Filing for bankruptcy is one of the hardest financial decisions a person can make. It’s easy to feel paralyzed by the prospect, and awareness of the stigma attached to bankruptcy can lead to emotional and psychological distress. But bankruptcy is a legal process that exists to help people resolve debts that they are unable to pay and to get a fresh start. For most, it means a chance to take control of their finances, free from the fear of harassment by debt collectors and the devastating threat of losing everything!
Bankruptcy may be a great tool, but is not a magic wand; it won’t solve all of your problems. There are rules about what debts can be discharged, what property you can keep, and what chapter of bankruptcy you can file under.
This blog will walk you through these elements and explain what debts can and cannot be wiped out in bankruptcy. It will also explain what the differences between Chapter 7 and Chapter 13 bankruptcy are, and what assets you can keep when you file!
Which Debts Are Eliminated During Bankruptcy?
One common motivation for individuals to file for bankruptcy is to eliminate specific debts, providing them with much-needed relief and the opportunity to start over. But not all of your debts will be treated equally under bankruptcy law. Let us take a closer look at what it means to have certain debts discharged when you file for bankruptcy.
Unsecured Debts Eligible for Discharge
Unsecured debts—those that aren’t backed by collateral—are typically dischargeable in bankruptcy and include:
- Credit card debt
- Medical bills
- Personal loans
- Utility bills
- Certain types of unsecured loans
These types of debts often make up a large portion of what people struggle with, and their discharge can provide significant relief.
Secured Debts and Reaffirmation
Secured debts, such as your mortgage or car loan(s), are based on collateral—property—and bankruptcy could help you manage the debt, but it might not fully discharge it unless you want to lose the property tied to the loan. In some cases, you could be required to reaffirm the debt, agreeing to continue paying it if you want to keep the asset. If you want to keep your home or car, you might have to keep making payments after you file for bankruptcy.
What Debts Cannot Be Discharged?
Bankruptcy can lead to a fresh start, but it doesn’t mean a completely clean slate depending on your situation. While bankruptcy allows you to eliminate most kinds of debt, some types debts will not be discharged, which means they never go away and must be repaid. Understanding which debt will stick around after your bankruptcy filing can help you better plan for your financial future.
Non-Dischargeable Debts
Some of the most common debts that cannot be discharged in bankruptcy include:
- Student loans: In most cases, student loans are not eligible for discharge. Exceptions are rare and usually require demonstrating significant hardship.
- Child support and alimony: Obligations to pay child support or alimony remain intact after bankruptcy.
- Recent tax debts: While older tax debts may be eligible for discharge, recent tax obligations generally are not.
- Court fines and penalties: Debts related to criminal fines or penalties are also non-dischargeable.
- Debts resulting from fraud: If a debt is found to have been incurred through fraudulent activity, it cannot be discharged.
The Key Differences Between Chapter 7 and Chapter 13 Bankruptcy
If you are considering bankruptcy, it is important to be aware of the differences between Chapter 7 and Chapter 13 bankruptcy because each is a different method of relief with different consequences, depending on your particular circumstances. Each chapter affects how your debts are handled, how your property is treated, and what your personal financial future may look like after a bankruptcy.
Chapter 7 Bankruptcy
Chapter 7 bankruptcy is known as a “liquidation bankruptcy” because debtors must sell some non-exempt assets to pay back creditors. This type of bankruptcy is typically reserved for people who are earning little or are unable to repay their debts. Here’s what you need to know about Chapter 7.
- Eligibility: To file under Chapter 7, you must qualify for it according to the statewide median income for Texas. Your income must be less than that amount to automatically qualify. If your income exceeds the statewide median, you will be required to undergo a “means test” to determine your ability to repay your creditors after covering your living expenses.
- Discharge process: Unsecured debts that can be discharged include credit card debt, medical bills—basically, almost everything collectible (Chapter 13 bankruptcies are different), with filing to discharge taking three to six months in a Chapter 7 bankruptcy.
- Asset liquidation: The bankruptcy trustee assigned to your case will evaluate your assets and determine whether any can be liquidated to pay your creditors. But Texas has some of the most liberal bankruptcy exemption laws in the country (see below), and, depending on your circumstances, many of your assets will be protected from liquidation.
Chapter 13 Bankruptcy
Chapter 13, also known as a “wage earner’s plan”, allows people with a steady income to establish a plan to pay their debts over three to five years. Chapter 13 doesn’t involve liquidation of assets like Chapter 7; it’s a structured, formalized way to bring up-to-date any secured debts while giving you breathing room to keep your property from foreclosure or repossession.
- Repayment plan: In Chapter 13, you propose a repayment plan to the court. The length of your repayment plan will range from three to five years. Each month during this time, you make payments to a bankruptcy trustee, who then distributes the money to your creditors.
- Secured debt: Chapter 13 is especially good for people who are behind on secured debts such as mortgages or car loans. You can catch up on these payments over the life of the plan so that you don’t have to lose your home to foreclosure or your car to repossession. In addition, Chapter 13 allows you to reduce your debt by securing debt down to the asset’s value.
- Discharge: Those eligible unsecured debts that you still have at the end of the repayment period are canceled, meaning you’re no longer legally obligated to pay. This might include medical expenses, credit card bills and personal loans.
Limitations of Chapter 13:
Although Chapter 13 is attractive for all these reasons, it does have some drawbacks. The most important downside is that it requires you to remain on a repayment plan for three or five years. Each month, that plan will require that you pay a certain portion of your disposable income toward your debts. Also, if you don’t make your payments, the judge could dismiss your case and allow the creditors to once again seek to collect on your debt.
Texas-Specific Bankruptcy Considerations
- Texas Homestead Exemption
One of the most important protections to Texas residents is called the homestead exemption. Unlike most states, which exempt only a certain dollar amount of the value of your home equity, in Texas you can exempt the total amount of your primary residence. If you live in a city, town or village, the homestead is limited to 10 acres. If you live in a rural area, you can exempt up to 100 acres for an individual, or 200 acres for a family. For people filing bankruptcy, this could be the difference between keeping their home and losing it.
- Personal Property Exemptions
Beyond the homestead exemption, you can also protect a good deal of other personal property in bankruptcy under Texas law, including:
- Personal Cars: The value of one car per licensed person per household can be excluded. This is a good one for families with more than one car.
- Retirement Accounts and Pensions: When filing for bankruptcy in Texas, most retirement accounts – including 401(k)s, IRAs, and pensions – will be exempt from creditor claims.
- Personal Property: Up to $100,000 of personal property may be exempted for a family, and $50,000 for individuals. This includes household furnishings, tools of trade, livestock, etc.
These large exemptions mean that Texas is one of the friendliest states in the nation for bankruptcy filers who would prefer to shelter larger amounts of property.
Other Factors to Consider
- Selection of exemptions: Texas provides residents with a choice between a federal exemption and a state exemption. The Texas exemptions are often more generous (especially in the context of home equity), but a bankruptcy attorney should carefully review both with you.
- Community property laws: Texas is a community property state. Unless there is a prenuptial agreement, all property purchased during marriage is generally treated as being owned equally by both parties. Community property is a big issue in bankruptcy. Married couples who are filing for bankruptcy need to understand how community property laws may impact their case.
Bankruptcy as a Path to Financial Freedom
While bankruptcy is a major decision, it can also lead to a clean slate. Whether you pursue a full Chapter 7 bankruptcy or a Chapter 13 restructuring, knowing your Texas exemptions and how they protect you from liquidation can help you to better realize the fresh start that bankruptcy can provide.
If you are thinking about filing bankruptcy, it’s best to speak with an experienced attorney familiar with Texas law. Having the right attorney can mean the difference between getting the financial fresh start that you need while preserving or protecting as much of your property as you can. At Ted Machi & Associates, we help clients every day work through the details of the bankruptcy process so they can get the fresh start they deserve.
If you are ready to file a petition for bankruptcy or simply want to explore your options, reach out to our office today for a free consultation and see how we can help.