Intro

If you've picked up this book, you probably have more debt than you can handle. Most likely, your debt mushroomed because of circumstances beyond your control -- job loss, divorce, business failure, illness, or accident. You may feel overwhelmed by your financial situation, and uncertain about what to do next. Maybe a friend, relative, or even a lawyer suggested bankruptcy, describing it as the best thing in the world for you. Someone else may have said the opposite -- that bankruptcy is a huge mistake and will ruin your life.

This book will help you sort through your options and choose the best strategy for dealing with your debts. It explains:

• how the new bankruptcy law works
• how filing for bankruptcy under Chapter 7 or Chapter 13 (the two bankruptcy options for consumers) will affect your debts, property, home, and credit
• the procedures you'll have to follow (and paperwork you'll have to complete) to file for bankruptcy, and
• some alternative ways to handle your debt problems, outside of the bankruptcy system.

Armed with this information, you'll be ready to decide whether filing for Chapter 7 or Chapter 13 bankruptcy makes sense for you.

As you consider the strategies available to you, keep in mind that you're not alone. During each of the first five years of the new millennium, more than 1.5 million Americans filed for bankruptcy. So did thousands of companies. Although filings dropped dramatically just after the new law took effect, bankruptcy remains a necessary and pervasive part of our economic system.

And bankruptcy may be right for you. You may be able to stop creditor collection actions (such as foreclosures, wage garnishments, and bank account levies) and:

• wipe out all or most of your debts in a Chapter 7 bankruptcy while hanging on to your home, car, and other necessary items, or
• use Chapter 13 bankruptcy to pay back a portion of your debts over three to five years.

If your debts are overwhelming and your creditors are hounding you, bankruptcy may seem like a magic wand. But bankruptcy also has its drawbacks. And, because everyone's situation is a little bit different, there is no one-size-fits-all formula that will tell you whether you absolutely should or should not file. For many, the need for and advantage of bankruptcy will be obvious. Others will be able to reach a decision only after closely examining their property, debts, income, and recent financial transactions -- and how persistent their creditors are. For some, simple non-bankruptcy options might do the trick -- these are explained in Ch. 11 of this book.

This chapter provides some basic background information about the two types of bankruptcies most often filed by individuals: Chapter 7 and Chapter 13. In the chapters that follow, you'll find more detailed information on the issues you are likely to face under the new bankruptcy law, including:

• whether you are eligible to file
• which debts will and will not be cancelled
• what will happen to your home, car, and other essential property items
• how your post-bankruptcy credit will be affected,
• how bankruptcy will affect your personal life, and
• whether you need to be represented by a lawyer or can represent yourself, perhaps with some outside help.

Bankruptcy laws have changed. As you know from this book's title, Congress recently made big changes to the bankruptcy laws -- and these changes will affect the filing options and decisions of many readers. One major new requirement has to do with eligibility: Filers with higher incomes (as measured against the median family income for their state) may not be allowed to file for Chapter 7 at all, and will have to pay back more of their debts, over a longer period of time, if they file for Chapter 13. (You can find more on these requirements in Ch. 2.) And this is just one of the many changes. The new law leaves few areas of bankruptcy untouched, so you shouldn't assume that anything you thought you knew about bankruptcy before October 2005 is still correct: You may be unpleasantly surprised. The most important changes are described at the end of this chapter; each subsequent chapter concludes with a brief summary of the new rules covered in that chapter.

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Types of Bankruptcy

There are two kinds of bankruptcy: "liquidation" and "reorganization." In a liquidation bankruptcy (referred to as a Chapter 7 bankruptcy because of its location in the Bankruptcy Code), some of your property might be sold (liquidated) to pay down your debt; in exchange, most or all of your debts will be wiped out. Individuals can file for Chapter 7 (a "consumer" Chapter 7 bankruptcy) as can businesses (a "business" Chapter 7 bankruptcy). A Chapter 7 bankruptcy typically lasts three to six months.

In a reorganization bankruptcy, you devote part of your income to paying down your debt over time. There are three different kinds of reorganization bankruptcies:

• Chapter 13 bankruptcy is for individuals only.
• Chapter 11 bankruptcy is for businesses and for individuals with very large debts.
• Chapter 12 bankruptcy is for individuals whose debts come mainly from the operation of a family farm.

This book focuses exclusively on consumer Chapter 7 bankruptcies and Chapter 13 bankruptcies. However, Chapter 11 and Chapter 12 bankruptcies are briefly described in Ch. 11.

Chapter 7 Bankruptcy

This section answers some common questions about Chapter 7 bankruptcy.

How a Chapter 7 Case Begins

To begin a Chapter 7 bankruptcy case, you must first complete a two-hour credit counseling session that typically costs about $50. When you file for bankruptcy, you must either include a certificate provided by the counseling agency that shows you've completed the counseling or certify that you've done the counseling and will file the certificate of completion within 15 days. There are a few exceptions to this requirement, discussed in Ch. 2.

Once you've completed your counseling, you can actually file for bankruptcy by completing a packet of forms and filing them with the bankruptcy court in your area. Perhaps the most important form -- made necessary by the new bankruptcy law -- requires you to compute your average income during the six months prior to your bankruptcy filing date and compare that to the median income for your state. If your income is above the median, the same form takes you through a series of questions (called the "means test") designed to determine whether you could file a Chapter 13 bankruptcy and pay some of your unsecured debts over time. The outcome of this test will determine whether you will be allowed to file for Chapter 7 bankruptcy. (See Ch. 2 for detailed information about these calculations and other Chapter 7 eligibility requirements.)

In addition to completing the means test form and the petition, you must also complete forms that provide information about your property, debts, current income and expenses, and prefiling economic transactions. If you are making payments on a car or other personal property, you will have to file another form stating how you wish to handle those debts after bankruptcy. As explained in detail in Ch. 6, you will have the choice of:

• giving the property back to the creditor and wiping out the debt
• paying the value of the property to the creditor in a lump sum and keeping the property (this is called "redemption"), or
• agreeing to continue the contract and make the payments after your bankruptcy is final, so you can keep the property (this is called "reaffirmation").

The laws of some states may give you an additional option of getting rid of the debt while keeping the property, as long as you stay current on your payments.

You can find information in Ch. 9 on all the forms you need to file in a Chapter 7 bankruptcy.

Which Debts Are Discharged

In a Chapter 7 bankruptcy, you get to cancel, or "discharge," many types of debts. As a general rule, most credit card, medical, and legal debts are discharged, as are most court judgments and loans. Many filers can discharge all of their debts.

However, some debts are not discharged in Chapter 7 bankruptcy. The most common of these are:

• debts incurred to pay nondischargeable taxes
• court-imposed fines
• back child support and alimony
• debts owed under marital settlement agreements
• loans owed to a pension plan
• student loans (unless you can show that repaying the loans would be an undue hardship, which is tougher than you might think)
• recent back taxes, and
• debts for personal injuries or death resulting from your drunk driving.

Some types of debt will not be discharged if -- and only if -- the creditor gets a court order that the debt will survive bankruptcy. These are: debts arising from your fraudulent actions, recent credit card charges for luxuries, and willful and malicious acts causing personal injury or property damages. (For more on which debts are and are not discharged in a Chapter 7 bankruptcy, see Ch. 3.)

Which Property Is at Risk

The sum total of your property that is subject to the bankruptcy court's control is called your bankruptcy estate. In a Chapter 7 bankruptcy, a trustee exercises legal control over your bankruptcy estate (see "The Bankruptcy Trustee," below). Your bankruptcy estate consists of all the property you own on the date you file, property you recently transferred to others for less than it's worth, and a few types of property you reasonably expect to own in the near future. (See Ch. 4 for more information about what is and is not in your bankruptcy estate.)

In return for having your debts discharged, the trustee may sell any property in your bankruptcy estate that isn't exempt under applicable state or federal bankruptcy laws, then distribute the proceeds to your creditors. In some cases, an item is exempt regardless of its value (for example, a state's exemption laws might allow you to keep a burial plot, a piano, and/or your clothing). Sometimes, there are limits on an exempt item's value. For example, debtors who use the Georgia exemptions may keep jewelry only up to a $500 limit. If your wedding ring is worth $1,000, the bankruptcy trustee can take the ring, sell it, give you your $500 exemption, and pay the rest to your unsecured creditors.

In your bankruptcy papers, you must tell the court which property you claim is exempt under the exemption laws available to you. Under the new bankruptcy law, you must use the exemptions for the state where you have been living for the two-year period prior to filing. If you haven't lived in your state for two years, you must use the exemption laws for the state where you were living before that two-year period began. (Some states allow you to choose between their exemption laws and a special set of federal exemptions -- you can use whichever rules allow you to keep more of the property you really want.)

Exemptions are a bit complicated -- and they are very important, because they determine what you get to keep (and what you may lose) when you file for Chapter 7 bankruptcy. Ch. 4 explains exemptions in detail, including how to figure out which state's exemptions are available to you and how to apply those exemptions to the property you own.

Houses and Cars

Property you are making payments on -- such as a house or car -- is treated a little differently than property you own outright. If your equity in property you are making payments on doesn't exceed the exemption available to you, you can keep the property as long as you continue making the payments. For example, if you owe $10,000 on a truck that's worth $9,000, you can keep the truck as long as you keep making the payments. You'll remain on the hook for the full $10,000 debt if something happens to the truck or you stop your payments. This is called "reaffirmation."

If your equity is worth significantly more than the exemption allows, the trustee can:

• sell the property
• pay off the creditor for that property (the bank that lent you the money to buy the car or house, most likely)
• give you what you're entitled to under the applicable exemption law, and
• distribute what remains to your unsecured creditors.

For example, if you owe $4,000 on a car that's worth $12,000, and your state's exemptions allow you to keep only $2,000 worth of equity in a motor vehicle, the trustee can sell your car, pay off the $4,000 note, give you $2,000 for your exemption, and use the rest to pay your creditors.

Later chapters include detailed information on exemptions. Ch. 4 covers exemptions in general, Ch. 5 explains exemptions for a home, and Ch. 6 covers cars and other property that secures a loan.

Costs and Fees

The filing fee for a Chapter 7 bankruptcy is $299. If you can't afford the fee, you can apply for a fee waiver or permission to pay in installments. The form, rules, and eligibility guidelines for getting a fee waiver are available at www.uscourts.gov/bankruptcycourts/resources.html. If you want to be represented by a lawyer, you will likely have to pay an additional $1,500 to $2,000 in attorneys' fees.

If you decide to handle your own case, you will probably want to buy some outside help. This will typically consist of one or more of the following:

• one or more do-it-yourself books on bankruptcy (roughly $30 a pop)
• telephonic legal advice from a lawyer (roughly $100 an hour), and
• clerical assistance with your forms from a bankruptcy petition preparer (between $150 and $200).

See Ch. 10 for more on resources you can use to file for bankruptcy.

The Meeting of Creditors

When your Chapter 7 bankruptcy is filed, the court will set a date for an event called the meeting of creditors. You are required to appear at this meeting, often referred to as a "341 meeting" because it is covered in Section 341 of the Bankruptcy Code. The meeting is held outside of court, in a separate hearing room in the bankruptcy courthouse or another federal building. The bankruptcy trustee who has been assigned to your case runs the meeting. No judge is present. In most Chapter 7 bankruptcies, this is the only personal appearance the debtor has to make.

At the creditors' meeting, the trustee asks you questions about the information in your filing paperwork and about other issues in your case that might affect your ability to obtain a bankruptcy discharge or have a particular debt erased. For example, the trustee might inquire further about:

• anticipated tax refunds
• recent large payments you made to creditors or relatives, if applicable
• methods you used to arrive at the value of big-ticket property items you are claiming as exempt, such as a house or car
• whether you should be required to proceed under Chapter 13 rather than Chapter 7
• your failure to file any of the required documents, if applicable
• inconsistencies in information you provided that might indicate you are being less than honest, and
• if you didn't have a lawyer prepare your papers, how you got the information necessary to make certain choices, such as which property is exempt (your answer would typically be the Internet, a Nolo book, or a telephone advice lawyer).

If you've done a good job on your paperwork, you clearly qualify for Chapter 7, and you filed all required documents, your particular "moment of truth" will likely be brief. Creditors rarely show up at these meetings, and the trustee is typically the only one asking the questions. The trustee may simply ask whether all the information in your papers is 100% correct and end the meeting if you say, "Yes."

Issues That Must Be Decided by a Judge

Chapter 7 bankruptcy is designed to run on automatic, without the need for a judge to decide contested issues. However, you (and/or your attorney, if you have one) will need to appear in court if:

• your income appears to make you ineligible for Chapter 7 bankruptcy and you want to argue that an exception should be made in your case
• a creditor contests your right to file for Chapter 7 bankruptcy or discharge a particular debt
• you want the judge to rule that you are entitled to discharge a particular type of debt (such as taxes or student loans -- see Ch. 3 for more information on debts that can be discharged in Chapter 7 bankruptcy only with the judge's approval)
• you want to eliminate a lien on your property that will survive bankruptcy if the judge doesn't remove it (see Ch. 9), or
• you are handling your own case, are making payments on a car or other personal property, and want to keep the property and continue the contract after bankruptcy. This is called "reaffirming" the contract. (See Ch. 6 for more on reaffirmation agreements.)

See Ch. 9 for more on these and other types of issues that require action by a judge.

How a Chapter 7 Case Ends

Chapter 7 bankruptcy ends with a discharge of all the debts you are entitled to discharge. (For information on which debts can be discharged in Chapter 7, see Ch. 3.) When a debt is discharged, the creditor is forever barred from trying to collect it from you or reporting it to a credit bureau. Government entities may not discriminate against you simply because you've received a bankruptcy discharge, but private companies can in some circumstances. (See Ch. 8 for more on the consequences of receiving a bankruptcy discharge.)

If you file for Chapter 7 bankruptcy and then change your mind, you can ask the court to dismiss your case. As a general rule, the court will do so unless it would not be in the best interests of your creditors. For example, your request to dismiss might be denied if you have nonexempt assets that the trustee could sell to raise money to pay your creditors.

Example: Jake files for Chapter 7 bankruptcy, thinking all of his property is exempt. Shortly after he files, Jake's mother tells him that he is on the deed for a 20-acre ranchette that he, his sister, and his mother inherited from his father. Under the exemption laws applicable to Jake's bankruptcy, his share of the ranchette is not exempt and can be taken by the trustee for the benefit of Jake's unsecured creditors (which means the property will have to be sold). Upon learning this, Jake tries to dismiss his bankruptcy. His request is denied because it would not be in the best interest of Jake's creditors. The moral? Don't file Chapter 7 unless and until you know what property you own and what will happen to it in bankruptcy.

If you do dismiss your case, you can file again later, although in some circumstances you may have to wait 180 days and pay a new filing fee. Instead of dismissing your Chapter 7 case, you can always convert it to another type of bankruptcy for which you qualify (typically Chapter 13 for consumers).

Chapter 13 Bankruptcy

Chapter 13 bankruptcy works quite differently from Chapter 7 bankruptcy. In Chapter 13, you use a portion of your income to pay some or all of what you owe to your creditors over time (anywhere from three to five years, depending on your income and how much of your debt you can afford to repay). The trick to successfully using Chapter 13 to get out of debt is to make sure you have enough income to meet all of your payment obligations under the Chapter 13 laws. (See Ch. 2 to learn about the eligibility requirements for filing under Chapter 13.)

How a Chapter 13 Case Begins

To begin a Chapter 13 bankruptcy, you must complete a credit counseling course, then fill out and file a packet of forms -- mostly the same forms as you would use in a Chapter 7 bankruptcy, as well as:

• a workable plan to repay some or all of your debts over the plan period (either three or five years, depending on your income)
• proof that you've filed your federal and state income tax returns for the previous four years, and
• your most recently filed IRS income tax return (or transcript). (See Ch. 9 for more on Chapter 13 paperwork.)

The Repayment Plan

Under a Chapter 13 plan, you make payments, usually monthly, to the bankruptcy trustee, the official who oversees your case. The trustee uses that money to pay the creditors covered by your plan and to pay his or her own statutory fee (usually 10% of the amount to be paid under your plan).

Under Chapter 13, you are required to devote all of your projected disposable income (the amount left over after paying your expenses) to your plan for either a three-year or five-year period. Your repayment period will be three years if your gross average income over the six months before you file is below your state's median income and five years if it is above. (See Ch. 2 for more on making this calculation.)

Some creditors are entitled to receive 100% of what you owe them, while others may receive a much smaller percentage or even nothing at all. For example, a Chapter 13 plan must propose that any child support you owe to a spouse or child (as opposed to a government agency) will be paid in full over the life of your plan; otherwise, the judge will not approve it. On the other hand, the judge could approve a plan that doesn't repay any portion of your credit card debts if you won't have any projected disposable income left after paying your back child support obligations.

One of the oddities of the new law is that your projected disposable income may be different than your actual disposable income. The new law calculates your projected disposable income based on your average income over the six-month period prior to your filing date. For example, if your income was $8,000 a month for the first three months of that period and $4,000 for the second three months, your projected monthly disposable income will be $6,000 -- the six-month average -- even though your actual income through the life of the plan may only be $4,000. (Ch. 2 explains projected disposable income in more detail, as well as how these figures and requirements might be juggled to come up with a workable repayment plan that a judge will approve.)

To have your debts discharged under Chapter 13, you must usually make all payments required by your plan and:

• remain current on your federal and state income taxes
• remain current on any child support or alimony obligations
• annually file your federal income tax return or transcript of the return with the court, and
• annually file an income and expense statement with the court.

You also have to provide your creditors with copies of the income tax returns or transcripts you file with the court, if they request it.

Which Debts Are Discharged

If your Chapter 13 bankruptcy pays your unsecured debts in full, then you will receive a complete discharge of those debts no matter what type they are. If your plan pays less than 100%, the balance will be discharged unless they are the type of debts that aren't discharged in Chapter 13 bankruptcy.

As a general rule, most credit card, medical, and legal debts are discharged, as are most court judgments and loans. Debts that have to be fully paid to be discharged in a Chapter 13 bankruptcy are:

• court-imposed fines and restitution
• back child support and alimony
• student loans
• recent back taxes
• unfiled taxes, and
• debts you owe because of a civil judgment arising out of your willful or malicious acts, or for personal injuries or death caused by your drunk driving.

Debts arising from your fraudulent actions or recent credit card charges for luxuries will not be discharged if the creditor gets a court order to that effect. Ch. 3 explains which debts are discharged in a Chapter 13 bankruptcy.

Which Property Is at Risk in Chapter 13 Bankruptcy

Unlike Chapter 7, you are not required to give up any property you own when you file your Chapter 13 bankruptcy case. In Chapter 13, your income is used to pay off some portion of your debt, not your nonexempt property.

Houses and Cars

Filing for Chapter 13 bankruptcy lets you keep your house and car as long as you stay current on the payments. You can also pay off arrearages you owe when you file. For instance, if you are $5,000 behind on your mortgage payments, you can pay an extra amount into your plan to pay it off in a reasonable amount of time. That's why Chapter 13 is typically the remedy of choice if you are facing foreclosure. (See Ch. 5 for more on what happens to your home when you file for either type of bankruptcy.)

Costs and Fees

The filing fee for a Chapter 13 bankruptcy is $274. If you can't afford the fee, you can apply for a fee waiver. If you want to be represented by a lawyer, you will probably have to pay $2,500 to $4,000 in legal fees, which can be paid through your plan.

If you decide to handle your own case (as many do), you will want to buy some outside help. This will typically consist of one or more of the following:

• one or more self-help law books on Chapter 13 bankruptcy (roughly $40 a pop)
• telephonic legal advice from a lawyer (roughly $100 an hour), and
• clerical assistance with your forms from a bankruptcy petition preparer (between $150 and $200).

See Ch. 10 for more on resources you can use to file for bankruptcy.

The Meeting of Creditors

Shortly after you file your Chapter 13 bankruptcy petition (usually within about a month), the court will schedule a meeting of creditors and send an official notice of the bankruptcy filing and the meeting to you and all of your creditors. You (and your spouse if you have filed jointly) are required to attend. You'll need to bring two forms of identification -- a picture ID and proof of your Social Security number.

A typical creditors' meeting in a Chapter 13 case lasts less than 15 minutes. The trustee will briefly go over your paperwork with you. No judge will be present. The trustee is likely to be most interested in whether your repayment plan meets all legal requirements and whether you will be able to make the payments you have proposed. (See Ch. 2 for more on Chapter 13 requirements.) The trustee has a vested interest in helping you successfully navigate the Chapter 13 process because the trustee gets paid a percentage of all payments doled out under your plan.

The trustee will also make sure you have filed your tax returns for all taxable periods during the four prior years. If not, the trustee will continue the creditors' meeting to give you a chance to file these returns. You cannot proceed with a Chapter 13 bankruptcy unless and until you bring your tax filings up to date.

When the trustee is finished asking questions, any creditors who show up will have a chance to question you. Secured creditors often come, especially if they have any objections to the plan you have proposed as part of your Chapter 13 filing. They may claim, for example, that your plan isn't feasible, that you're giving yourself too much time to pay your arrears on your car note or mortgage, or that your plan proposes to pay less on a secured debt than the replacement value of the collateral property. (See Ch. 6 for more information on collateral and other property that secures a loan.)

An unsecured creditor who is scheduled to receive very little under your plan might show up, too, if that creditor thinks you should cut your living expenses and thereby increase your disposable income (the amount from which unsecured creditors are paid).

Come to the meeting prepared to negotiate with disgruntled creditors. If you agree to make changes to accommodate their objections, you must submit a modified plan. While any objections raised by creditors won't be ruled on during the creditors' meeting (because the judge won't be there), the trustee may raise these objections on behalf of the creditors at your confirmation hearing before the judge.

Issues That Must Be Decided by a Judge

Unlike Chapter 7, Chapter 13 bankruptcy requires at least one appearance in court. At this appearance, called the "confirmation hearing," the judge either confirms (approves of) your proposed plan or sends you back to the drawing board for various reasons -- usually because your plan doesn't meet Chapter 13 requirements. (For example, a judge might reject your plan because you don't have enough projected disposable income to at least pay your priority creditors in full and stay current on your secured debts -- such as a car note or mortgage.) For more information on the confirmation hearing, see Ch. 9.

You are entitled to amend your proposed plan until you get it right, or the judge decides that it's hopeless. Each amendment requires a new confirmation hearing and appropriate written notice to your creditors.

In addition to attending the confirmation hearing, you may need to go to court to:

• amend your plan (if necessary)
• value an asset (if your plan proposes to pay less for a car or other property than the creditor thinks it's worth)
• respond to requests by a creditor or the trustee to dismiss your case or amend your plan
• respond to a creditor who opposes your right to discharge a particular debt (perhaps because you engaged in fraud when incurring the debt)
• discharge a type of debt that can be discharged only if the judge decides that it should be (such as discharging a student loan because of hardship), or
• eliminate a lien on your property that will survive your Chapter 13 bankruptcy unless the judge removes it.

These procedures are described in Ch. 9.

How a Chapter 13 Case Ends

If you complete your full three- or five-year repayment plan, are current on your income tax returns and your child support or alimony payments, and complete a budget management course approved by the U.S. Trustee, the remaining unpaid balance on any of your debts that qualify for discharge will be wiped out. If any balance remains on a debt that doesn't qualify for discharge, you will continue to owe the unpaid amount. (The debts that qualify for discharge in a Chapter 13 bankruptcy are explained in Ch. 3.)

If you can't complete your Chapter 13 plan as written, you can ask the court to modify it. As long as it's clear that you're acting in good faith, the court is likely to approve your request. If it isn't feasible to modify the plan, you may still be able to get what's called a "hardship" discharge if:

• you failed to complete your plan due to circumstances "for which you should not justly be held accountable," and
• your unsecured creditors have received at least what they would have gotten if you had filed for Chapter 7 bankruptcy (that is, at least the value of your nonexempt property).

If the bankruptcy court won't let you modify your plan or give you a hardship discharge, you can:

• convert your Chapter 13 bankruptcy to a Chapter 7 bankruptcy, unless you received a Chapter 7 discharge in a case filed within the previous eight years (this is explained in Ch. 9), or
• dismiss your Chapter 13 case. This means you'll owe your creditors the balances on your debts from before you filed your Chapter 13 case, less the payments you made, plus the interest that accrued while your Chapter 13 case was open.

As you can see, Chapter 13 bankruptcy requires discipline. For the entire length of your case, you will have to live strictly within your means -- and even more strictly if your income exceeds the state's median income. The Chapter 13 trustee will not allow you to spend money on anything deemed nonessential. In past years, only about 35% of Chapter 13 plans were successfully completed. Many Chapter 13 filers dropped out early in the process, without ever submitting a feasible repayment plan to the court. Nevertheless, for the 35% of those who proposed a plan and made it to the end, the rewards often included an earlier and easier path to restoring good credit.

Which Type of Bankruptcy Is Right for You

Under the new bankruptcy law, some people will no longer have a choice between Chapter 7 and Chapter 13 bankruptcy -- they will have to file Chapter 13 and repay some of their debt. Most of those who still have a choice will probably want to file under Chapter 7, but there are some situations when Chapter 13 will be the better option.

Upper Income Filers Must Use Chapter 13

Under the old law, most people could choose to file under either Chapter 7 or Chapter 13 bankruptcy, as long as they met the eligibility requirements for their Chapter of choice. This is still the case under the new bankruptcy law, with one major exception. Those whose average income over the six months prior to filing is higher than the median monthly income for their state cannot file for Chapter 7 bankruptcy if their projected disposable income would allow them to pay their unsecured creditors at least $182 a month over a five-year period. (Eligibility requirements for Chapter 7 and Chapter 13 bankruptcies are explained in Ch. 2.)

Reasons to Choose Chapter 7

Most people who have a choice opt to file for Chapter 7 bankruptcy because it is relatively fast, effective, easy to file, and doesn't require payments over time. In the typical situation, a case is opened and closed within three to six months, and the filer emerges debt free except for a mortgage, car payments, and certain types of debts that survive bankruptcy (such as student loans, recent taxes, and back child support). In addition, few filers lose any property in Chapter 7 bankruptcy because state and federal exemption rules allow them to keep most necessities.

Of course, the new bankruptcy law has put a few more hurdles in the way of Chapter 7 filers. For example:

• attorneys' fees have doubled in many cases
• more documents have to be filed, including the most recent tax return and wage stubs for the 60 days prior to filing
• credit counseling and budget management education are mandatory, and
• people who have not lived in the state where they are filing for at least two years now have to use the exemptions for the state where they lived before the two-year period (see Ch. 4 for more on this rule).

Nevertheless, assuming they qualify, most people will still find it easier -- and more effective -- to file for Chapter 7 than to keep up with a long-term payment plan under Chapter 13.

If your Chapter 13 fails -- and historically, most do -- you have two options. You may be able to convert your case to Chapter 7 and discharge what remains of your unsecured debts (except those that aren't dischargeable), or you can handle your remaining debt outside of bankruptcy. If you choose to convert to Chapter 7, any money you paid into your plan for dischargeable debts will have been for naught.

Example: Frank files for Chapter 13 bankruptcy. His plan includes payment of an arrearage on his mortgage, current payments on his mortgage, and repayment of a portion of $50,000 worth of credit card debt. Frank remains current on his plan for three years, and then loses his job. In that three-year period, Frank, through the Chapter 13 trustee, cured the mortgage arrearage and paid off $12,000 worth of the credit card debt.

If Frank converts his case to Chapter 7, he can discharge all of the remaining credit card debt. But had Frank filed Chapter 7 from the beginning, he could also have discharged the $12,000 that was paid to the credit card companies under his Chapter 13 plan. If Frank decides to skip Chapter 7 and negotiate a repayment schedule for the remaining $38,000 outside of bankruptcy, Frank will at least have made a dent in the original $50,000 debt by filing for Chapter 13.

The moral of the story is that you should file for Chapter 7 in the first place if you have significant doubts about your ability to complete a Chapter 13 repayment plan.

Reasons to Choose Chapter 13

Although Chapter 7 is easier and doesn't require repayment, there are some good reasons why people who qualify for both types of bankruptcy choose Chapter 13 bankruptcy over Chapter 7 bankruptcy. Generally, you are probably a good candidate for Chapter 13 bankruptcy if you have adequate projected disposable income to fund your plan and are in any of the following situations:

• You are behind on your mortgage or car loan, and want to make up the missed payments over time and reinstate the original agreement. You generally cannot do this in Chapter 7 bankruptcy.
• Your car is reliable and you want to keep it, but it's worth far less than you owe. You can take advantage of Chapter 13 bankruptcy's option (for cars purchased more than 2 1/2 years prior to filing for bankruptcy) to keep the car by paying its retail value (in your Chapter 13 plan) rather than the full amount you owe on the contract.
• You have a tax obligation, student loan, or other debt that cannot be discharged in Chapter 7 bankruptcy, but can be paid off over time in a Chapter 13 plan. (Nondischargeable debts are discussed in Ch. 3.)
• You owe debts that can be discharged in a Chapter 13 bankruptcy but not in a Chapter 7 bankruptcy. For instance, nonsupport debts arising from a divorce can't be discharged in Chapter 7 but can be discharged in Chapter 13.
• You have a sincere desire to repay your debts, but you need the protection of the bankruptcy court to do so.
• You want to restore your good credit as soon as possible and a Chapter 13 bankruptcy facilitates that process.

How Bankruptcy Stops Collection Efforts

One of the most powerful features of bankruptcy is that it stops most debt collectors dead in their tracks and keeps them at bay for the rest of your case. Once you file, all collection activity (with a few exceptions, explained below) must go through the bankruptcy court -- and most creditors cannot take any further action against you directly.

You don't need bankruptcy to stop your creditors from harassing you. Many people begin thinking about bankruptcy when their creditors start phoning their homes and/or places of employment. Federal law prohibits this activity by debt collectors once you tell the creditor, in writing, that you don't want to be called. And if you orally tell debt collectors that you refuse to pay, they cannot, by law, contact you except to send one last letter making a final demand for payment before filing a lawsuit. While just telling the creditor to stop usually works, you may have to send a written follow-up letter. (See Ch. 11 for a sample letter.)

When you file for any kind of bankruptcy, something called the "automatic stay" goes into effect. The automatic stay prohibits creditors and collection agencies from taking any action to collect most kinds of debts you owe them -- unless the law or the bankruptcy court says they can.

Under the new law, however, the stay is not as automatic as it once was. In some circumstances, the creditor can file an action in court to have the stay lifted (called a "Motion to Lift Stay"). In others, the creditor can simply begin collection proceedings without seeking advance permission from the court.

The good news is that most common types of creditor collection actions are still stopped dead by the stay -- harassing calls by debt collectors, threatening letters by attorneys, and lawsuits seeking a money judgment for credit card and health care bills. This section explains the collection rules for various types of debts.

Credit Card Debts, Medical Debts, and Attorney Fees

Anyone trying to collect credit card debts, medical debts, attorney fees, debts arising from breach of contract, or legal judgments against you (other than child support and alimony) must cease all collection activities after you file your bankruptcy. They cannot:

• file a lawsuit or proceed with a pending lawsuit against you
• record liens against your property
• report the debt to a credit reporting bureau, or
• seize your property or income, such as money in a bank account or your paycheck.

Public Benefits

Government entities that are seeking to collect overpayments of public benefits such as SSI, Medicaid, or TANF (welfare) benefits cannot do so by reducing or terminating your benefits while your bankruptcy is pending. If, however, you become ineligible for benefits, including Medicare benefits, bankruptcy doesn't prevent denial or termination of the benefits on that ground.

Domestic Relations Proceedings

Almost all proceedings related to a divorce or paternity action continue as before -- they are not affected by the automatic stay. These include:

• the setting and collection of current child support and alimony
• the collection of back child support and alimony from property that is not in the bankruptcy estate (see Ch. 4 for more on what's in the bankruptcy estate)
• the determination of child custody and visitation
• a lawsuit to establish paternity
• an action to modify child support and alimony
• proceedings to protect a spouse or child from domestic violence
• withholding of income to collect child support
• reporting of overdue support to credit bureaus
• the interception of tax refunds to pay back child support, and
• withholding, suspension, or restriction of drivers' and professional licenses as leverage to collect child support.

Criminal Proceedings

If a case against you can be broken down into criminal and debt components, only the criminal component will be allowed to continue -- the debt component will be stayed while your bankruptcy is pending. For example, if you were convicted of writing a bad check and have been sentenced to community service and ordered to pay a fine, your obligation to do community service will not be stopped by the automatic stay (but your obligation to pay the fine will).

Landlord-Tenant Proceedings

With a few exceptions, the automatic stay does not stop the eviction of a tenant if:

• the landlord obtained a judgment prior to the bankruptcy filing, or
• the tenant is endangering the property or using controlled substances on it.

Ch. 5 explains when evictions on these grounds may occur. It also covers the new requirements imposed on both the tenant and the landlord if there is a dispute about whether an eviction can proceed.

Tax Proceedings

The IRS can continue certain actions, such as a tax audit, issuing a tax deficiency notice, demanding a tax return, issuing a tax assessment, or demanding payment of an assessment. The automatic stay does, however, stop the IRS from issuing a lien or seizing (levying against) any of your property or income.

Pension Loans

The stay doesn't prevent withholding from a debtor's income to repay a loan from an ERISA-qualified pension (this includes most job-related pensions and individual retirement plans). See Ch. 4 for more on how pensions are treated under bankruptcy.

Foreclosures

Although foreclosures initially are stayed by your bankruptcy filing, the stay won't apply if you filed another bankruptcy within the previous two years and the court, in that proceeding, lifted the stay and allowed the lender to proceed with the foreclosure. In other words, the law doesn't allow you to prevent a foreclosure by filing serial bankruptcies.

Utilities

Companies providing you with utilities (such as gas, heating oil, electricity, telephone, and water) may not discontinue service because you file for bankruptcy. However, they can shut off your service 20 days after you file if you don't provide them with a deposit or other means to assure future payment. They can also cut you off if you don't pay for services you receive after you file for bankruptcy.

Special Rules for Multiple Filers

If you had a bankruptcy case pending during the previous year, then the stay will terminate after 30 days unless you, the trustee, the U.S. Trustee, or the creditor asks for the stay to continue as to certain creditors and proves that the current case was filed in good faith.

This rule doesn't apply to any case that was dismissed because you should have filed under Chapter 13 instead of Chapter 7 (see Ch. 2 for more on when a case may be dismissed on that ground).

If a creditor had a motion to lift the stay pending during a previous case that was dismissed, the court will presume that you acted in bad faith in your current case. You will have to overcome this presumption in order to obtain continuing stay relief. If you had more than two cases pending during the previous year, then you will have to seek a court order to obtain any stay relief.

The Bankruptcy Trustee

Until your bankruptcy case ends, your financial assets and problems are in the hands of the bankruptcy trustee.

The Trustee's General Duties

With few exceptions, the trustee assumes legal control of your property and debts as of the date you file. If, without the trustee's consent, you sell or give away property while your case is open, you risk having your case dismissed.

The court exercises its control through a person called a bankruptcy trustee, who is appointed by a branch of the federal Department of Justice called the Office of the United States Trustee. The trustee's primary duties are:

• to see that your unsecured creditors are paid as much as possible on the debts you owe them, and
• to make sure you comply with the bankruptcy laws.

The trustee may be a local bankruptcy attorney or a nonlawyer who is very knowledgeable about Chapter 7 or Chapter 13 bankruptcy generally and the local court's rules and procedures in particular.

Just a few days after you file your bankruptcy papers, you'll get a Notice of Filing from the court, giving the name, business address, and business phone number of the trustee. The trustee may follow up with a list of any financial documents the trustee wants to see, such as bank statements, property appraisals, or canceled checks, and the date by which the trustee wants them.

As used in this book, the term "trustee" means the trustee who will actually be handling your case on behalf of the bankruptcy court, unless otherwise stated.

The U.S. Trustee's Office

In addition to the trustee assigned to your case, another type of trustee -- a U.S. Trustee -- will be involved, usually behind the scenes. The Office of the U.S. Trustee is a part of the United States Department of Justice. Its role is to supervise the trustees who actually handle cases in the bankruptcy court, to make sure that the bankruptcy laws are being followed and that cases of fraud and other crimes are appropriately handled. There are 21 regional U.S. Trustee offices throughout the country.

If a U.S. Trustee decides to take an active part in your case, the parties to the case -- including you -- will be sent a notice about the proposed action. You will have an opportunity in bankruptcy court to oppose the action proposed by the U.S. Trustee. Later chapters in this book suggest some ways to respond to various actions the U.S. Trustee might propose.

Happily, most of you will never have to deal with the U.S. Trustee. It will likely happen only if you file a Chapter 7 bankruptcy and your bankruptcy papers -- or your testimony at the creditors' meeting -- indicate that:

• your "current monthly income" is more than the median income for your state (see Ch. 2)
• you earn enough actual income to support a Chapter 13 plan (see Ch. 2)
• you have apparently engaged in illegal actions that warrant investigative follow-up (such as perjuring yourself in your bankruptcy papers), or
• your case is selected for a random audit (one out of every 250 bankruptcy cases is supposed to be audited under the new bankruptcy rules).

Chapter 7 Trustee

In a Chapter 7 bankruptcy, the trustee is mostly interested in what you own and what property you claim as exempt. This is because the court pays the trustee a commission on property that is sold for the benefit of the unsecured creditors. The trustee may receive 25% of the first $5,000, 10% of any amount between $5,000 and $50,000, and 5% of any additional money up to $1,000,000.

If your papers indicate that all of your property is exempt, your case initially is considered a "no-asset" case and your creditors are told not to file claims (because you don't have any property that can be used to pay them). The trustee also won't show much interest in a no-asset case unless your papers suggest that you may be hiding or mischaracterizing assets. After all, if there is no property for the trustee to seize and sell to pay your unsecured creditors, then there is no commission for the trustee.

The first time you will encounter the trustee in a Chapter 7 case is when you appear at your creditors' meeting, which you must attend if you don't want your bankruptcy dismissed. Typically, if all of your assets are exempt, you will hear nothing further from the trustee. However, if there are (or it appears that there might be) nonexempt assets in your bankruptcy estate, the trustee may continue your creditors' meeting to another date and ask you to submit appropriate documentation in the meantime. More rarely, the trustee may hire an attorney to pursue nonexempt assets you appear to own or even refer your case to the U.S. Trustee's office for further action if it looks like you have engaged in dishonest activity.

If there are nonexempt assets for the trustee to seize and sell, you will be expected to cooperate in getting them to the trustee for disposition. You may also "buy the assets back" from the trustee at a negotiated price or substitute exempt assets for the nonexempt assets.

If you have nonexempt property that isn't worth very much or would be cumbersome for the trustee to sell, the trustee can -- and often will -- abandon the property, which means you get to keep it. For example, no matter how much your used furniture may be worth in theory, many trustees won't bother selling it. Arranging to sell used furniture is expensive and rarely produces much profit.

Many people wonder whether a trustee can search their homes to determine whether they are hiding property. While such searches are rare, part of your duty to cooperate with the trustee could consist of a guided tour of your home upon the trustee's request. And if you don't voluntarily cooperate, the trustee can obtain an order from the court to force the issue.

The trustee is also required, under the supervision of the U.S. Trustee, to assess your bankruptcy papers for accuracy and for signs of possible fraud or abuse of the bankruptcy system.

Chapter 13 Trustee

In a Chapter 13 bankruptcy, the trustee's role is to:

• examine your proposed plan and make sure it complies with all legal requirements
• receive the payments you make under the plan and distribute them to your creditors in the manner required by law
• monitor your duty to file tax returns with the appropriate federal and state taxing authorities for the four years previous to your filing date and annually while your Chapter 13 case is pending
• monitor your duty to file an annual financial statement charting your income and expenses (see Ch. 2), and
• if you owe back child support, provide the payee and your state's child support enforcement agency with information described in "If You Owe Back Child Support," above.

Chapter 13 trustees pay themselves by keeping a percentage of the payments you make -- almost always 10%, the maximum allowed under law.

Many Chapter 13 trustees play a fairly active role in the cases they administer. This is especially true in small suburban or rural judicial districts, or in districts with a lot of Chapter 13 bankruptcy cases. For example, a trustee may:

• give you financial advice, such as helping you create a realistic budget (the trustee cannot, however, give you legal advice)
• actively participate in helping you modify your plan, if necessary
• give you a temporary reprieve or take other steps to help you get back on track if you miss a payment or two, or
• participate at any hearing on the value of an item of property, possibly even hiring an appraiser.

Despite the trustee's great interest in your finances, your financial relationship with the trustee is not as stifling as it may sound. In most situations, you keep complete control over money and property you acquire after filing -- as long as you make the payments called for under your repayment plan, and you make all regular payments on your secured debts. However, if your income or property increases during the life of your plan (for instance, you win the lottery), the trustee can seek to amend your plan to pay your creditors 100% of what you owe them rather than the lesser percentage originally called for in your plan.

Changes to the Bankruptcy Laws

As noted throughout this chapter, Congress made major changes to the bankruptcy laws effective October 17, 2005. This section describes some of the most important legal changes and the practical effects they are likely to have on those considering or filing for bankruptcy. These changes and others are fully covered in the text of the chapters that follow. In addition, each chapter includes a final section that summarizes the legal changes covered in that chapter.

Higher Income Filers Must File Chapter 13

Under the old rules, most filers could choose the bankruptcy type that made the most sense for them -- and most preferred Chapter 7 to Chapter 13. The new rules force those with higher incomes to file under Chapter 13. Filers whose average monthly income is higher than the median income for their state will not be allowed to file for Chapter 7 bankruptcy.

As it turns out, most filers have a lower median income and, therefore, are still eligible for Chapter 7 bankruptcy. To find out if you're one of them, you'll have to use the instructions in Ch. 2 to

• compute your average monthly income (a somewhat complicated formula)
• compare it to the state median income, and
• if your income is more than the median income, figure out whether any exceptions apply that will still let you file Chapter 7 bankruptcy.

Filings Are Scrutinized More Closely

One reason Congress changed the bankruptcy laws was to prevent fraud. Even though studies show that 90% of filers don't engage in fraud, the bankruptcy rules are now explicitly designed to catch cheats. All filers will be notified that they are subject to criminal prosecution for errors in their paperwork, cases will be audited for fraud by lawyers from the Attorney General's office with much greater frequency, and all filers will have to produce their income tax returns -- which must also be provided to creditors upon request.

Lawyers Are Harder to Find and More Expensive

The new laws impose a number of responsibilities on bankruptcy lawyers, which has caused many to get out of the field (and those who remain to charge more for their services). Chief among these new responsibilities is that lawyers must personally vouch for the accuracy of the information their clients provide them. This rule changes the traditional alliance between lawyers and their clients. It also adds to the time and money lawyers have to spend on bankruptcy cases, which in turn causes legal fees to go up. (See Ch. 10 for more on working with a lawyer.)

Chapter 13 Filers Have to Live on Less

Under the old rules, people who filed under Chapter 13 had to devote all of their "disposable income" to their repayment plan. A filer's actual living expenses determined the filer's level of disposable income, as long as the expenses were reasonably necessary. For instance, if your actual reasonable expenses left you with $100 a month extra, you only had to pay $100 a month under your plan.

Under the new law, if your income is higher than your state's median income (see Ch. 2), you must commit to a five-year plan and compute your disposable income using "official" expenses compiled by the Internal Revenue Service. These expenses are often lower than actual costs, which means you may have to pay more each month into your Chapter 13 repayment plan (and live on less). Even worse, because your disposable income will be based on your average income over the six months prior to filing, you may have less income to actually pay into your plan than the law assumes you have.

Credit and Budget Counseling Is Required

Under the new law, you must undergo credit counseling before filing a Chapter 7 or Chapter 13 bankruptcy (unless an exception applies). You must pay for this counseling yourself on a sliding scale. In addition, you'll have to complete a course on personal financial management before obtaining final relief from your debts.

Property Must Be Valued at Replacement Cost

Under the old law, you could value your property at what you could get for it in a "fire" sale or auction. This meant that used furniture, hobby items, cars, heirlooms, and other property a debtor might want to keep was typically assumed to have little value -- and, therefore, that it often fell well within the exemption categories offered by most states.

Under the new law, your property is supposed to be valued at what it would cost to replace it from a retail vendor, taking into account the property's age and condition. In theory, this requirement makes it more likely that you'll lose your property: The more your property is worth, the less likely it is to be covered by an exemption. For example, assume that the "fire sale" value of your car is $2,000, but the replacement value is $4,000. If your state's exemptions allow you to exempt $2,000 of equity in a vehicle, your car would be exempt if the first value was used, but not the second.

As a practical matter, however, this change hasn't made much difference. If the trustee sells your car, it will probably fetch an amount closer to the fire sale value than the replacement value. Plus, the trustee has to factor in what it will cost to take the car, store it, and sell it.

State Exemptions Aren't Available to Recent State Residents

Under the old bankruptcy law, the personal property you could keep was determined by the exemption laws of your state of residence (as long you lived there for more than three months). Under the new law, you must live in a state for at least two years prior to filing in order to claim that state's personal property exemptions.

Example: Al moved from California to Nevada 18 months ago. If he wants to file for Chapter 7 bankruptcy, he will have to use California's personal property exemptions. Instead of being able to claim Nevada's relatively liberal exemption for a motor vehicle ($15,000), Al will have to use California's parsimonious motor vehicle exemption of $2,300.

Residency Requirements for Homestead Exemptions

There are also new residency requirements for homestead exemptions, which determine how much of your equity in a home you can keep when filing a Chapter 7 bankruptcy. Under the old law, the exemptions for the state where your home was located (with rare exceptions) determined how much equity you could keep in your home, as long as you lived in that state for more than three months.

Under the new law, you must live in a state for 40 months prior to filing in order to claim more than $136,875 worth of homestead exemption. For instance, if Al moved from California to Nevada three years ago (36 months) and wants to file a Chapter 7 bankruptcy, his homestead exemption will be capped at $136,875 even though Nevada's homestead is higher.

In this case, it might make sense for Al to wait out the four months before filing. Once he has spent 40 months in Nevada, he will be able to claim Nevada's homestead exemption of $350,000. Otherwise, he will have to use California's homestead exemption, which runs from $50,000 for single people to $150,000 for people over 65 or over 55 and disabled.