged, I can’t ever repay them

Bless you for even thinking about such a thing. You’re no longer obligated to repay them, but you always have that opportunity. If your conscience won’t let you sleep nights because you didn’t pay your debts, there’s nothing in the bankruptcy code that prevents you from doing that once you’re back on your feet. The code requires that you don’t leave any account with a balance out of your list of creditors.  In general, all creditors receive notification of your bankruptcy filing, whether they are listed in the petition or not.  Also, there are processes for paying for things which must be paid such as an auto that is worth what you owe.

  1. Filing for bankruptcy will improve my credit rating because all those debts will be gone

Like many other things in life, there are plusses and minuses to filing Bankruptcy.  While debt to income ratio will favor income over debt, Bankruptcy filings stay on your credit for ten (10) years.  The effect of a debt to income ratio which favors income is that you appear to be a better risk which is what the credit ranking agencies look for in giving your credit on favorable terms.  The effect of having bankruptcy remain on your record is that it wards off creditors who seek payment of discharged debt.  There are also ways to put these creditors in their place.  For many, filing bankruptcy favors struggling along, while borrowing from Peter to pay Paul, because bad credit will linger for longer than 10 years.  Poor credit has the effect of increasing interest rates, brings about penalty and late payment fees and makes car insurance more expensive.

  1. You can’t get rid of back taxes through bankruptcy

False.  Taxes that go uncollected after three years in which the tax return is filed beyond two years of filing can be forgiven.  There are exceptions to this if the IRS files a substitute for return or if taxes are liened.  In either of these cases relief can be had outside of bankruptcy such as lien avoidance and offer in compromise together with penalty abatement to decrease the taxes you owe.

  1. You can only file for bankruptcy once

The truth is, you can only file for Chapter 7 bankruptcy once every eight years, says Justin Harelik, Bankrate’s Bankruptcy Adviser. For Chapter 13 reorganization, you can file more often than that.  Of course, that doesn’t make it a good idea.  “Multiple bankruptcies are really bad,” Rosenberg says. “Many people get into the habit of once they’ve done it, it becomes a way of life. This is not good for your karma”, or your credit rating.

  1. I can max out all my credit cards, file for bankruptcy, and never pay for the things I bought

That’s called fraud and bankruptcy judges can get really cranky about it.