10 Things Bankruptcy Court Won't Tell You

1. “Personal bankruptcy’s not just for the poor.”

Linda Frakes, an entrepreneur in Georgia, built a life around her six-figure income. But when her new business collided with the credit crunch, Frakes found herself facing a financial fate she never anticipated. “It’s a far way to fall,” she says. Meet the new face of bankruptcy. This nation’s worst downturn in 70 years pushed more formerly affluent people into bankruptcy than in previous recessions. Overall, personal bankruptcy filings were up 36.5 percent in the first half of 2009 from the same time a year ago, and experts predict the number of filings will keep rising even as the economy recovers.

Leslie Linfield, executive director of the Institute for Financial Literacy, calls it “a middle-class recession”: Last year the institute surveyed likely bankruptcy filers and found 8.1 percent made more than $60,000, up from 6.9 percent in 2007. Experts blame the increase on slumping real estate and job losses, which have cut deeply into professional positions. Claire Ann Resop, a bankruptcy attorney in Madison, Wis., sees a
lot of mortgage brokers and real estate developers: “They made a lot of money, and now they can’t.”

2. “When it comes to bankruptcy, one size doesn’t fit all.”

No type of bankruptcy will eliminate certain kinds of obligations, like child support, alimony and most student loans. But there are differences in the way debt gets handled in personal bankruptcy, often depending on which kind you file for, either Chapter 13 or Chapter 7. And each has pros and cons. Chapter 13 allows those with regular income to repay debts over three to five years. That drags things out a bit, but it stops the foreclosure process, meaning debtors behind on their mortgage can keep their house and catch up on payments over time. Those without regular income must file Chapter 7, which involves no payment plan—all eligible debt, such as credit card balances, gets wiped out. But it’s hardly a free pass. Most debtors find the process pretty traumatic, not to mention severely damaging to their credit score. And Chapter 7 doesn’t stop foreclosure, so banks can still take the homes of debtors behind on a mortgage.

How do you know which form is right for you? Bankruptcy law is complex, and certain provisions vary from state to state, so it’s often best for potential filers to consult an attorney before deciding.

3. “We don’t want your house if we can’t get good money for it.”

A common belief about bankruptcy is that it will leave you with nothing, living out of a cardboard box, says Cathleen Moran, a bankruptcy lawyer in Mountain View, Calif. But that’s not necessarily true, even in Chapter 7 cases. In theory, Chapter 7 involves liquidating most of a debtor’s assets to pay creditors, including the home. But in reality, homeowners who end up filing often don’t have enough equity in their home to benefit creditors, either because they’ve taken out a second mortgage, the home’s value has fallen or both. In such cases, the trustee handling the bankruptcy can decide not to liquidate the home, in which case the debtor gets to keep it.

Also, there’s something called the homestead exemption, which in most circumstances allows you to keep your primary residence if your equity in it is below a certain threshold. It can vary widely from state to state: from $30,000 for a married couple filing Chapter 7 in Illinois, for example, to $75,000 for the same in California. But since Chapter 7 doesn’t stop foreclosure—although it tends to delay it by a few months—those behind on their mortgage often can lose their home regardless.