6 bankruptcy myths you probably think are true
By Allie Johnson
December 17, 2014
Ever heard that you can pull out your credit card and buy a big-screen TV, a diamond ring and a designer bag right before you file bankruptcy, then keep those items as freebies? Like many bankruptcy tales, this one may be inspired by truth, but actually getting away with it is a myth.
“I hear all kinds of stories,” says Todd Esser, a Wisconsin lawyer who focuses on bankruptcy. “And many are more myth than truth.”
That’s partly because bankruptcy is complicated. For starters, there are several types, the most common of which are: Chapter 7, in which most of your debts are wiped away, and Chapter 13, in which you pay back all or part of your debt over three to five years.
Here are six common misconceptions about bankruptcy to help you separate fact from fiction:
1. You can rack up credit card debt right before you file. In fact, if you use credit to buy luxury goods or services that cost over $550 within 90 days before you file, you probably won’t get that debt discharged, according to Minnesota consumer law firm Friedman Iverson. So, while debt from the purchase of, say, a Jet Ski, likely would not be erased, you might get by with charging food, gas or diapers, according to Friedman Iverson. But consumers planning to file bankruptcy should stop using their credit cards, New Jersey bankruptcy attorney Ronald LeVine says. “It’s called loading up, and there’s a prohibition against it,” he says. In fact, if a judge sees a suspicious spending pattern, your bankruptcy could be denied, says Lita Epstein, author of “The Complete Idiot’s Guide to Personal Bankruptcy.” She says: “If it’s reckless spending, it’s considered fraud.”
2. You need to be late on your bills to file bankruptcy. Not true: You can be current on all of your accounts, from mortgage to car loan to credit cards, when you file. And it’s important to keep making payments on your house and car, if you want to keep them. That’s because Chapter 7 bankruptcy, the type in which you can wipe away many debts, doesn’t excuse you from making payments on secured debts if you want to keep the assets, LeVine says. (Secured creditors have a loan that is backed by collateral.) Fall behind on payments, and the creditor can grab the asset, he says. But the reality is that consumers who file for bankruptcy rarely are current on all bills, he says: “Consumers typically struggle for a long time first.”
3. If you file for bankruptcy, you lose your house and car. “One of the myths is you lose everything,” Esser says. The reality: It’s rare to lose your assets, he says. Federal bankruptcy laws contain exemptions that let debtors protect certain personal property including $22,975 of equity in a home, $12,250 worth of household goods, $3,675 for a car and $1,550 in jewelry. (The amounts get adjusted for inflation every three years.) Some states use their own rules — for example, Florida is known for its unlimited homestead exemption for many residents. “You could buy a big mansion in Florida and claim it as totally exempt,” Esser says. But there are exceptions to exemptions. The bottom line: A bankruptcy lawyer can assess your situation, tell you if you’re in danger of losing anything and offer options, he says.
“A bankruptcy doesn’t give you a scarlet B on your forehead.”
— Steven Wieckowski,
GreenPath Debt Solutions
4. Bankruptcy automatically gets rid of all of your debts. With Chapter 7 bankruptcy, you can wipe away some debts. However, there are certain types of debt that can’t be discharged in bankruptcy. Examples include federal or private student loans, the past three years of back taxes, spousal or child support, some government fines and debt stemming from a drunk driving incident. “There are classes of debt that cannot be wiped out,” LeVine says. Student loans can present a major difficulty for debtors, he says: “The only way out is death.”
5. Bankruptcy will wreck your credit for 10 years. In some cases, filing for bankruptcy can result in a faster recovery of your FICO score than not filing, Esser says. (FICO is the scoring model most lenders use to evaluate your creditworthiness.) That’s especially true if you’re really struggling and unable to stay current on your bills, he says. “Believe it or not, you can actually start rebuilding credit within a few months,” Epstein says. You typically need to start with a secured card, deposit a certain amount — say, $500, and use that as your credit line, she says. As long as you make your payments on time, you should be able to get an unsecured card with a low credit limit of a few hundred dollars in six months to a year, she says. But a Chapter 7 bankruptcy does stay on your credit report for 10 years, while a Chapter 13 remains for seven years, according to MyFICO.com. “It’s definitely not a good mark to have on your credit record,” Esser says.
6. Everyone will find out about your bankruptcy. “A bankruptcy doesn’t give you a scarlet B on your forehead,” says Steven Wieckowski, a bankruptcy counselor with GreenPath Debt Solutions. People often feel ashamed and believe their friends and family will find out they filed, he says. But bankruptcy filings are typically not published in the newspapers and are not as easily available to the general public as some other court filings, Esser says. Bankruptcy records are available on the federal electronic courts system, PACER, but that requires a paid membership and a PIN in order to look up cases. “It’s not one of those public websites where anyone can just look up and see if their neighbor ever filed for bankruptcy,” Esser says.