There are many different types of debts that can cause a person or family to experience financial difficulties. In many cases, these difficulties occur because of circumstances that are out of a person’s control. For example, a person who suffers a serious injury or illness may have received multiple different forms of medical treatment, resulting in high medical bills that they are unable to pay. These problems can become even more serious if a person has been unable to work and earn enough income to cover their living expenses while also repaying the debts they owe. Fortunately, different forms of debt relief may be available, including filing for bankruptcy. Those who are considering bankruptcy will need to understand how different debts may be handled and how different types of bankruptcy may be used to provide financial relief.

Dischargeable and Non-Dischargeable Debts

Filing for bankruptcy can provide some immediate relief from debts through what is known as the “automatic stay.” After a bankruptcy petition is filed in court, this stay will go into effect, and it will prevent creditors from taking any actions to collect debts. Any foreclosure proceedings or repossessions will be halted during the bankruptcy case, and creditors will be prohibited from contacting the debtor in any way. The debtor will then be able to determine how to handle different types of debts throughout the bankruptcy process.

A Chapter 7 bankruptcy will generally allow a person to discharge their debts within a few months, and once these debts have been discharged, the debtor’s obligations to creditors will be removed. For those who do not qualify for Chapter 7 or who wish to avoid the loss of certain assets, Chapter 13 bankruptcy may be an alternative option. In this type of bankruptcy, a person’s debts will be grouped together into a three-to-five-year repayment plan, and after this plan has been completed, their remaining debts will be discharged.

How the Pandemic Has Impacted Mortgages

The COVID-19 pandemic has wrought wide-reaching economic implications throughout the country, including substantial layoffs and furloughs in many business sectors. If you have recently lost employment or income as a result of the pandemic, you may have been worried about making your mortgage payments.

Thankfully, the CARES Act, passed on March 27, 2020, introduced emergency mortgage forbearance opportunities, giving many homeowners much-needed relief. Those with loans backed by Fannie Mae, Freddie Mac, the FHA, VA or the USDA, which together encompass almost 75% of the mortgage market, were eligible to apply for forbearance. If approved, you had the opportunity to request up to 180 days of forbearance, and an option to request up to another 180 days if you were still unable to pay at the end of the first period. Many private banks not covered by the CARES Act have also elected to offer forbearance and relief programs.

However, forbearance is not equivalent to forgiveness, and the delayed mortgage payments will eventually need to be repaid. Given the extent and further uncertainty of the pandemic's fallout, it remains possible you will still be experiencing financial difficulties when your mortgage forbearance period ends. If you are still unable to make your resumed mortgage payments, your lender may choose to initiate foreclosure proceedings, meaning you could lose your home.

Of the six types of federal bankruptcies, Chapter 7 and Chapter 13 are the ones used commonly for personal bankruptcies. There are some important distinctions between these two chapters. At the heart of the differences is the fact that Chapter 7 is a liquidation bankruptcy. Nonexempt assets of yours will likely be seized to pay creditors, and most of your unsecured debts (debts with no collateral) will be discharged within a matter of months. Chapter 13, on the other hand, lets you keep your house and other collateral but subjects you to a 3-5 year repayment plan in which you start to pay your creditors.

Based on these distinctions, you can see why Chapter 7 is more attractive for many debtors. At its best, bankruptcy gives you a clean financial slate from which you may work diligently to rebuild your credit and finances on a solid foundation. However, not everyone is eligible for a Chapter 7 bankruptcy. To be eligible, you must first pass what is called the means test.

What is the Means Test?

The means test is a formula that figures your monthly income against your debts to determine if your situation warrants a Chapter 7 bankruptcy over a Chapter 13 filing. The basic tenet is that if you do not bring in enough money per month to even make a dent in your debts, then Chapter 7 is the way to go.

Many people benefit from a well-structured, rightly timed bankruptcy filing. While bankruptcy can give individuals some closure on many different debts and provide a fairly blank slate from which you may build a better financial foundation, there are limits to what bankruptcy can do for you. Knowing these limits is useful in giving people accurate expectations before they file for Chapter 7 or Chapter 13 bankruptcy.

What Types of Debts Are Not Dischargeable?

In the context of discussing what bankruptcy is not able to do, the most important consideration is the debts that will stay with you even after you have received a discharge in bankruptcy. Here are some common examples of these debts:

Will Filing For Bankruptcy Effect My Tax Refund?

Those who file for Chapter 7 or 13 may be able to keep their tax refund, however, whether or not you can keep it depends on the prebankruptcy precautions you take to protect your refund. If you have already filed for bankruptcy, will the trustee assigned to your bankruptcy case take your refund? Is your tax refund safe at any point if you will file for bankruptcy before the year is over?

This blog will answer those and other questions you have about taxes and personal bankruptcies.

If I Want to Keep my Tax Refund, When Should I File for Bankruptcy?

It may be a good idea to file bankruptcy after you have received your tax refund. In fact, you may want to use a portion of your tax refund to pay for the costs to file bankruptcy. That is not uncommon. You also may want to spend your tax refund on other necessary expenses, such as food, shelter, or transportation. If you decide to go this route, don't forget to keep receipts showing how the money was used.