When you are in a financial crisis, one of the first things that will come to your mind is filing for bankruptcy. It seems that it is the easy way out for people who find it hard to make ends meet and pay off their monthly obligations at the same time.
However, you need to understand that there is more to filing for bankruptcy than meets the eye. It is not a simple discharging of debt. Although it is the easiest debt solution for most people and oftentimes the fastest, you have to consider that there are negative consequences to it. On top of that is the effect on your credit score. This is the reason why a lot of financial experts encourage consumers to know all the alternative to escape personal bankruptcy.
Also, people fail to realize that filing for bankruptcy is not as easy as it used to be. The bankruptcy means test is a recent addition that the US Justice Department imposed to filter out the people who really deserve to have their debts fully discharged.
Why you need to go through the means test before bankruptcy
The main purpose of the bankruptcy means test is to determine if you qualify to file for a Chapter 7 bankruptcy or a Chapter 13. Here is the difference between the two.
Chapter 7. This is also known as the liquidation bankruptcy. This is the option that most people aim for in bankruptcy because they rarely have to shell out money in the process. Their personal assets (excluding those qualified to be exempted) will be sold by the US Trustee assigned to your case. The money raised from the transaction is distributed by the bankruptcy court to your different creditors. Anything that is not paid will be discharged.
Chapter 13. Also known as the repayment bankruptcy, this option involves a repayment plan that the consumer is mandated to follow. It usually covers a percentage of the debt owed and takes a couple of years to complete. Once the repayment plan is complete, the rest of the debt will be discharged.
Obviously, you are better off with a Chapter 7 bankruptcy if you have no money or very little coming in every month. And if you have no assets to begin with, then there is really nothing much that you will lose.
The authorities imposed the bankruptcy means test to limit the people escaping their debts through Chapter 7. They noticed that a lot of people abused this type of bankruptcy and that some of them can actually afford to pay a portion of their debts – thanks to their monthly income. This test was designed to keep high earners from the Chapter 7 bankruptcy. It simply separates the people who can pay off their debts (or a portion of it) from those who are in a real financial hardship.
Also, the bankruptcy means test is only for people with consumer debts. A different set of rules apply for business debts.
What happens when you get a means test in bankruptcy
When you go through the means test in bankruptcy, you need to answer two important questions.
Where does your income fall in the average median salary in your state? If it falls below the average, you immediately pass and qualify for Chapter 7. That is how simple it goes for you. Of course, you need to consider the size of your house and the standards in your state to really determine if you fall below the average. If you are above the average, you do not immediately go to Chapter 13. Instead, you have to ask the next question.
Is your disposable income enough to pay off a portion of your debts? Getting the answer to this question is a bit more complicated than the other. You need to compute for your disposable income – which is the amount left after you have paid off the “allowed” expenses. Definitely, expenses like your annual vacation or that club membership will not be included in the “allowed” list. If it turns out that your disposable income is enough to pay off a portion of the debts you owe, then you will be forced to file for Chapter 13. Each state defines different “allowed” expenses so you need to do your research well.
There are two important forms that you will be filing to complete the means test. The Official Bankruptcy Form 22A is for those who will file Chapter 7 and the Form 22C is for those who failed the income test and has to check if they will file for Chapter 13. Some of the information will be coming from the personal files of the debtor but some will also be coming from the IRS.
Before filing your petition for bankruptcy, you are highly encouraged to try to calculate if you qualify for Chapter 7 or not. There are online calculators from sites like the LegalConsumer.com that will help you estimate how you will fare when you take the actual test. If you fail and you will be forced into a Chapter 13 bankruptcy, you might as well consider debt settlement.
In case you have conducted your own means test and you do qualify for bankruptcy, we highly encourage you to continue learning about Chapter 7. The more you know about it, the smarter your decisions will be as you go through the process of bankruptcy.