Individual Bankruptcy FAQs

A Chapter 7 bankruptcy will grant you a discharge of most of your debt, including credit card debt, personal debt, medical bills, foreclosures and automobile repossessions. Generally, student loans and tax debt are not eliminated. Typically, you are allowed to keep certain assets, such as bank accounts, automobiles, pension plans, IRA’s, and your house.

To qualify for a Chapter 7 bankruptcy, your family income must be less than the average family income in the state and county in which you live. For example, the median (middle) income of a family of 3 living in Alabama (in 2020) is $68,554 and for a family of 4 is $82,991.

As soon as you file a Chapter 7 bankruptcy “petition,” the Bankruptcy Code imposes an injunction on all of your creditors called the “Automatic Stay.” The automatic stay prohibits creditors from any collection activities, including lawsuits, wage garnishments, collection calls, collection letters, bank restraints, foreclosures or repossessions.

A Chapter 13 bankruptcy may be appropriate if you have substantial assets, substantial equity in your home or earn above the average family income for the state and county in which you live. In a Chapter 13 bankruptcy case, you may keep your assets while under the protection of the Bankruptcy Code.

In exchange for keeping your assets, the Bankruptcy Code requires you to create a “plan” which proposes to repay creditors over a term of 3-5 years. The plan will allow you to “catch up” on your mortgage or car payments while stopping creditors from all collection activities.

Under a Chapter 13 plan, you repay your “unsecured creditors” only what you can afford to pay based upon your income and expenses. “Unsecured” debt includes credit cards, medical bills, personal loans, debts owed on car loans over the value of the car once repossessed or sold, and mortgage debts over the value of the home after the home is sold in foreclosure. Between 5%-100% of your unsecured debt is repaid through the plan over a 3-5 year period. Once your Chapter 13 plan is completed, all remaining debt is eliminated (“discharged”).

Just as in a Chapter 7, as soon as you file a Chapter 13 bankruptcy case, the Bankruptcy Code imposes an injunction on all of your creditors called the “Automatic Stay.” The automatic stay prohibits creditors from any collection activities, including lawsuits, wage garnishments, collection calls, collection letters, bank restraints, foreclosures or repossessions.

To qualify for a Chapter 13 bankruptcy, you must be an individual (no corporations, partnerships or other non-natural entities), you must have a regular income, you must have disposable income at the end of each month (your income is greater than your reasonable living expenses), your unsecured debts may not exceed $394,725, and your secured debts may not exceed $1,184,200.

No. Each person may file as an individual, or as a married couple. The effect of your bankruptcy on your spouse will depend on your individual circumstances.

Prior to filing bankruptcy under either Chapter 7 or Chapter 13, you must complete a credit counseling course. This course is approximately 90 minutes long, and is available in person, by telephone, or through the internet. The course must be given by an agency approved by the bankruptcy administrator’s office. You are then given a certificate that must be filed with your bankruptcy petition.

Our firm can arrange and register you for the credit-counseling course. Most clients take this course by telephone or via the internet.

After you file your Chapter 7 or Chapter 13 bankruptcy petition, the Bankruptcy Code requires that you complete a second course called a “Personal Financial Management Course” or “Debtor Education Course.” As with the credit counseling course, the personal financial management course is approximately 90 minutes long, and is available in person, by telephone, or through the internet. The course must be given by an agency approved by the bankruptcy administrator’s office.

Our firm can arrange and register you for the debtor education course. Most clients take this course by telephone or over the internet.

Once the course is completed, the accredited agency will issue a certificate of completion which will then be filed with the Bankruptcy court.

A bankruptcy attorney will prepare your bankruptcy “petition” to file with the court. Depending upon your circumstances, a bankruptcy petition may be 50 pages or more. The petition includes all your financial information, your financial history, and a list of all of your assets, cars, real estate, personal property, bank accounts, CDs, IRAs, and life insurance policies. It also includes lists of all of your debt, including credit card debt, medical bills, personal loans, bank loans, mortgages, and car loans. The bankruptcy petition also lists the names and addresses of all of your creditors.

As soon as you file the bankruptcy petition, the Bankruptcy Code imposes an injunction on all of your creditors called the “Automatic Stay.” The automatic stay prohibits creditors from any further collection activities, including lawsuits, wage garnishments, collection calls, collection letters, bank restraints, foreclosures, or repossessions.

The Bankruptcy Court will then appoint a “trustee” to supervise your case. The bankruptcy trustee is typically a local bankruptcy attorney who will review your bankruptcy petition – though the trustee could be an accountant or other person with financial expertise. In addition to the materials provided in your petition, you must provide to the trustee copies of your tax returns, pay stubs, bank statements, and appraisals for your home or car. The trustee is responsible for the management of your “bankruptcy estate” which is composed of all your non-exempt property.

Approximately 3-4 weeks after your bankruptcy petition is filed, you will meet with the bankruptcy trustee for the “Creditor’s Meeting” or “341 Meeting.” The bankruptcy judge is not present at this meeting The trustee conducts this meeting in a large room at the bankruptcy court. The trustee will usually schedule 40-50 such meetings for the same time. Each meeting usually lasts from five to fifteen minutes and is audio recorded. This meeting is called a “Creditor’s Meeting” because your creditors have the right to appear at this meeting and to question you about your bankruptcy, your petition, or your assets. However, most creditors choose not to appear at these meetings.

In a Chapter 7 case, if the bankruptcy trustee determines it is a “no-asset” case, then you will likely receive a discharge of all your unsecured debts within 4-6 weeks after the Creditors Meeting. If the trustee determines there are potential assets or equity in assets to pay creditors in your bankruptcy estate, then the trustee will begin the process of selling those assets to collect a “pot” of funds in the estate to pay your unsecured creditors.

In a Chapter 13 case, following the Creditor’s Meeting, you will begin (or continue) making payments to the trustee under your plan. The trustee will then disburse payments to the unsecured creditors (and sometimes the secured creditors) under your plan. Barring any other issues that the Bankruptcy Court must address, your plan will be confirmed. Upon the completion of your plan, you will receive your discharge.

Certain debt under the Bankruptcy Code cannot be eliminated and is known as “non-dischargeable” debt. Non-dischargeable debt includes recent income taxes, student loans, alimony, child support, restitution or compensation ordered by a criminal court, civil judgments for injuries due to intentional torts or driving while intoxicated, and any debts incurred by fraud. The type of debt that is dischargeable may vary depending upon whether you file a Chapter 7 or Chapter 13 case.

Yes. When you file your bankruptcy “petition,” all foreclosure or eviction proceedings are immediately stopped. At the moment you file a petition seeking bankruptcy relief, the Bankruptcy Code imposes an injunction on all of your creditors called the “automatic stay.” The automatic stay prohibits your creditors, including a mortgage lender or landlord, from any collection activities, including foreclosure or eviction. Typically, once you initiate bankruptcy, your lender or landlord may only proceed with foreclosure or eviction after requesting permission of the Bankruptcy Court and proving to the Court that you did not comply with the requirements of the Bankruptcy Code as it relates to your mortgage or lease.

No. Neither the Bankruptcy Court nor creditors have a right to garnish your wages while you are under the protection of the Bankruptcy Court.

Most likely.

You may be able to retain your home if you have no “equity” in the property. If your home is currently valued at less than the outstanding amount of your mortgage (or the outstanding amount of your first, second, third mortgage, etc. when combined), then you home has no value as an “asset” to you or your bankruptcy estate. Assuming you meet all other requirements of the Chapter 7 bankruptcy, then you may be able to keep your house and discharge all your remaining debt.

A debtor is permitted to keep (“exempt”) up to $15,000 equity in his or her home. If a couple files jointly, that is doubled to $30,000. “Equity” is the value of your home over and above the total outstanding debt on your mortgage(s). If your home is worth $150,000 and your mortgage is $90,000, then you have “equity” in your home valued at $60,000. If the house is in the name of you and your spouse, then you may qualify for relief under Chapter 7, keep your home and the equity in your home, and still discharge all your “unsecured” debts (which would include credit cards, medical bills, personal loans, etc.).

Yes. Under a Chapter 13 plan, you must prove to the Bankruptcy Court that you have sufficient income to once again start paying your monthly mortgage payments. You must also prove to the Court that you can pay the past due amounts to your mortgage lender (the “arrears”) spread out over the plan period (between 3-5 years) with no interest. As long as you can restart your monthly mortgage payments, and pay the arrears over 3-5 years, then your mortgage lender is prevented from foreclosing on your home.

In Chapter 7, you currently can’t do anything with that second or third lien on the house if you want to retain the home. But, in Chapter 13, if the total debt outstanding on your first mortgage exceeds the value of your home (i.e., your home is “underwater”), then you may be permitted to “strip” away the junior (2nd or 3rd) lien.

You are only permitted to strip a junior lien if the amount of the senior loan is greater than the fair market value of the home. Suppose, for example, that your house is worth $150,000, and you have a first mortgage of $100,000, a second mortgage worth $50,000, and a third mortgage of $20,000. In that case, since the first and second mortgages fully secure the value of the house, the third mortgage is considered to be “unsecured.” Because the third mortgage is unsecured, the Bankruptcy Court can “strip” the third mortgage. By stripping the third mortgage, that mortgage is converted from “secured” debt, to “unsecured” debt. Note that you will still be responsible for the other two mortgages.

In contrast, if your house were worth $160,000 and you had three mortgages of the same amounts as the above example, the third mortgage would be partially secured by the house. The third mortgage in that case could not be stripped.

In some cases, the mortgage holder may challenge your appraisal of the fair market value of the home if you claim that the junior mortgage is wholly unsecured. In that case, the court may hold an evidentiary hearing, during which your appraiser will be required to testify, to determine if the fair market value is less than or more than what is owed on the mortgage or mortgages that are not to be stripped.

When you ask the Bankruptcy Court to “strip” a lien, you are asking the Court to convert junior mortgages that are not fully secured into unsecured debt. This means that the converted junior mortgage will be removed from the property and treated like any other non-priority debt that is not secured by collateral, such as credit card debt, medical debt or personal loans. You will have to pay a part of this unsecured debt through your Chapter 13 plan, but usually you will not have to pay all of the unsecured debt.

Once you complete the plan, the remaining unpaid and unsecured debt, including the stripped junior mortgage, is discharged. If you do not complete the plan, however, the junior mortgage will not be stripped, and you will still be responsible for paying it.

The Bankruptcy Court will not take your car. But, depending on the debt associated with the car and your ability to repay the car loan, the Chapter 7 trustee (a person appointed by the Bankruptcy Court to “liquidate” or sell your “non-exempt” assets, gather the funds received from such sales and then distribute any funds to your unsecured creditors) may require that you surrender the car to the lender or you may not be afford the car under your Chapter 13 plan. Alabama does not have a separate exemption for automobiles. If your car is secured by a car loan, or is under a lease, then in most cases you will have the option to retain your car.

If your car is worth more than you owe your lender, then the Chapter 7 trustee could sell the vehicle, pay your lender in full and use the remaining funds to pay your unsecured creditors. Under your Chapter 13 plan, you will need to prove to the Bankruptcy Court that you can continue making the required payments for your car and repay any overdue payments over the life of the plan.

Another alternative is to use the Alabama “wildcard exemption” to “exempt” up to $7,500 worth of “equity” in your car.

Under the Bankruptcy Code and Alabama law, IRA’s, pension or profit-sharing plans, or other retirement plans protected as IRA’s or 401k’s are generally “exempt” from your bankruptcy case and not a part of your bankruptcy “estate” (with certain exceptions). Therefore, you can likely retain those benefits as long as they remain in these protected accounts, even if you are filing under Chapter 7.

Exempt assets are certain assets that do not become a part of your “bankruptcy estate” and, thus, cannot be taken by creditors or included as a part of the bankruptcy case. These “exempt assets” are defined under the Bankruptcy Code by either federal statute or Alabama law. Some exempt assets are exempt up to a certain value, and some exempt assets can be of unlimited value.

Homestead Exemption

The Homestead Exemption protects the equity in your home. The equity is calculated by taking the value of your home less the outstanding mortgage due on the home. In Alabama, you are is entitled to $30,000 exemption of the equity in your home (which doubles to $60,000 if you are filing jointly with a spouse).

For example, if your home is worth $200,000, and the payoff on your mortgage is $150,000, then you have $50,000 equity in your home. Under the current Bankruptcy Code and applicable Alabama statutes, you would be entitled to keep $30,000 of the equity in your home, and you and your spouse filing jointly would be entitled to keep all $50,000 in equity in your home, and still discharge all of your remaining debt.

Household Goods and Furnishings and Clothing

Each debtor is entitled to keep reasonable household goods, furniture, and clothing. This may not include unnecessary or high-value items.

Life Insurance Policies and Annuities

Most life insurance benefits and annuities are exempt in a bankruptcy case. There may be exceptions applicable here, including the amount of the annuity.

Worker’s Compensation or Disability Benefits

These payments are generally exempt but may be subject to a limitation based on the amount of the payment.

Tools of a Trade

Alabama law permits you to exempt certain “tools” used in carrying out your trade or business.

Wages

75% percent of any wages owed to you are exempt.

However, practically speaking, this exemption has little meaning, as it would only apply if you filed your petition after the work was performed but before you were paid. Thus, if your paycheck is received on a Friday, but is for the work done for the two weeks that ended on the previous Friday, and your petition filing was in the middle of the two Fridays, you would only be entitled to keep 75 percent of the paycheck as exempt. The amount of non-exempt wages and salary is normally so small that the bankruptcy trustee does not bother taking it.

NOTE: In a Chapter 7 case, all of your future earnings (i.e., all wages earned by you after the filing of your petition) are not a part of the bankruptcy estate and are kept by you. In a Chapter 13 case, those wages are what is used to pay creditors under your plan.

Wild Card Exemption

Alabama statutes also allow for a “wild card” exemption of up to $7,750.

Yes. However, the filing of a bankruptcy petition, and the entry of the automatic stay, requires that even the IRS must stop its collection actions. However, since most tax debt is non-dischargeable, in Chapter 7 bankruptcy the IRS will continue its collection efforts after the case is closed. In a Chapter 13 bankruptcy, any non-dischargeable claims by the IRS against you must be paid through your plan.

No. In most Chapter 7 cases, your tax debt is not discharged, but the IRS cannot penalize you for filing bankruptcy.

Typically when you negotiate down a credit card or other debt or obtain a debt reduction of any kind from a creditor, the IRS will treat the amount of the debt which you did not pay income for tax purposes. This is sometimes known as “debt forgiveness” income or “phantom” income. However, the IRS cannot tax you on all the debt you discharge, such as credit card debt, medical bills, and personal loans, in your bankruptcy case.

In a normal bankruptcy case, no one will come to your house to examine your personal belongings.

However, if your bankruptcy trustee has a reasonable suspicion that you have hidden or transferred assets, or have undervalued your possessions, the trustee may have the right to send an appraiser to home. This is a rare and exceptional occurrence, and will only happen if the bankruptcy trustee has reasonable grounds to believe that you are attempting to defraud your creditors or hide your assets. For this reason, you should be completely upfront and honest with your attorney so both you and your attorney can be completely honest with the bankruptcy court. Momma always said “honesty is the best policy,” and that is certainly true in the bankruptcy court.

No. The Bankruptcy Court only sends notice of the bankruptcy to those creditors that you list on your bankruptcy petition for the purpose of giving those creditors adequate notice that their debt may be discharged in your bankruptcy. If your employer is not a creditor (i.e., you do not owe your employer money), then your employer is not notified of the filing of your bankruptcy petition.

This is the opposite of a wage garnishment, when a creditor obtains a judgment against you, and is allowed by law to notify your employer and garnish your wages. In a bankruptcy, all wage garnishments cease immediately once the bankruptcy petition is filed and the automatic stay comes into effect.

In order to qualify for a Chapter 7 bankruptcy, the post-2005 Bankruptcy Code requires that you complete a Statement of Current Monthly Income and Means Test Calculation. These are mathematical calculations designed to ensure that Chapter 7 debtors are eligible to file a Chapter 7 bankruptcy.

Essentially, the Means Test Calculation compares your current monthly income to the current monthly income of a family of your size in the state and county in which you reside. The Current Monthly Income Calculation is not the same as your actual monthly income. Rather, it starts with an average of your actual income received during the last six months and reduces it by certain IRS and government deductions. Your disposable monthly income is then calculated and this sum will be used by the Bankruptcy Court to determine whether you are eligible for a Chapter 7 bankruptcy or a Chapter 13 bankruptcy.

If your family income is greater than the average family income for the county in which you live, then you must file under Chapter 13 instead of Chapter 7. In a Chapter 13 case, you would file a “plan” for repayment of your unsecured debts and your excess income will be used to pay your unsecured creditors a portion of the debt owed to them. The Chapter 13 plan would be in effect for a period of 3-5 years. The Chapter 13 plan can provide for as little as 5 – 10% payback (but as much as 100%) of your unsecured debt. The remainder of the debt will then be discharged upon your completion of the plan.

In most cases, your credit is already in trouble when you files for bankruptcy. Late payments, collections, lawsuits, foreclosures and repossessions all destroy your credit. In the usual situation, bankruptcy is only filed after some or all of these events already occurred.

The credit reporting laws allow for credit reporting agencies to report your debt for 10 years. This 10-year period applies to late payments, collection efforts, foreclosures, and repossessions. Similarly, your bankruptcy will also remain on your credit report for a 10-year period.

However, typically about 12 months after your discharge, you will once again be eligible for credit card offers. Approximately 24 months after your discharge (or 24 months into your Chapter 13 bankruptcy plan), mortgage lenders and auto finance companies will be willing to be extend credit to you. The reason for this is that once you have filed a bankruptcy, you have become a better risk to your remaining creditors. You have eliminated much of your other debt, allowing you to keep current on your mortgage or car loan. Further, except in certain instances, you cannot file another bankruptcy within the next 8 years, so your new creditors are assured that, at least for a time, you will not be able to discharge their new debt under the Bankruptcy Code.

No. The bankruptcy trustee has the right to “look back” at transfers made up to 10 years ago and pursue a “fraudulent transfer” action to take back improperly transferred assets. In a fraudulent transfer action, the bankruptcy trustee may have the right to recover those assets from the persons who received the assets. For example, if you transfer your house to a relative right before filing a bankruptcy, the trustee would have the right to proceed against your relative to transfer the house back to your name, and sell the house to pay your creditors. Additionally, the bankruptcy trustee may recommend that the bankruptcy court deny you a discharge based upon improper transfers.

On the one hand, you are required by the Bankruptcy Code to list all of your creditors and debt. You are not allowed to “prefer” one creditor over another creditor. This would include keeping one credit card that offers you better terms and discharging another credit card. Being up front and honest with the bankruptcy court is essential if you want to receive a discharge.

More importantly, you cannot “prefer” a family member or friend to whom you owe money by paying them back then attempting to discharge your debt to other creditors, such as your credit card companies. This concept is called a “preference” in the Bankruptcy Code. Your trustee will be entitled to seek the return of any “preference payments” made within a certain time before your bankruptcy (generally, 90 days for most creditors and 1 year for “insiders,” who are your family, friends, etc.).

On the other hand, once you receive a discharge of your debt, you are then free to repay any creditor whom you wish to pay. Different credit cards have different rules regarding your continued use and payment of the card after filing for bankruptcy. Some credit card companies may allow you to continue using and paying a credit card despite a bankruptcy filing. Also, there are various credit card companies which will still offer you credit cards after a bankruptcy – though the cards may have to be “secured” by some other property (such as the equity in your home or car).

There is a common misconception that income taxes are never dischargeable in bankruptcy. This is not always true. Certain older federal and state taxes, including penalties and interest, may be dischargeable under the right circumstances.

The general rule for discharge of income taxes may be referred to as the “3-2-240 Rule.” This rule refers to the timing for a potential discharge of income taxes. If the taxes came due (i.e., assuming no extension on April 15 of the year following the taxable year) 3 years prior to the filing of your petition, and if you filed returns more than 2 years prior to the filing of your petition, and if it has been more than 240 days since the taxes were assessed by the IRS (due for payment), then you may be able to discharge your tax debt.

Certain variables will “toll” these time limits. For example, if you owe 2015 taxes but did not file your tax return until 2020, then the 2-year rule applies and you will not be able to discharge those taxes until 2 years after you filed the return (i.e., in 2022).

If you file an amended tax return, or you were audited by the IRS and a new assessment or tax return is filed, then the 240-day rule may come into play. You would not be able to discharge that income tax debt until after the 240 day period following assessment.

IMPORTANT NOTE: Certain taxes cannot be discharged. Taxes cannot be discharged if they are payroll tax, sales tax or other “trust taxes” that you are required to collect on behalf of the government.

Please also note that both tax liens and judgment liens will not be “automatically” removed or released despite the fact that the tax debt and interest and penalties may be discharged in full. It is incumbent on you and your attorney to request that the bankruptcy court discharge, remove or release those liens. Removing tax liens, as well as judgment liens, is a complex subject and you should discuss any such liens with your bankruptcy attorney.

In order to determine if it may be possible to discharge any income taxes, you may request a “tax transcript” from the IRS using IRS Form 4506-T for each year that you feel the taxes may be dischargeable.

Section 523(a)(8) of the U.S. Bankruptcy Code exempts from discharge student loans, except those student loans that would impose an “undue hardship on the debtor and the debtor’s dependents.” This includes both public and private student loans. Currently, it is extremely difficult to obtain a hardship discharge of student loans unless the debtor is fully disabled or absolutely unable to obtain employment in any field whatsoever.

It should be noted that unpaid tuition bills or other charges incurred by college students may be discharged as long as they are not characterized as “student loans.” Therefore, if you are attending a school on a “pay as you go” basis, and you have defaulted on the tuition payments, those payments may be discharged in your bankruptcy case.

In some cases, you may be seeking student loans in the future. Generally, federal guidelines permit a student to be denied further student loans based upon that student’s prior bankruptcy filing. Private schools may, nevertheless, consider the bankruptcy and pre-bankruptcy and post-bankruptcy credit history of the student in determining their willingness to issue a new loan to the student.

No. You can find copies of all bankruptcy forms on the general website for the United States bankruptcy courts at www.uscourts.gov/Bankruptcy courts.html.

However, it can be very difficult to file your bankruptcy alone. The rate of discharges for individuals filing without an attorney is much lower than the rate for those with an attorney. The Bankruptcy Code and the bankruptcy petition are very detailed and complicated. This results in many people filing a bankruptcy case without an attorney having their cases dismissed by request of the bankruptcy administrator or the bankruptcy trustee. Other people who initially file their cases without an attorney end up hiring an attorney to sort out problems that arise in filing their own case.

Overall, most debt consolidation companies or debt negotiators achieve poor results and may further hurt your credit. Most debt consolidators or negotiators will collect a monthly payment from you over the course of 12 to 24 months. In the meantime, these companies stop paying your credit cards. The interest rates, penalties, late charges and over the limit fees accumulate. Additionally, your credit score goes from bad to worse. These companies will then approach each credit card company and attempt to negotiate your debt using the amounts you paid to the company during the last 12 to 24 months. Sometimes these methods are effective, but usually they are not. Most creditors do not make it easy to negotiate or consolidate the debt. Even if the debt is paid at a reduced rate, your credit is not restored.

Moreover, when you negotiate down a credit card debt, or obtain any debt reduction, the IRS will treat the amount you saved and did not pay to the creditor as income for tax purposes. This is sometimes known as “debt forgiveness” income or “phantom” income. In a bankruptcy case, the IRS cannot tax you on the credit card debt, medical bills and personal loans that are discharged in the bankruptcy.