Many people (wrongly) think that bankruptcy will take everything they own, even the TV in their living room. Not true. The bankruptcy laws are designed to leave you with an adequate standard of living after the bankruptcy, usually allowing you to keep most of your personal property, including your home and car.
What Will Happen to My House?
The Arizona Homestead Exemption
In Arizona, the first $150,000 in equity in your home is protected from the Bankruptcy court. This is known as the homestead exemption. For example, if your house is worth $200,000, but you only owe $75,000 on the mortgage, then you have $125,000 in equity. If you file Chapter 7 Bankruptcy, that $125,000 is safe and won’t be taken by the bankruptcy court to pay your creditors. It is yours to keep. That means the court won’t sell your house and you can continue living there as before bankruptcy.
If you have more than $150,000 in equity, the court may liquidate (sell) your home to pay your creditors. Although, you would still be entitled to receive your $150,000 in equity first. Note that if you are only slightly over the limit, say $155,000, it is unlikely the court will want to sell your home since there are costs involved in such a sale and it is unlikely anything would be left over after the sale anyway.
What Happens to the Mortgage in Bankruptcy?
The homestead exemption applies to the equity protected from “non-consensual” liens like judgments and creditor actions. It does not apply to consensual (voluntary) liens that you signed up for like mortgages. Mortgage lenders on your home have a certain priority in bankruptcy court.
Practically speaking, this means that you need to keep paying your mortgage if you want to keep your home as you go through bankruptcy. If you are behind on your mortgage when you file bankruptcy or fall behind later, your lender will likely be able to get permission from the bankruptcy court to proceed with a foreclosure to take your home. In essence, they are exercising their rights on the lien (deed of trust) on your home.
To put it simply, if you want to keep your home in a Chapter 7 bankruptcy, you can, as long as you can keep making the mortgage payments and don’t have more than $150,000 in equity.
The Mortgage Debt is Eliminated But the Lien is Not
One of the more bizarre and counter-intuitive aspects of a Chapter 7 bankruptcy involves what actually happens to your mortgage debt through the bankruptcy process.
When you bought your home, you signed a promissory note, which is the loan document in which you promised to repay the debt. You also signed a deed of trust, which is the lien (often called a mortgage) on your home. It is the security instrument that entitles the lender to foreclose if you default on the note.
In a Chapter 7 bankruptcy, the debt obligation under the promissory note is discharged or eliminated but the lien is not. At first, it seems like if the loan has been forgiven, you would just get to keep the house for free. Not so fast. Because of the lien, you have to keep making the house payments or the bank can and will foreclose after bankruptcy.
What Will Happen to My Car?
Arizona Car Exemption in Bankruptcy
In Arizona, the equity in your vehicle is exempt up to $5,000. If you are disabled, the exemption is $10,000. This applies to one car or vehicle. A married couple can double the exemption, which means two cars, each exempt up to $5,000 in equity, or one car exempt up to $10,000 in equity. Note that a married couple cannot allocate the exemption differently than that. In other words, you can’t apply $9,000 of exemption to one car and $1,000 to another car. It has to be 50/50.
By equity, we mean the value of the car that exceeds the amount of any loan on the car. So if your car is worth $10,000 and you owe $6,000, you have $4,000 in equity in the car. That $4,000 is protected from the bankruptcy court, meaning the court will not force the sale of your car to pay creditors. However, if the equity in your car significantly exceeds the $5,000 limit, the court may sell it to satisfy creditors.
What Will Happen to Your Car Loan in a Chapter 7 Bankruptcy?
If you have a loan on your car, you likely have a secured creditor. When you bought the car, you would have signed a promissory note, which is the document that says you promise to repay the debt. And the lender would have taken a lien on your car to secure the loan. Typically, this means the lender holds the title until you payoff the loan. If you default on the loan, the lender can repossess the car by exercising its lien rights.
In a Chapter 7 bankruptcy, the debt (promissory note) is wiped out, but the lien is not. Practically speaking, this means that you will need to keep making your car payments if you want to keep your car. Often, the lender will ask you to “reaffirm” the debt after the bankruptcy filing. This means the lender wants you to once again become obligated on the promissory note. Whether or not this makes sense for you to do depends on many factors and requires a unique analysis by a bankruptcy attorney.
What if Your Car is Underwater (Worth Less than What You Owe)?
Option 1: Surrender the Car
If your car is really worth a lot less than you owe, you should ask yourself whether it is even worth keeping. After all, the point of bankruptcy is to eliminate debt and move on with your life. Why would you want to keep a car that is so upside down with debt?
In a Chapter 7 bankruptcy, you have the option to surrender the vehicle, essentially a voluntary repossession. And the bankruptcy will protect you from liability for the amount of debt not covered by the value of the vehicle. In some cases, this may be your best option. You will lose the vehicle, but you will also lose the debt associated with it, which is part of the “fresh start.”
Option 2: Redeem the Car
One of the really powerful features of Chapter 7 bankruptcy is the redemption right. This means that you the debtor have the right to “buy” the car from the lender for what it is worth, not what you owe. For example, if you owe $10,000 on your car, but it is only worth $4,000, you have the right to redeem it for $4,000. You get to keep the car and eliminate the excess debt. What a deal. There is one catch: you typically have to come up with the $4,000 in one lump sum. And needless to say, financing will be difficult to come by. But if you have access to the cash, this can be a great way to keep your car and eliminate debt.
Option 3: Reaffirm the Car Loan
Option 3 is usually the one preferred by the lender. Reaffirming the car loan means you will once again be obligated for the loan debt, even after bankruptcy. If you really want to keep the car, it is upside down, and you don’t have the ability to redeem, then this may be your only option.
One positive aspect of a reaffirmation agreement is that it may be an opportunity to renegotiate the terms of the loan with the lender. Since the lender is getting paid, more than in option 1 or 2 above, they may be willing to work with you a little.
Are Retirement Accounts Protected?
Your 401(k), IRA and State Pensions are Typically Protected.
The good news is most types of retirement accounts are protected from the bankruptcy court taking them during a Chapter 7 bankruptcy. The government doesn’t want people to not be able to retire because of bankruptcy. That would create a burden on the government and be a recipe for disaster. So the government encourages retirement saving by protecting it from creditors in a bankruptcy or collection action.
Tax exempt retirement accounts are usually protected in bankruptcy, including:
What This Means? Don’t Tap Retirement Accounts to Pay Debts
Unfortunately, many people don’t know that retirement accounts are exempt in a bankruptcy and end up going through their life savings before filing bankruptcy. While bankruptcy should be a last resort, you should not inflict unnecessary pain on yourself.
When you think of the powerful lobbyists that represent the big banks and lenders in this country, it is sort of amazing that congress managed to protect retirement savings from creditors. This is great news for debtors and should not be taken lightly. Bankruptcy is about your past. Retirement accounts are for your future. Keep the two separate.
What Happens to Household Items
Arizona Exemptions Protect Most Household Items
Unfortunately, many people are under the mistaken impression that bankruptcy will take everything they own, even their sofa. Not true. The goal of the bankruptcy process is to provide you a fresh start, free of debt, but not destitute. In order to get that fresh start, you will need a basic and adequate standard of living. And the Arizona property exemptions have taken this into account.
Here is a list of some of the common exemptions clients want to know about. Note that a married couple can double these amounts:
$4,000 for 2 beds & bedding; 1 living room chair per person; 1 dresser, table, lamp, kitchen table, dining room table & 4 chairs (1 more per person); living room rug; couch; 3 lamps; 3 coffee or end tables; pictures, paintings, drawings, portraits; refrigerator, stove, washer, dryer, vacuum cleaner; TV, radio, stereo, alarm clock.
$150 in one bank account
$500 for bicycle, sewing machine, rifle, pistol, shotgun
$1,000 wedding/engagement rings
$250 musical instruments
Food & fuel to last 6 months
$5,000 funeral deposits
Car up to $5,000 in equity
What Happens to Your Income in Bankruptcy
Chapter 7 Bankruptcy: Post-Bankruptcy Income is Usually Safe
Under a Chapter 7 bankruptcy, the court is concerned primarily about your income in the 6 months BEFORE you filed bankruptcy. In other words, you need to have a low enough income in the preceding 6 months to qualify for a Chapter 7 bankruptcy. If you do, then your income after you file bankruptcy is yours to keep for the most part. This is why it is usually a better idea to file a Chapter 7 bankruptcy while you are unemployed or not making much money, rather than after you land some high paying job.
One word of caution, if you anticipate a significant increase in your income within one year after filing the bankruptcy petition, the court may be interested in that and you have to disclose it. For example, if you just landed a high paying job but don’t start for a month and you file bankruptcy now, you will need to disclose that fact and the bankruptcy trustee may try to force you into a Chapter 13 bankruptcy instead.
Chapter 13 Bankruptcy: Post-Bankruptcy Income Used to Pay Creditors
In a Chapter 13 bankruptcy, the income you earn after filing bankruptcy will be used (in part) to pay creditors under the Chapter 13 repayment plan. Not all of your income will be used and not all of your creditors will be paid in full, but the idea in a Chapter 13 bankruptcy is to come up with a reasonable monthly payment that goes to creditors for the length of the plan, which is 3 to 5 years.
If your income is too high for a Chapter 7 bankruptcy, then you will have three choices: 1) do nothing; 2) file a Chapter 13 bankruptcy; or 3) Debt Settlement to avoid bankruptcy all together. If you don’t qualify for a Chapter 7, we often recommend our debt settlement process as an alternative to bankruptcy. Although, a Chapter 13 bankruptcy may be appropriate in some circumstances.
How Much Does it Cost to File Bankruptcy in Arizona?
Costs for a Chapter 7 Bankruptcy in Arizona
There are two to three main costs if you file a Chapter 7 bankruptcy in Arizona. First, is the filing fee. This is the fee paid to the Court when you file your bankruptcy petition. The current amount of this fee is $335, which is paid directly to the court.
The second fee you will encounter is for the mandatory credit counseling courses that are required by the court. You have to take one course before filing bankruptcy and one course after you file but before you receive the discharge order that discharges your debt. These courses can be taken online and range in price from about $25-$35 or more per course, depending on which company you take the course from. Our firm can provide a recommendation for these courses. But the cost on these courses is fairly minimal.
The third type of cost would be attorneys fees. Although you are not required to hire an attorney to file a Chapter 7 bankruptcy, it is usually to your benefit to do so. The bankruptcy laws are very complex and a skilled bankruptcy attorney will be able to help you take full advantage of the protections of the bankruptcy laws, which could result in you keeping more assets and minimizing any negative consequences. We offer many of our bankruptcy services on a flat fee basis and can provide you a specific quote during a consultation.
Costs for a Chapter 13 Bankruptcy in Arizona
Just like above, you will encounter two to three types of costs when filing a Chapter 13 bankruptcy. In Arizona, the filing fee for a Chapter 13 bankruptcy is currently $310. Credit counseling courses are similarly $25-35.
The attorneys fees for a Chapter 13 bankruptcy are typically more than for a Chapter 7. However, some of these fees may be paid through the court process over time rather than all up front.
The exact amount of attorneys fees will depend on the complexity of your case and other factors. We can provide you a detailed quote after a consultation.
While there are costs associated with filing bankruptcy, for many clients the benefits will far outweigh the costs.