The most widely held misconception about bankruptcy is that its the debtors version of the get out of jail free card in Monopoly. While most people know that bankruptcy affects your credit for 7 to 10 years, very few people know that its possible that youll have to pay back the debt anyway, even if you file a Chapter 7 straight bankruptcy. The formal definition of bankruptcy is a proceeding in federal court in which an insolvent debtors assets are liquidated and the debtor is relieved of further liability. On the other hand, the commonplace definition of bankruptcy is probably the process of completely wiping out your debts for free. In the majority of cases, the latter definition may be appropriate, but in some scenarios, its likely that even with bankruptcy, youll still have to pay back at least a portion of the debt.
So when is it likely that youll have to pay back your debts? Here are the most common scenarios when youll get all the negatives of filing bankruptcy (severe credit impact for 7 to 10 years), but none of the benefits (youll still have to pay back at least part of the debt):
1) You make more than the average person in your state. If this is the case, then its likely that youll be forced into a Chapter 13 bankruptcy plan. In a Chapter 13 bankruptcy, the court orders that you pay all your disposable income to a court appointed trustee, who in turn disburses payments to your creditors. Keep in mind that the court determines your disposable income by national and county statistics on average necessary expenses, not what youre paying. So just because youre paying a lot for a car doesnt mean the court will approve it. There are numerous cases when a judge ordered families to stop sending their children to private schools so they can have more money to pay back their creditors. In Illinois, here are the latest statistics on the Illinois median income by size of household:
Illinois Estimate
1-person families 41,650
2-person families 52,891
3-person families 62,176
4-person families 72,368
2) You have assets. If you own a home or car, then its possible that the bankruptcy court will force you to sell them to generate sufficient cash to pay back your creditors. Chances are if have a good chunk of change invested (unless its in a tax-exempt account like an IRA) then youll also be forced to liquidate it. If you have a second home or another vehicle (assuming you own both completely), then youre really out of luck. Fortunately, there are some safeguards to protect consumers from bankruptcy hell. In Illinois, every resident is entitled to at least $7,500 of the value of their home, $1200 of the value of their vehicle, and $2,000 for anything that they want (known as the wildcard exemption). Also, these values double if youre married (assuming the property is in both of your names).
What does this actually mean? Consider the following example.
Lets say you have a house thats worth $250,000, and its in both yours and your wifes name. You still owe about $200,000 on your mortgage, and you decided to file Chapter 7 bankruptcy. In this example, you would be forced to sell your home, and with the proceeds you would pay back the mortgage company what you owe on the outstanding balance of the loan ($200,000), youd pay yourself the Illinois real estate exemption ($15,000), and then youd pay back your other creditors whatever was left ($250K-200K-15K=$35,000).
Let say your house was only worth $215,000, but everything else in the above example remained the same. In this case, you wouldnt be forced to sell your home because the proceeds from the sale wouldnt amount to anything after you paid back the mortgage company and then paid back yourself the Illinois real estate exemption.
3) The creditors can prove that you were fraudulent and never had any intention of paying them back.
For the majority of us it means that unless a) you dont have a lot of equity in any of your property, b) you dont have any investments like stocks, real estate, ect., c) you dont care about having to sell anything mentioned in points a and b, or d) you dont care about having to give up your disposable for 5 years in a Chapter 13, then bankruptcy may not be your best option.
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