No one wants to file for bankruptcy. But if you're one of the millions laid off because of the COVID-19 pandemic, it might make sense—especially if you're struggling with debt. Learn how a "last resort" bankruptcy plan can give you a sense of control during this unpredictable time and, if necessary, help get you back on your feet financially.
Don't know much about bankruptcy? Start by learning the basics of Chapter 7 and 13.
Losing your job due to a layoff means one crucial thing—there's less money to pay the bills. No matter how much effort you put into turning down the thermostat or eating in, such measures rarely stop the pile of unpaid debt from accumulating.
Fortunately, local, state, and federal governments, along with many creditors, are working hard to provide safety nets during the COVID-19 crisis. And for many, cash payments and increased unemployment benefits will do the trick—especially when coupled with the mandated holds placed on evictions and utility shut-offs in many areas.
Even so, it's unlikely that these measures will keep everyone afloat if the crisis lasts longer than expected. So it's prudent to have a plan that assumes a best-case scenario while providing for the worst. Just in case.
Stimulus packages can certainly help. But the truth is that for many, they'll be useful in the short term, but won't go as far as most people will need. Evaluating the real impact on your finances will be crucial.
The key here is to pay special attention to payment requirements. Does the plan simply shift payment to a later date? When will you be expected to pay?
For instance, in many areas, local and state governments have put a stop to evictions. The policy, designed to help people shelter-in-place, keeps people inside instead of on the streets spreading disease and works well to fight the coronavirus.
These plans don't waive payment, however, which is a contractual issue between you and the landlord. Instead, the government is essentially closing all courtrooms to landlord/tenant cases for a period of time, which is within its power. So once the stay lifts, you should assume that the missed rent will be due unless the government puts further protections in place (such as subsidizing rent).
IMPORTANT TIP. Remember that you must pay deferred payments later. Find out if you'll have to pay immediately after the coronavirus restrictions lift, or if you'll get additional time.
The first step? Learning about programs that will help you conserve money now. Keep in mind that most will require you to prove that you or a family member has been affected by COVID-19. A layoff that occurred post-pandemic will likely be enough.
Here's a list of some of the bills you'll want to pay special attention to:
IMPORTANT TIP. Don't stop making a payment based on the information you've read online or heard on the news. You'll have to apply for programs with the creditor, or your state or local government. Even then, wait until you receive qualification confirmation—preferably in writing, and especially in the case of mortgage payments. A mistake could result in losing your home to foreclosure.
After speaking with creditors, you'll be in a better position to plan. If you don't have enough income from unemployment or other sources to make all regular payments, consider deferring bills and setting aside the funds you'd use to pay them. Then you'll take an either/or approach:
This strategy ensures that if filing for bankruptcy is inevitable, you won't waste money paying a bill that you could erase in your bankruptcy case. Even so, you'll still have another chance to avoid bankruptcy—keep reading.
If enough of the funds you've set aside remain after the crisis ends, negotiating a lesser payment amount with outstanding creditors—including your landlord—will likely be possible (although you can't count on it). Recent history bears this out.
After the economy came to a halt in 2008, money was tight, and creditors were willing to accept whatever they could get. Similarly, after the coronavirus crisis holds lift, many people will likely find themselves deeply in debt. Landlords and other creditors might be willing to adjust how much they'll take in full payment. You might find an opportunity to settle with your creditors and avoid bankruptcy.
That said, if you can't negotiate your obligations, filing for bankruptcy will likely be inevitable. But you'll know that you did your best to avoid it and that you maximized the money available to you.
IMPORTANT TAX TIP. Tax laws require you to pay tax on any amount over $600 forgiven by a creditor. You'll want to take potential tax liability into account when weighing whether to negotiate debt or file for bankruptcy. (An exception exists for insolvency, but it's a fine line between negotiating debt to avoid bankruptcy and declaring bankruptcy. Talk with your accountant.) Also, be sure that you can settle with all creditors before paying one. If you settle with some creditors but not all, and file for bankruptcy instead, you'll have thrown away the payments, and any tax assessed on the forgiven amount won't be dischargeable in bankruptcy.
Sometimes filing for bankruptcy is inevitable. If you can't find a clear financial pathway through the coronavirus pandemic after your layoff, bankruptcy might be your best course of action. The sooner you file, the faster you'll rebuild your credit and get back on your feet.
ENCOURAGING TIP. It's possible to qualify for a home mortgage as soon as two years after receiving a bankruptcy discharge. Learn more about mortgages after bankruptcy.
One of the most significant benefits of bankruptcy is its ability to wipe out (discharge) credit card balances, medical bills, and rent—the same types of debts that will likely get out-of-hand during the coronavirus crisis.
It doesn't discharge all debts, however. Domestic support arrearages, newly acquired tax debt, and student loan balances are a few debts you can't get rid of in bankruptcy, so filing for Chapter 7 bankruptcy won't help you. By contrast, Chapter 13 won't wipe out these debts, but you'll get more time to pay (three to five years).
Here are more details about the two chapters most individuals file.
Most people prefer filing for Chapter 7, if possible, and use this chapter almost exclusively shortly after being laid off. It's quick—taking about four months to complete—you won't pay creditors anything, and you'll keep the property you need to work and live, which for many, is everything they own.
Keep in mind that you will have to give up luxury items, such as a vacation home, an expensive diamond necklace, or a valuable coin collection in exchange for a debt discharge. Ultimately, your state decides the bankruptcy property you can exempt (keep). Each state lists protected property in the state's exemption laws.
IMPORTANT TIP. You'll want to think carefully before dipping into an ERISA-qualified retirement account to pay a bill that a bankruptcy discharge can wipe out. Many debtors, not realizing that retirement accounts are protected in bankruptcy, make the mistake of trying to avoid bankruptcy by exhausting retirement funds. Most debtors would do far better to file sooner and retain their retirement savings than to file later and find themselves left with nothing.
You'll take the means test to find out if this chapter is available to you. Your income must be at or below the median income for your state to be eligible for a Chapter 7 discharge. Two exceptions exist, however:
Don't assume that just because you're not making anything now that you'll qualify. The means test looks at your income over the last six months. So if your employer just laid you off of a high-paying job, you might have to wait a few months before qualifying. (You'll add your gross income over the last six months, divide it by six, and multiply it by 12 to find the yearly amount you'll compare to your state's median income.)
IMPORTANT TIP. Paying close attention to timing is essential. You'll want to be sure that the worst is past, and that you don't anticipate accumulating additional bills, such as medical debt. Why? Filers can only receive a discharge in Chapter 7 once every eight years. Also, only debts owed before the filing date get erased.
Learn when Chapter 7 is a better choice than Chapter 13.
Most newly unemployed people don't have the income needed to file this chapter. It's intended for those with higher income who can pay some amount toward bills, or who need time to catch up on past-due mortgage or car payments to avoid foreclosure or repossession. Filers can keep all of their property, but they must pay all discretionary income into a three- to five-year repayment plan.
Find out when Chapter 13 is better than Chapter 7.
It's never a good idea to stop paying bills if you don't know whether you'll qualify for bankruptcy for the simple reason that it can be hard to catch up on payments (although sometimes you don't have a choice). If you're considering bankruptcy, speak with a local bankruptcy lawyer as soon as possible. Most offer a free consultation and can help you file for bankruptcy even if you're quarantined during the coronavirus pandemic.