Payday Loans in Bankruptcy

In most cases, you can wipe out (discharge) a payday loan in Chapter 7 bankruptcy or pay some part of it in Chapter 13 bankruptcy (often a small portion). Even so, special issues exist that you'll want to consider before filing bankruptcy if you owe money for a cash advance, payday loan, or similar debt—especially if you took it out shortly before filing for bankruptcy.

Find out the ways that a payday loan lender could challenge the discharge of its debt and problems that might violate the law.

(Learn more in Your Debt in Chapter 7 and Unsecured Debt in Chapter 13: How Much Must You Pay?)

Creditor Challenges to Payday Loans in Bankruptcy

Most people intend to pay for the things that they buy on credit—which is a good thing. Why? Knowingly taking out a loan or using credit when you don't intend to repay the debt is considered a fraudulent act.

You don't get to discharge fraudulent debts in bankruptcy, and bankruptcy law has rules that help a creditor ferret out fraud. A creditor who suspects fraud can object to your discharge (challenge your ability to wipe out the debt) by filing a type of lawsuit called an adversary proceeding.

What Is Presumptive Fraud?

The presumptive fraud rule can cause particular difficulty if you've taken out a payday loan or other cash advance within 70 to 90 days of filing bankruptcy. Transactions that run afoul of this timing rule are presumed fraudulent. The burden would be on you to prove that you didn't have fraudulent intent.

Will the Payday Lender Win its Objection to Discharge?

It's questionable. Payday lenders that challenge the discharge of payday loan debt are often unsuccessful in bankruptcy court. Many bankruptcy courts don't look favorably upon payday lending practices and require the payday lender to prove that you acted with fraudulent intent.

• Was there fraudulent intent? Many times, payday loans are not one-time loans or advances. Instead, a borrower falls into a long-term pattern of taking payday advances to pay the exorbitant finance charges and balances on prior payday advances. Because of this cycle, borrowers end up relying on the high-interest payday loans as a source of income. In this situation, courts often find that (1) there was no fraudulent intent, and (2) that the payday loan is a single debt that dates back further than the most recent payday advance.
• Consequences of a fraud finding. You want to avoid fraud allegations in bankruptcy court. The consequences of a fraud finding can include not receiving a discharge for the debt, the dismissal of your case, or, in some cases, criminal fines and imprisonment. Simply put, it's not worth the risk.

You can learn about your court's practices by speaking with a local bankruptcy attorney.

Avoiding Problems With a Payday Loan in Bankruptcy

Of course, you could lose your discharge if a payday lender can prove a fraud case. Rather than deal with the time, money, and risk of fighting a discharge objection by a payday lender, you might be able to avoid this problem by:

• not taking any loans shortly before filing for bankruptcy, or
• filing Chapter 13 bankruptcy and paying the debt through your repayment plan.

Problems With Post-Dated Checks

It's common for payday lenders to require an active checking account. Some might require you to write a post-dated check or allow automatic withdrawals. Here are some problems that come with post-dated checks that you'll want to be aware of:

• Automatic stay violation. If you gave the payday lender a post-dated check in exchange for the last advance before filing bankruptcy, the creditor might try to cash the check after you file bankruptcy. If the payday lender deposits your post-dated check when it knows you are in bankruptcy, it might be violating the automatic stay—the order that stops collection activity during bankruptcy. If this happens, the court could require the lender to return the funds to the bankruptcy trustee appointed to administer your case.
• Bad check writing allegation. Also, the payday lender might accuse you of writing a bad check and threaten to press criminal charges. If a payday lender does this to you, it might violate various state and federal fair debt collection rules and other consumer laws in addition to violating the automatic stay.

Some states prohibit or restrict payday lenders from engaging in the practice of demanding post-dated checks. You can learn more in Illegal Debt Collection Practices.