Using Your Credit Cards for Luxury Purchases Before Bankruptcy

Although you can typically erase credit card debt in bankruptcy, it's not always the case. Using your credit card to buy luxury goods shortly before filing isn't a great idea because you could have to repay the debt. You can avoid this problem by understanding these basic principles:

• purchasing luxury items or services totaling $725 or more within 90 days of filing for bankruptcy is presumed fraudulent
• the credit card company is likely to challenge the dischargeability of the debt, and
• if you lose, you'll remain responsible for repaying the charge.

Of course, there's more to know, so we also explain the basics of a bankruptcy discharge, what it takes to prove two fraud types, and when to expect a creditor to sue you. If you'd like to learn about other things to know when filing for bankruptcy or more ways you could jeopardize your credit card debt discharge, go to Credit Cards and Bankruptcy.

What Is a Bankruptcy Discharge?

Everyone files for Chapter 7 or Chapter 13 bankruptcy to get a discharge of debts. The bankruptcy discharge wipes out your personal liability for the qualifying debts you had before filing for bankruptcy so you won't be legally obligated to pay them back. Once your creditors receive a copy of the discharge, they'll have no choice but to write off your account and stop collection actions.

Typically, Chapter 7 will wipe out all your credit card debt, and in Chapter 13, you'll likely pay a percentage of what you owe. However, some types of debts are not dischargeable in bankruptcy. Credit card debt can be made nondischargeable if the credit card company can prove to the court that you committed fraud or are abusing the system.

Can I Use a Credit Card for Luxury Purchases Before Filing for Bankruptcy?

The straight answer is that you could find yourself facing a fraud charge if you aren't careful. The easiest way to prevent this is by learning about the two types of fraud recognized in bankruptcy:

• actual fraud, and
• constructive fraud.

Actual fraud. Actual fraud occurs when the debtor (the person who filed bankruptcy) used the credit card with the intent to defraud the credit card company. For example, when a debtor knowingly runs up the balance on the credit card shortly before bankruptcy with no intention of repaying the charges. Actual fraud requires presenting evidence. While it isn't that hard to do, an easier way of proving fraud exists—the creditor can rely on "constructive fraud."

Constructive fraud. The debtor doesn't have to intend to commit fraud in this case. All that's needed is for the debtor to engage in a particular act. If the debtor does so, fraud is implied or construed. Specifically, fraud is presumed when a debtor uses a credit card to make luxury purchases of $725 or more during the 90 days before the bankruptcy filing. So if you use your credit card to buy $725 or more of luxury goods or services within that period, the creditor can sue for nondischargeability based on constructive fraud. If you lose, the court will enter a judgment declaring the debt nondischargeable.

What Are Luxury Purchases?

Any goods or services that are not reasonably necessary for the maintenance and support of you and your dependents are considered luxury goods and services. Fur coats, jewelry, home decor, makeup, hair products, manicures, plane tickets, salon services, alcohol, and electronics are just a few of the items and services considered luxury purchases under bankruptcy law.

Suppose you make a luxury purchase within 90 days before filing for bankruptcy. In that case, the credit card company might sue you under a theory of presumptive fraud. In that case, you'll need to prove the purchases were reasonably necessary for your maintenance and support.

Example 1. Xavier used his credit card to buy a $5,000 engagement ring for his girlfriend. 45 days later, Xavier filed for Chapter 7, and the credit card company sued for nondischargeability. The court would likely find that the engagement ring was a luxury purchase. If Xavier couldn't produce credible evidence of an intention to repay the debt, he'd remain obligated for the purchase.

Example 2. One day, Jasmin's car breaks down. Because she has a meager income, she can't afford to pay $900 to replace the transmission. However, she needs the car to go to work, so she uses her credit card to pay for the repair. A court would likely find that this was a reasonably necessary expense and allow the discharge of the credit card debt.