Old fashioned 401k plan

Borrowing against one’s retirement is bad for a number of reasons.

Depleting your retirement will not help your future

You spent a lot of hours earning the money that is in your retirement and took the advantage of a retirement account to do so.  These accounts have many benefits, including that they are not taxed until you withdraw the money.  You also, in many cases, get a tax deduction for contributing to them as it reduces your gross income.  To take out a 401k or retirement loan, you must pay a fee to do so, making it even less attractive from a financial standpoint.

Failure to repay a 401k or other retirement loan will result in tax consequences.

If a retirement loan is not repaid, not only do you lose the fees you have to pay to take out the loan in the first place, but the loan then becomes taxable income to you.   Depending on your other income and financial situation, this can result in a significant tax debt.

Payments on retirement loans do not count towards bankruptcy eligibility

People think that a 401k loan is the same as a loan against their car, or house.  It is not.  You are simply repaying yourself.   As such, most (if not all) bankruptcy courts will not include the amount being repaid when analyzing your budget to see if you have income available to pay your creditors.   Thus, if you have net income of $3,000 per month, and necessary living expenses (such as rent, mortgage, car payment, food, clothing) of $3,000 per month, but $700 of that $3,000 is your retirement loan deduction from your paycheck, you will likely not be eligible for a Chapter 7 case, and would have to do a repayment plan in a Chapter 13 (or Chapter 11) instead.

This is one of the biggest obstacles clients of mine face.  They finally run out of options, and money, and decide they need a fresh start and want to file a bankruptcy but because of the 401k loan (which they think they MUST pay), they don’t have any surplus income, yet also may not qualify for a Chapter 7  (which requires no repayment to creditors).

Know the Risks Before Borrowing

I’m not saying that it never makes sense to borrow against your retirement.  Sometimes using it to save your home can be as important as the future benefit from the retirement funds themselves.   But be sure to understand the problems you are getting yourself into by doing so, and use that when weighing your decision.

This article is part of my bankruptcy alphabet series.  For others writing on the letter “K” see:

1. 401k    Marin County Bankruptcy Attorney, Catherine Eranthe
2. Keep    Northern California Bankruptcy Lawyer, Cathy Moran
3. Keep your retirement accounts    Taylor, Michigan Bankruptcy Attorney, Christopher McAvoy
4. Keeping Secured Loans    Hawaii Bankruptcy Lawyer, Stuart T. Ing
5. Keeping your business     Dorota Trzeciecka Bankruptcy Blog
6. Keys    New York Bankruptcy Lawyer, Jay S. Fleischman
7. Kids    Colorado Springs Bankruptcy Attorney Bob Doig
8. Knowledge    Omaha and Lincoln, Nebraska Bankruptcy Attorney, Ryan D. Caldwell
9. Knowledge    Metro Richmond Consumer and Bankruptcy Attorney, Mitchell Goldstein
10. Know    Cleveland Area Bankruptcy Lawyer, Bill Balena
11. Keep    San Francisco Bankruptcy Attorney, Jeena Cho    

Image Courtesy of Kenteegardin

and www.SeniorLiving.Org

-Burt Bacharach and Hal David

If there’s anything that is a centerpiece of an individuals’ bankruptcy case, it’s their house and whether they can keep and, if so, how?  I have many clients who call up and think that they automatically lose their home when they file a bankruptcy case.  I have others who believe that they get to keep their house under any circumstance.   The truth lies in between.

There are different options available regarding retaining property depending on which bankruptcy chapter is filed.

Keeping Your House in Chapter 7

In a Chapter 7 liquidation case, whether one gets to keep their house, or any other property for that matter, depends on how much equity is in it, and whether they have sufficient exemptions under applicable law to protect that equity value.    Exemptions are “protections” for value you have in certain assets such that they are “exempt” from collections.  Every state has different exemptions amounts available. Exemption laws are based on the state where you resided for the 2 years prior to filing your bankruptcy case or, if you lived in more than 1 state during that period, in the state where you resided for the greater part of the 180 days prior to that 2 year period.

How to Calculate Equity

How is equity calculated?  This is for some reason a big hurdle for many.  Calculating equity is simple.  You take the fair market value of the property (preferably from an appraisal, or at least a broker’s written opinion) and then subtract out the amounts owed to any mortgages or other liens¹ against the property, and that’s the equity.   In most courts, you can also subtract out another 8% of the fair market value for “costs of sale” of the property.

Assuming there is no equity, or you have sufficient exemptions to cover whatever equity exists, then the bankruptcy trustee will not sell (liquidate) the house.  However, there is still the obvious requirement that you must stay current with your contractually due mortgage payments in order to prevent foreclosure.

Keeping Your House in Chapter 13

Chapter 13 is very different.  You will not lose your house in a Chapter 13 regardless of how much equity there is in it.  However, any non-exempt equity will need to be paid to your creditors over the term of your repayment plan (36-60 months).  ²

Lien Stripping in Chapter 13 (and Chapter 11)

Another nifty feature of Chapter 13, not available (at least not yet) in a Chapter 7 bankruptcy case, is the ability to remove certain liens against real estate.   How and to what extent this can be done depends on a number of factors, including whether the house is the principal residence of the debtor.  If it is, then a junior mortgage can be “stripped” (i.e. removed) if the value of the property is less than the amount owed to any senior mortgages (e.g. the 1st mortgage). ³  For non-principal residences (such as a rental property),  even partially secured liens can be stripped down to the value of their lien.

Catch up on payments in Chapter 13 (and Chapter 11)

Another great feature of Chapter 13 is the ability to use your 36-60 month plan payments to catch up on past due amounts on your mortgage(s).  Frequently one files a Chapter 13 to gain the benefit of the automatic stay to stop a foreclosure, and then propose a repayment plan to catch up on the past due arrearages and reinstate the loan over a period of time.

But whether one gets to keep their house or not, they can always make another place their home because as the great songwriting team quoted at the top of this article point out, a house is not a home.

__________

¹ This excludes liens, such as judgment liens, when they are able to be removed in a bankruptcy case.  This will be discussed more in my Letter “L” blog.

² This isn’t precisely accurate.  Technically, in a Chapter 13 the debtor must pay more than the creditors would receive in a Chapter 7 case, so one gets to deduct anticipated Chapter 7 Trustee administration fees from the equation.

³ This may not be available in all bankruptcy courts, but is allowed in the Central District of California.

This article is part of my bankruptcy alphabet series

Others playing the Alphabet Game:

Jay Fleischman believes that H is for Household

Cathy Moran agrees that H is for House

Cate Eranthe finds H to be about HOA  Dues

Stuart Ing explains about Household Size

Cleveland Attorney Bill Balena talks about Honesty

Christopher McAvoy discusses Harassment

Mitchell Goldstein examines Households

Daniel Winter looks at Harrassment

Image courtesy of james.thompson

Filing fees for all fee-required documents to the bankruptcy court are increasing effective November 1, 2011.    In particular, the following are the new fees to be required for commencing cases under the “main” chapters:

Chapter 7-$306

Chapter 11-$1,046

Chapter 13-$281

The above are only a $7 increase from the existing fees, but an increase nonetheless.

Other fees, such as filing an adversary complaint, Motions regarding the Automatic Stay, and others, will also be increasing by differing amounts.

COURT FILING FEES ARE SEPARATE FROM ATTORNEY’S FEES

The above fees are paid to the court clerk.  They are always IN ADDITION to any attorney’s fees for representation in a case.

Image courtesy of Eric Steuer

You filed for Chapter 7 bankruptcy and had a balance due to the lender.  Faced with what seemed to be certain repossession, you agreed to sign a reaffirmation agreement.  All set, right?  Not necessarily.

There’s a moment in time when you reach a point of desperation.  You need that car to get to work each morning, pick up the kids from school, and a million other reasons.  It doesn’t matter that the car payments are bleeding you dry, the darn thing breaks down on a regular basis, or you just plain don’t like it.

You need a car, and you know chances are slim to none that you’re going to be able to qualify for new financing immediately after bankruptcy.

So you tell your lawyer to call up the car lender to get a reaffirmation agreement.  Your lawyer probably cautions you against committing yourself to new debt on the heels of bankruptcy.  Ultimately, you make the decision.  You sign on the dotted line.

What’s The Procedure?

You’ve got to sign an agreement that contains a number of disclosures.  Once that’s done, your lawyer’s got to sign the agreement as well.  That’s where it gets a bit thorny, because your lawyer’s signature means that he or she doesn’t think you’ll have a problem making the payments under the agreement.

Lots of bankruptcy lawyers don’t sign reaffirmation agreements for exactly this reason – after all, if you get in debt trouble after bankruptcy then your lawyer’s going to look pretty bad in front of the court.

If your bankruptcy lawyer doesn’t sign the agreement then it’s up to the judge to allow the agreement to stand or not.  If the attorney does sign, no court hearing is needed.

Filed And Honored

Under the bankruptcy laws, a reaffirmation agreement must be filed with the court in order to be valid.  If it’s not filed then the agreement isn’t binding.

Once the agreement is filed, you get 60 days (or the date of your bankruptcy discharge, whichever is sooner) to rescind it – in other words, you can still change your mind.  All you need to do is write a letter to the creditor and file it with the court.  Nothing fancy necessary to back out of the deal.

Effect Of Discharge

If your reaffirmation agreement is unfiled or rescinded in a timely manner then you’re no longer held personally liable for the debt.  You’re still going to make the loan payments (assuming the lender doesn’t repossess the car due to the bankruptcy filing, but that’s another article for another day) but if it’s repossessed then you’re off the hook financially.

Statements In The Mail After Bankruptcy

Your lender can’t legally send you statements each month after your bankruptcy discharge unless the reaffirmation agreement was in effect as of the date of discharge.  Any demands for payment are considered violations of the discharge injunction, and may subject the lender to legal action if you decide to sue.  For that reason, it’s a good idea to think about setting up an automatic payment system through your bank to ensure that payments are sent on time each month.

Your Credit Report After Bankruptcy

Once a debt is discharged in bankruptcy, the lender must update the consumer’s credit report to indicate a zero balance and the fact that the debt was discharged in bankruptcy.  No other information may be provided on a going-forward basis.  Though this protects you in the case of discharged credit card debts and the like, you need to realize that it applies to car loans without reaffirmation agreements in place.

Those car payments you’ve been making after your bankruptcy discharge aren’t going to help your credit score.  The lender may provide information on your payment history to a new prospective lender at your request, but nobody’s going to know about them solely by looking at your credit report.

If you’re habitually late on payments, that’s not so bad.  But if you’re making payments purely as a way to re-build credit after bankruptcy, it’s not going to help unless you’ve got a filed and binding reaffirmation agreement in place.

In the end, the decision is yours whether to reaffirm a debt or not.  Make the choice carefully, and know the implications for your life after your bankruptcy discharge is issued.

Image credit:  katherinetompkins

Jay S. Fleischman is a consumer bankruptcy lawyer who sues creditors and bill collectors for harassment after bankruptcy. When not helping people with bill problems, he works with attorneys to help improve their law firm marketing efforts.

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Once you get to the promised land in a bankruptcy case–the date your discharge is granted–there is frequently confusion among many as to which of their debts were in fact discharged.   The confusion stems from expectations that there is some official specific ruling as to each debt.   That would be nice, but it’s not the way it works.

The Discharge Notice

When the discharge is entered in a bankruptcy case (for purposes of this article, I am referring to Chapter 7 or Chapter 13 cases; Chapter 11 is somewhat different) the only document that is sent out by the court is a 2-page document that generically states that “the debtor is granted a discharge”.  The second page lists, again generically, which types of debts are usually discharged, and which are not, but does not specify which debts in this case are discharged.

Figuring Out Which Debts Are Discharged

The reason it does not state which debts are discharged is that it is simply impossible.  The bankruptcy code provides numerous exceptions to which debts are discharged.   These exceptions are codified in section 523 of the Bankruptcy Code.¹   Some of these exceptions, such as debts incurred through fraud require the creditor to actively object  within a very specific time frame,  and prevail at trial, in order for the debts to not be discharged.  But many others are automatically not discharged if certain (and in many cases very complicated) conditions are met, and those conditions frequently have many exceptions of their own.  A good example of this is tax obligations.   For a quick look at how income tax dischargeability is determined, click here.

A lot of the criteria for determining whether a debt is discharged is subject to argument and can only be decided by a Judge if brought in front of the judge by one of the parties specifically.  Without that, the best the court can do is issue a general discharge that applies to all those debts which do not have a specific exception from discharge in the bankruptcy code.

Ask Your Attorney!

The bottom line is that most debts, such as credit card, medical, repossession and foreclosure deficiencies,  are in fact discharged.   But you need an attorney to really analyze your facts, preferably before you filed your case,  to let you know which debts might not have been discharged (yet another reason to have a bankruptcy attorney for your case–see more).  Ultimately, if there is a dispute, it will need to be decided by a Judge at trial.

¹ To further complicate matters, each bankruptcy chapter (7, 13, 11) incorporates various parts of section 523 differently, so a debt that is discharged in a Chapter 13 case, for example, may not be discharged in a Chapter 7 or 11, etc. )

Image courtesy of  kangotraveler

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As many of you know, I answer a lot of questions posted on various free legal service sites such as avvo.com and allexperts.com.  One fact pattern I see repeatedly are clients who filed a Chapter 7 case and then find out to their horror that their bank–to whom they do NOT owe any money–has frozen the funds in their account. How can this happen? Doesn’t the automatic stay prevent this?

When this happens, I immediately know that they either represented themselves, or have an inexperienced attorney representing them.

At the present time, there are only a couple of institutions that do this (and one of them is Wells Fargo Bank). And how can they do this? The reason this is allowed is a rather esoteric and legalistic one. It basically has to do with the bank holding the funds as a custodian for the bankruptcy trustee. The funds aren’t seized–they are just frozen until such a time as the Bankruptcy Trustee directs the bank to turn them over, or “abandons” the asset back to the debtor. In most cases the debtor has an exemption which can protect the funds in the bank account. But there may be several weeks or even months where they will not have access to these funds, and this can cause obvious problems paying the rent/mortgage and other necessary obligations.

The obvious solution to this is to simply make sure that there isn’t a large amount sitting in one of these accounts on the date one’s bankruptcy case is filed. This is something almost any experienced bankruptcy attorney will advise his/her clients.

It is worth noting, however, that the above “freeze” only affects funds in a debtor’s bank account on the date the case is filed. it does not affect funds deposited after.

Credit card and student loan payments do not factor in to the analysis for determining Chapter 7 eligibility.  It seems not a day goes by that I’m not trying to explain to a potential client why their payments to debts owed to unsecured creditors do not count in their budget in determining eligibility to file under Chapter 7 of the Bankruptcy Code.    They certainly aren’t an allowed expense on the dreaded “means test“, which uses specific expenses allowed by the IRS.   But it also doesn’t “count” as part of an ordinary current income/expense analysis, which is also used for determining eligibility.  If such an analysis shows a surplus of income, then one may not be eligible for Chapter 7 and may need to do a Chapter 13 or Chapter 11 (if too much debt for Chapter 13) repayment plan instead.

A typical scenario is where the client has income of, let’s say $5,000 per month; $3,800 after taxes.   Their monthly expenses–as they see them–are $5,000 per month, so there’s no way they cannot qualify for a Chapter 7 case in their minds because they have a monthly deficit of $1,200.    But of that $5,000 per month in expenses,  $1,500 are minimum payments on credit cards,  and $600 for student loan payments, neither of which qualify as “necessary living expenses” in a bankruptcy case.   So when those are subtracted out, the client has almost $900 per month they can afford to pay to their creditors, according to their budget.    This is probably way too much of a surplus to do a Chapter 7 case.  The court, instead, would want them to repay that amount to their creditors over 36-60 months in a Chapter 13 case.

Doing so may repay anywhere from approximately 10%-100% of their unsecured debts depending on what they owe (with any unpaid portion being discharged in the Chapter 13 or 11 case), but the point is their creditors will be receiving something and that is the criteria.

Except for certain taxes, domestic support obligations and other debts designated as “priority” debts under the bankruptcy code (11 U.S.C. 507), you can’t use credit card payments, student loan payments, or payments on any unsecured debts you owe as an expense in your budget to determine what you can afford to pay to your credit card, student loan, or other unsecured lenders!  That would be nonsensical.   One stated purpose of the bankruptcy law is to have those that can afford to make payments on their debts do so, and those who can’t don’t.   If your budget shows you have the ability to make some meaningful payments on your debts as shown above, you will likely not be eligible for Chapter 7 but will need to take advantage of a different bankruptcy chapter.

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The key for this lies in a common misconception people have about what bankruptcy does.    Bankruptcy discharges the  party filing bankruptcy from the legal obligation of paying on a given debt;  it does not eliminate the debt itself.  The debt still exists  and the party who is owed the debt cannot pursue recovery of that debt from a party discharged in bankruptcy.

The entire reason for having a co-signer on a loan or credit card application, for example,  is so that if the primary obligor defaults on the debt (such as by filing bankruptcy), they can recover against the co-signer.

If filing bankruptcy could discharge the debts of people other than the party filing the bankruptcy, we could all benefit by having one person in the United States file a bankruptcy case, and we’d all be discharged from our debts.   That obviously doesn’t make any sense (fun though it may be to imagine).

For the second period in a row, due to the declining economy, the median income is dropping and will go into effect for cases filed after October 31, 2010.  Thus, depending on how close you are to the limit, it may be important to file your case before November 2010.

In California, the median income for a 1-person household will be reduced to $3,936 per month; for 2-persons, $5,162 and a family of 4, $6,466.

Be sure to discuss the timing of your bankruptcy case with your attorney to maximize your chances of qualifying for Chapter 7 if possible, or reducing your obligations in a Chapter 13 case.

There are only two bankruptcy choices for a corporation:  Chapter 11 or Chapter 7.

Chapter 11 would be used if the goal is to continue operating the corporation’s business and reorganize the debts by proposing a repayment plan to creditors.  Creditors get to vote for or against the plan.  Sometimes less than 100% can be repaid, but there are a lot of complexities to Chapter 11, which is beyond the scope of this article.

Chapter 7 is a straight liquidation of assets of the corporation.   The corporation must (if it has not already) stop doing business when the Chapter 7 case is filed.   A Trustee is appointed to sell the corporate assets and disburse the proceeds in accordance with statute to creditors.   It is very important to understand that corporations do NOT receive a discharge of debts in a Chapter 7 case.

I frequently get inquiries from owners of corporations asking about filing a Chapter 7 case for their corporation so they can discharge the corporation’s debts and move on .    After I inform them that corporations don’t receive a discharge of debts, they ask me how they are going to deal with all that debt.   When I ask if they mean themselves personally or the corporation, their eyes frequently glaze over in a source of some confusion.

The confusion apparently stems from the fact that many small business owners do not understand that a corporation is a separate legal entity (which is, presumably, why it was formed to begin with).   Whether or not a corporation files bankruptcy has nothing to do with any personal obligation the owners or officers of the corporation may have.    For example, if the owner of a corporation signed personal guarantees on certain corporate debts, or has personal tax liability for corporate tax obligations (such as employee payroll trust fund taxes), that obligation does not disappear unless and until those debts are paid.  So unless there are enough assets available in the corporation to pay all those debts, the owner will still owe on those debts for which they are personally responsible regardless of what the corporation does.

So, in short, whether or not a corporation receives a discharge of debts is a big “who cares?” because it simply doesn’t affect anything.   If a corporation is going out of business, it simply doesn’t matter whether the debts are discharged or not because the corporation’s creditors will just sue the corporation and recover against whatever assets of the corporation are available and that does not affect the principals of the corporation.

90% of the time, what these owners of corporation are really looking to do is file a bankruptcy for themselves (the owners) personally–not the corporation.   In such cases, they should consult with a bankruptcy attorney about an individual bankruptcy case.   However, there are times where filing a Chapter 7 case for a corporation is beneficial.   In the case where the corporation has assets and wants to stop doing business, having an independent Trustee appointed to sell and disburse assets to creditors can eliminate that responsibility for the owner(s) of the corporation and release them from liability for not having properly disbursed corporate assets and winding up the corporation properly.   In fact, corporate officers have a fiduciary duty to corporate creditors when the corporation becomes insolvent, so taking a step such as filing Chapter 7 can fulfill that duty.

Another benefit of filing a Chapter 7 for a corporation is that it puts all the corporation’s creditors on notice that the business is terminating and whatever assets may be available will be distributed through the bankruptcy, and that will be all.   Thus, there would be no reason for the creditors to sue the corporation post-bankruptcy, whereas if a bankruptcy is not filed, the owner of the corporation may have to continually appear in court to inform the judgment creditors that the corporation is no longer operating and has no assets.

There are a lot more pros and cons to be discussed and any owner of a corporation in this situation should consult with a qualified bankruptcy attorney to have their situation fully evaluated.

For more information, please also visit http://www.bklaw.com/business_bankruptcy.html