If you file for Chapter 7 bankruptcy and are hoping to hang onto one of your credit cards, you will likely be out of luck. Once your credit card company learns of your bankruptcy, it will almost certainly cancel your card. But all is not lost. When preparing to file for bankruptcy, it is common for a potential filer to want to exclude a particular debt from the bankruptcy petition, such as a credit card used for work expenses or a beloved pet’s medical expenses. No matter how important the card might be, excluding debt is not an option when you file for Chapter 7 bankruptcy.
Bankruptcy law requires you to list all of your debt on your bankruptcy petition, without exception. In other words, if you owe creditor money, the creditor must appear on your petition. This rule, however, goes a step further. Even if you don’t owe a balance on your credit card, you must still list it in your bankruptcy papers. A revolving credit card account is a type of contract, and your contracts are automatically canceled by bankruptcy, including credit cards, leases, and secured auto loans, to name a few. As a result, once your credit card company finds out about the bankruptcy and realizes that it no longer has a contract; it will cancel your card because it won’t be able to enforce any ongoing obligations. Simply put, without a valid agreement in place, the credit card company will not be able to make you pay for your purchases. Chances are if your employer provides you with a credit card to pay for travel expenses or supplies, you’re either an authorized user or an obligor on the account. The distinction matters because it will determine whether you’ll need to include the account in your bankruptcy paperwork.
For instance, if you’re an authorized user, business-related charges will often be billed to the company directly, and, since the account isn’t in your name, it’s likely that you won’t have to include it in your bankruptcy. You should also be able to continue using the card.
By contrast, if you’re an obligor on the account, you and your employer are likely jointly responsible for paying the balance. You probably pay the credit card bill and seek reimbursement from your employer afterward. If there’s a balance on the account, you’ll have to list it on your bankruptcy paperwork, and the credit card issuer will probably close the account. Even though you lose your cards during bankruptcy, you’ll still be able to obtain a credit card or other consumer financing and possibly sooner than you might think. Once the Chapter 7 bankruptcy closes, you will be free to start rebuilding your credit. In fact, many people receive new credit card offers in the mail within months of receiving their Chapter 7 discharge. While this might seem surprising, it will make sense once you understand why credit card companies will consider you a good risk. Here’s why:
• Bankruptcy wipes out all of your credit card debt, so you have more discretionary income to pay bills.
• Most people use credit cautiously after bankruptcy because they don’t want to find themselves in the same predicament (and tend to refrain from using credit for frivolous purchases).
• The credit card company knows that you can’t file for Chapter 7 bankruptcy for another eight years, and so there is lots of time to collect against you, if necessary.
How to Rebuild Your Credit After Bankruptcy
The credit reporting bureaus reward people who can responsibly handle the mix of credit that most households maintain, which includes one or two unsecured credit cards, a car loan, and a secured credit account, such as a furniture or jewelry store card. Car loans, furniture accounts, and jewelry store cards are secured accounts because you must promise to give back the merchandise if you fail to make your payments. Once you have the right mix of credit, of the utmost importance, of course, is making timely payments. Each month, you’ll want to pay your balances down to 10% to 30% of your available credit but not pay off the card. Paying off your entire balance triggers the credit card company to pull your credit, and every time that happens, your credit takes a hit. There is another reason why it’s not a good idea to use more than 30% of your available credit: The amount of credit available on your account strongly influences your credit score. For instance, your credit score will be much higher if you have $3,000 in available credit as compared to only $300. Plus, a heftier amount of available credit will allow you to use your card for your everyday purchases, such as groceries and utility bills and doing so is an important part of rebuilding your credit. When you use your card regularly and pay it down, but not off, each month, you put a lot of money in the credit card company’s coffers, because each time you use it, the store must pay the credit card company a percentage of your purchase. Credit card companies like it when you make money for them, and, as a result, the credit card company will likely increase your credit line in a surprisingly quick manner to encourage you to keep making the company money. This same rationale will help you understand why it is not a good idea to open cards with small limits. A credit line of $500 can hurt your score because you’ll never have much available credit. In other words, hold out for cards with a larger credit limit. If you follow the technique outlined above, your credit line will likely increase, and, as it does, your available credit will follow, the effect of which will be to drive up your credit score.
Filing for bankruptcy is not a decision to take lightly. But once you’ve decided to move forward, paying certain debts such as credit cards becomes a waste of money. Whether it’s time to stop making payments will depend on:
• whether you can afford to pay back the debt
• if you’ve verified that you qualify for bankruptcy
• whether you’re sure you want to file for bankruptcy, and
• if a bankruptcy lawyer has given you the go-ahead.
Unless you’ve done the entire above, not paying your credit card bills could put you in a worse financial position. Find out about these and other considerations. When contemplating bankruptcy, the first thing to consider is whether you can afford to pay off your credit cards. Why? Because if you make enough money to do so, you probably won’t qualify for Chapter 7 bankruptcy. The court requires filers with significant disposable income to pay some or all of your credit card debt through a Chapter 13 repayment plan. Plus, a bankruptcy filing will remain on your credit report for seven to ten years. So it’s best to consider all available options first.
If you stop making payments on your credit cards, you’ll typically begin receiving numerous calls from the credit card company or its agents. The more delinquent you are, the more frequent and harassing the calls will become. For most people, the constant harassment from debt collectors leads them to consider bankruptcy relief. Depending on your assets and the amount of debt you owe, the credit card company (or a debt collection agency) could decide to bring a lawsuit to collect its debt. If the credit card company obtains a money judgment against you, it will be able to garnish your wages or go after your assets to satisfy the debt. If you’re facing a lawsuit or the credit card company isn’t willing to work with you, it might be time to consider your bankruptcy options. In both Chapter 7 and Chapter 13 bankruptcy, a debtor can protect or “exempt” property using bankruptcy exemptions. Bankruptcy exemptions vary from state to state. What happens to “nonexempt” property that isn’t protected will depend on the bankruptcy chapter you file. In Chapter 7 bankruptcy, the bankruptcy trustee will sell your nonexempt assets and use the funds to pay back your creditors. If you own a lot of property that you can’t protect with a bankruptcy exemption, filing for Chapter 7 bankruptcy might not be in your best interest. By contrast, if you file for Chapter 13 bankruptcy, you can keep all of your property. But you’ll have to pay your unsecured creditors (like credit card companies) an amount equal to the value of your nonexempt assets. The good news is that you don’t have to pay it all at once. You’ll pay it over three to five years, depending on the length of your repayment plan.
In most cases, if you’re qualified to file for bankruptcy, making credit card payments is like throwing money down the drain. But if you’re still undecided or might not file your case for a long time, stopping your credit card payments can cause unnecessary damage. Also, before you stop paying your credit card debt, you’ll want to be sure that you qualify for bankruptcy. Once you stop, fees add up quickly, and if you don’t file, it might be hard to bring your accounts current. So you’ll want to confirm that you pass the Chapter 7 means test, the test required to qualify for Chapter 7. Otherwise, you might have to file for Chapter 13 and qualifying for Chapter 13 isn’t a given, either. Funding a Chapter 13 repayment plan can be too costly for many filers.
How Long Do Bankruptcies Stay On Your Credit Report?
The length of time that a bankruptcy filing stays on your credit report depends on what type of bankruptcy you filed. Chapter 7 bankruptcy is also known as liquidation bankruptcy, Chapter 7 is what is referred to as straight bankruptcy. It’s the most common form of consumer bankruptcy and is usually completed within three to six months. Those who file for Chapter 7 will no longer be required to pay back any unsecured debt (loans that were issued solely on creditworthiness), like personal loans, credit cards and medical expenses, but they may have to sell some of their assets to settle secured loans. Chapter 7 bankruptcies stay on consumers’ credit reports for 10 years from their filing date.
Chapter 13 bankruptcy refers to as the “wage earners bankruptcy. This form of filing offers a payment plan for those who have the income to repay their debts, just not necessarily on time. About a third of bankruptcies filed are Chapter 13 (the remaining being Chapter 7). Those who file are still required to pay back their debts, but instead over a three-to-five year time frame. Chapter 13 bankruptcies stay on consumers’ credit reports for seven years from their filing date.
While bankruptcies on your credit report will always get factored into your credit score for as long as they are on there, the impact on your score lessens with each year that passes. So, you may see a dramatic drop in your score in the first month immediately following your bankruptcy filing, but by the end of the first year it could have less weight, and certainly less in later years compared to year one. Your own credit profile will also play a part in how much your credit score is affected when you declare bankruptcy. Similar to how having a higher credit score can ding your more points if you miss a credit card payment, so, too, are the case if you file for bankruptcy. According to FICO, someone with good credit may experience a bigger drop in their score when a bankruptcy appears on their report than someone with an already poor credit score.
Running up your credit card balances when you plan to file bankruptcy fairly clearly indicates that you intend to defraud your creditors. If you do so, the credit card company can file a non-dischargeability complaint in your bankruptcy case, asking the court to declare the debt non-dischargeable. If the court rules in the credit card company’s favor, you’ll have to repay the debt. Even if you run up the balances on your credit cards without actually intending to defraud the creditor—for example, if you intend to repay every cent, you might still get in trouble. Special rules apply if you used the credit cards for luxury goods and services, or if you took out cash advances, and you did so within a couple of months before filing your case.
Here are the rules:
• If you use your credit cards within 90 days before filing bankruptcy for luxury goods and services aggregating more than $725, fraud is presumed
• If you use your credit cards for cash advances totaling more than $1,000 within 70 days before filing bankruptcy, fraud is presumed
• If your purchases fall into the luxury category, or if you took out cash advances, you’ll have to show that you didn’t have fraudulent intent, either by providing evidence that you intended to repay the debt or that you didn’t intend to file bankruptcy. Typically, you should show both.
In any case, your credit card debt will be discharged unless the credit card company files a nondischargeability complaint. If the credit card company fails to notice your card activity or does nothing, the debt will be discharged. You can learn more in Adversary Proceedings in Bankruptcy. However, most credit card companies will carefully review all your purchases and other activity on the card that occurred before the bankruptcy filing. If you run up your credit card balances and then file bankruptcy, you run the risk of having to repay the debt. For most people, when possible, it’s best to stop using credit cards entirely if you’re having financial difficulties.
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It’s not a matter of if, it’s a matter of when. Legal problems come to everyone. Whether it’s your son who gets in a car wreck, your uncle who loses his job and needs to file for bankruptcy, your sister’s brother who’s getting divorced, or a grandparent that passes away without a will -all of us have legal issues and questions that arise. So when you have a law question, call Ascent Law for your free consultation (801) 676-5506. We want to help you!
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