Bankruptcy v. Doing Nothing

Should you file for bankruptcy to get rid of debts, or can you sit back and wait?

If you are struggling with debt, bankruptcy may seem like a good way to get back on your feet. But not everyone who is struggling needs to file bankruptcy right away. There may be times when doing nothing (at least for now) is the best option. Whether or not you should file bankruptcy or do nothing depends on the nature of your debt and your vulnerability to creditors.

(For more articles on the bankruptcy decision, see Bankruptcy: Should I File?)

When considering whether you should file for bankruptcy or just let things lie, ask yourself the following questions:

Are You Judgment Proof?

If you have nothing that judgment creditors can collect from you, then you are “judgment proof.” A judgment creditor is a creditor that has obtained a court judgment against you. Generally, you are judgment proof if:

  • You don’t have any equity in real estate.
  • You don’t own any non-exempt assets. All states have "exempted" certain types of property (up to certain limits) from collection, such as equity in a home or car, food, or basic living necessities.
  • You are not working or have a very low-paying job.
  • Your income sources are exempt from judgment creditors. Examples include: unemployment benefits, social security, and other public entitlement benefits.

If you are relatively sure your asset situation will not improve substantially, and if collection pressure does not bother you, there may indeed be no reason to file bankruptcy. To learn more about what it means to be judgment proof, read What Does Judgment Proof Mean?

Will Your Debts Be Discharged in Bankruptcy?

Not all debts are wiped out by bankruptcy. If the debts that most worry you will remain after bankruptcy, then filing for bankruptcy may not be a good idea. On the other hand, if filing for bankruptcy gets rid of other debts and allows you to devote more money to those debts that worry you, bankruptcy may still help.

Below are some debts that are often not discharged in bankruptcy or are difficult to discharge. All of these types of debts also some with special enforcement powers -- the creditor can use things like wage garnishments or bank levies to collect, even if it does not have a judgment.

Past Due Child Support

If you are behind on your child support payments, you may face stiff penalties, including, but not limited to, the following:

  • wage garnishment
  • loss of unemployment compensation
  • jail time
  • offsets of federal and/or state income tax refunds
  • passport denial
  • offsets of state lottery winnings
  • driver’s license suspension
  • reduction of workers compensation benefits, or
  • reduction of social security or disability benefits.

A Chapter 7 bankruptcy filing will not eliminate or reduce child support debt. So if child support is your only debt, filing for Chapter 7 bankruptcy will not help. If you have other debts that can be discharged, however, a bankruptcy may free up future income that you can use to pay your child support.

In a Chapter 13 bankruptcy, you may be able to pay off the past due child support (in full) over a period of three to five years.

Regardless of whether you file for bankruptcy or not, you will still be responsible for ongoing child support payments.

If you owe past due child support, you should contact the appropriate enforcement agency or the custodial parent (if allowed) to make payment arrangements.

Past Due Income Taxes

Taxpayers with outstanding tax debts are subject to a levy on assets or other income sources. A levy is a legal seizure of your property to satisfy a debt. Once a levy is in place, it usually remains until your tax debt is paid.

If you owe past due income taxes and you do nothing, you may face the following:

  • offset of state or federal tax refunds
  • reduction in social security benefits
  • wage garnishment (depending on the state in which you live), or
  • real estate liens.

If you can’t pay the tax that you owe, you should contact the tax office to make payment arrangements. In general, a bankruptcy filing does not eliminate recent tax debts. (To find out when you can discharge tax debts, see Tax Debts in Chapter 7 Bankruptcy.) However, through a Chapter 13 case, you may be able to pay off the tax debt over a period of three to five years.

Student Loans

If you default on your student loans, the lender may impose the following:

  • wage garnishment (depending on the state in which you live)
  • offsets of federal and/or state income tax refunds
  • loss of eligibility for federal aid, including Pell grants
  • loss of deferment or forbearance options, or
  • reduction in social security or disability income.

If you can't afford your student loans, you should contact your lender and explain your situation. Your lender will be able to discuss your repayment options. For more information on getting out of default, read see Student Loans: Getting Out of Default.

In order to discharge student loan debt in bankruptcy, you must prove that paying your loans causes an undue hardship. This is usually a tough standard to meet, although not impossible in every situation. To learn more, see Student Loans in Bankruptcy.

Are You at Risk of Losing Your Home or Car?

If you are behind in your mortgage or car loan payments, you can catch up on those payments through Chapter 13 bankruptcy. You may also be able to get rid of second mortgages or home equity lines of credit or reduce your car loan to the market value of the car. (See Your Home in Chapter 13 Bankruptcy and Your Car in Chapter 13 Bankruptcy.)

In Chapter 7 bankruptcy, you cannot make up arrearages on loans, but if you can get rid of other debts to free up money to pay your mortgage or car loan, it might be worthwhile to file. (See Your Home in Chapter 7 Bankruptcy and Your Car in Chapter 7 Bankruptcy.)

If bankruptcy helps you save your home or car, it may be a good choice for you.

Alternatives to Bankruptcy and Doing Nothing

Before you decide on filing for bankruptcy or doing absolutely nothing, consider other alternatives for dealing with debts. For more information, see Alternatives to Bankruptcy.

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