What Constitutes an Economical Chapter 7 Bankruptcy?
In the previous post, I described a situation where a debtor has suddenly had their paycheck garnished by 25%, which is usually a catastrophic change to the household finances. In a case involving garnishment, economics are governed simply by “how can we turn this garnishment off?” But in other cases, the debtor may simply realize that there is too much debt that will never be resolved by repayment. In these cases, we need to look at whether a bankruptcy is an economical option for the debtor. This is a pretty simple, but flexible, look at the costs of the bankruptcy versus the debt that will be discharged. To keep the story simple, I’m going to break this into three scenarios.
The Economical Bankruptcy. First, the cost of filing a bankruptcy is substantial. My ordinary fee for a Chapter 7 is presently $1,500, and the court fees for a Chapter 7 are an additional $335. Thus, the direct cost is $1,835. In most cases, the bankruptcy fee and costs are paid up front, before the bankruptcy is filed. Alternatives will be discussed in a future post. Bottom line, if you are going to pay $1,835, you want the benefit of the bankruptcy to be far greater than that number. If your debt totals $5,000, you may be able to reach a compromise with the creditor where you can pay less than this amount to settle the debt. But even if you would have to pay the creditor the whole $5,000, this is probably not an economical bankruptcy, because there are additional costs to filing a bankruptcy that are less direct than the dollars. The bankruptcy requires a time commitment of several hours over the course of the entire proceeding, and work getting documents together for the attorney. I generally view the economic break even point of a bankruptcy as somewhere between $10,000 and $20,000. Individual circumstances dictate whether the number is lower or higher. Generally speaking, the more urgent the situation, the more economical $10,000 seems (garnishment, eviction, repossession of vehicle, civil lawsuit being filed).
The More Difficult Situation. Unfortunately, there are circumstances where a Chapter 7 simply will not solve the problem. One reason can be that the nature of the debts makes them non-dischargeable. Usually, this means taxes or student loans. Most kinds of consumer debt like credit cards, medical debt, payday loans, personal debts, civil judgments, and others are all dischargeable. But the tax man simply cannot be discharged, and currently student loans are only dischargeable in rare situations of undue hardship. Also, if debtors make over the median income for the household size, they may not qualify for Chapter 7. Further, a Chapter 7 will not stop a foreclosure. In many of these cases, a Chapter 13 can be another option for addressing a situation where a Chapter 7 is unavailable. Sometimes, even a Chapter 13 is not a good fit, but this requires a close look at the numbers by the bankruptcy attorney. If there is one major advice that I can give, it is to pay the IRS and state taxing authorities first before private creditors. Student loans are certainly important as well, but less so than the tax authorities, because student loans can be eligible for deferral or income based repayment.
The Easier Situation. The final scenario I would like to mention is the one where a short sentence or two of advice can go a very long way. Social security income, retirement pension income, child support, and public benefits are not subject to garnishment by a private creditor. Thus, there have been many times that I have been approached by a retired person on a fixed income and very few assets, and that person has not even needed bankruptcy protection because they are judgment proof. Even if it was a $1,000,000 judgment for a credit card debt, the creditor would not be able to garnish $1 from that person’s social security. All of a sudden, those creditor phone calls get a lot easier to handle, because this little bit of knowledge has shifted all of the power in that conversation. As a caveat, there can certainly be situations where it makes sense for an older person to file a Chapter 7 bankruptcy to avoid the creditors going after that person’s estate. For instance, even though the $80,000 house is exempt during the debtors’ lives, after they are gone, they would probably rather leave the house to their heirs than to pay off the old $20,000 credit card bill. Note also that an affidavit can be filed with the bank stating that the account includes only social security funds, which can prevent an inappropriate garnishment of those funds.
In summary, a Chapter 7 bankruptcy costs a little less than $2,000, so most economical bankruptcies involve at least $10,000 in dischargeable debts. Every situation is unique, and that is where the conscientious bankruptcy attorney can tailor legal advice to your specific needs.