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CHAPTER 7 OR BUST? OVER-MEDIAN DEBTORS

When a client comes to see me, they are usually struggling with debt. Might be a little or a lot; much of it depends on the eye of the beholder. For some, $20,000 in debt is a drop in the bucket; for others (most), it's the entire ocean drowning them with each additional dollar of interest.

So Mrs. Discouraged Debtor (Mrs. D.) tells me, "I want to file Chapter 7 to get rid of my debts, approximately $50,000 of old credit cards."

And I say, "I won't argue with you. You should eliminate this debt if you can no longer pay it back." (fraud arguments aside)

Mrs. D. then tells me, "Great, so you will help me?"

I say, "Of course I will, but first we must determine whether you qualify for Chapter 7 relief under the current standards."

Mrs. D. asks me, "What are these standards?"

I say, "First you must pass a means test, then show no excess monthly income and finally not have any unexempt assets that the court might liquidate for the benefit of your creditors." (besides not having filed bankruptcy within a certain period of time).

Mrs. D. says to me, "Well, lawyer, I make $150,000 a year and am single. Will I still qualify?"

I sink into my chair, get very cozy and say, "Maybe."

Mrs. D. says to me, "Maybe??? I want a more firm answer than 'maybe'! Are you sure you're an attorney?"

I say, "It's because I'm an attorney that I say 'maybe.'"

By now Mr. D. is very confused and getting frustrated, so I inform her, "The median income standard for a single woman with no dependents is less than $50,000 annual gross and you earn three times that amount. Now, I do not automatically disqualify you from qualifying for a Chapter 7 to eliminate your $50,000 in credit card debt, but I can tell you that unless you can convince the court that you cannot pay back your credit cards, you will not file a successful Chapter 7 and merit a discharge."

Mrs. D. asks, "How do I convince the court that I can't pay it back?"

I say, "You must pass the 'means test.'"

Mrs. D. exclaims, "What's with the $100 words?"

"It's quite possible for an over-median debtor to qualify for Chapter 7 if they can show that they have sufficient additional deductions/expenses above and beyond the standard deductions to pass the means test and they show no excess income. Meaning you must rebut any presumption of abuse."

Mrs. D. interjects, "English, doc!"

I translate, "Courts allow only so much for food, shelter and clothing (unless there are legitimate medical reasons requiring a higher expense). But there are some expenses that the courts will accept even if they are more than what the courts typically allow. Example, the standard deduction for rent is roughly $1200-$1300/month for a single woman in our county, but if you are paying $4,000/month in mortgage payments on your home, then you can use this payment to deduct another $2,800-$2900 each month from your gross income. Furthermore, if you have any mandatory retirement plans, hefty health insurance premiums, high car payments, regular charitable contributions, student loan payments or certain other additional expenses, they can be used to lower your disposable monthly income, giving you a chance to qualify. Make sense?"

Mrs. D. answers, "Sort of, but I'm still confused."

"The bankruptcy courts are designed to give honest debtors the relief they seek, but they are also there to ensure that creditors are treated fairly. Meaning, if the court determines that you make too much money and you do not have sufficient necessary deductions/expenses, then the court will want you to pay back some of your debts."

Mrs. D. yells, "Traitor! You're trying to trick me into one of those Chapter 13s! I won't do it!"

I calm her with, "Now, now Mrs. D., why are you so down on Chapter 13?"

"Because it's an unlucky number!"

I say, "If you're superstitious, I suppose. But let's look at the real unlucky numbers. You currently have $50,000 of credit card debt and are paying an average minimum of $1000/month in mostly interest. Over the next 60 month you would have paid $60,000 in mostly interest and you would still owe most, if not all, of the debt. Would you like to do this?"

Mrs. D. growls, "Blasted no!"

"I didn't think so. Now let's see what you would pay in a worst-case-scenario Chapter 13. The trustee takes 10% of the debt to administer the payment plan (some say 11%), so this would be another $5,000 or so on top of the $50,000 you owe. If you had to pay all of it in a Chapter 13 over the next 60 months, you would pay $917/month and be debt free in 5 years. Compare the interest you are currently paying and the worse-case Chapter 13. The 13 is world's better because as opposed to paying $60,000 in interest and still owing the $50,000, you would owe nothing in 5 years."

Mrs. D. grunts, "That's not so bad, but why do I have to pay it all back? I'm pretty certain I could not."

"You might not have to. First off, if your creditor does not file a claim against you within 90 days of filing the Ch 13, they get nothing. Many times unsecured creditors, who know they are at the bottom of the totem pole of repayment, decide against filing a claim because they assume that they will get nothing. That alone might lower the amount you pay back. Furthermore, even though a 100% plan is possible, they are rare. Most debtors in a Chapter 13 pay anywhere from 5%-70% of their unsecured debt (principal only), but when you consider the alternatives, there is no alternative. You can attempt a consolidation and this will probably get you sued by your creditors (because consolidators cannot prevent lawsuits - see my blog on Debt Consolidation Companies). You can attempt to settle if you have half of the debt in cash and are hoping they take it. You can run for the hills and hope the creditors don't trail with rifles at the ready. You can quit your job and your lifestyle and then attempt a Chapter 7 (but it would have to be in good faith; maybe you had a change in perspective and decided to become a missionary or monk). You can ignore them, but then they may sue you and take your money by force. You can continue to pay the minimum each month, but how far does that take you? See above. Now talk to me about unlucky numbers. Unfortunately, the damage was already done before you came to see me; the financial tumor is metastasizing and now we must do our best to either excise or shrink it. The truth remains that a Chapter 13 is a great option when a Chapter 7 is not available and we haven't even begun to discuss lien strips…do you own a house?"

Mrs. D. nods and with a gleam in her eye, says, "I'm listening…"

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