Last updated July 31, 2018. The federal bankruptcy laws promise a fresh financial start for the honest but unfortunate debtor. Bankruptcy balances the interests of the debtor to obtain a fresh start and the interests of the creditor to see that the debtor pays back whatever he or she can afford. But all too often, a debtor makes mistakes in bankruptcy, seriously compromising his or her case before it’s even filed. To help you avoid those unnecessary complications, we’ve prepared this list of the 7 biggest mistakes in bankruptcy:
1. Paying an Insider CreditorThe bankruptcy laws attempt to ensure that all creditors receive fair treatment during the bankruptcy process. One concern is that the debtor will pay loans to family or friends before filing bankruptcy, and therefore deprive other creditors from receiving payment. Family, friends, business partners, and other creditors who have close relationships with the debtor are called “insider creditors,” and transfers to insider creditors can be avoided by the bankruptcy trustee if the transfer occurred within one year before the bankruptcy filing. For instance, if you gave your mother $1,000 from your income tax refund as payment for a debt, and then filed bankruptcy two months later, the bankruptcy trustee can sue your mother to recover the $1,000. To make matters worse, often the debtor could have protected the cash money during the bankruptcy and paid the debt without difficulty after the case was filed.
2. Incurring Debt After Deciding to FileSome people decide to charge up credit cards or take payday loans just before filing bankruptcy. If you have decided to file bankruptcy, do not incur additional debt. Taking loans with no intention to repay the creditor could be fraud, which is a crime.
3. Transferring Property Before BankruptcyAnytime an individual transfers property for less than full value shortly before a bankruptcy filing, the transfer seems “suspicious.” The bankruptcy trustee scrutinizes all property transfers before bankruptcy, and if a property transfer was not a fair and honest exchange, the trustee may avoid the transfer and get the property back. One common bankruptcy mistake is transferring property to a friend or family member in an effort to hide it from the bankruptcy court. This is a very bad mistake that can result in: (1) losing the property anyway; (2) denial of your bankruptcy discharge; and/or (3) criminal prosecution for bankruptcy fraud. If you need to sell or transfer property before your bankruptcy, contact an experienced attorney and discuss your options!
4. Paying Off Loans Before BankruptcyIf you pay off a loan shortly before filing for bankruptcy, the bankruptcy trustee will be very interested in that payment. If you paid a large sum of money to one creditor just before filing, the trustee may ask the creditor to return the money. Also, paying off an unsecured debt that is otherwise dischargeable (like a credit card or payday loan) is like throwing your money away. You need that money to help rebuild your finances after your case is completed. And even paying off a secured debt can cause you problems. Bankruptcy exemptions commonly apply only up to a certain amount of equity. Your equity in some property is the difference between the fair market value of the property minus any secured loans. When you pay off a secured loan, you increase your equity in the property. If that causes your equity to exceed the exemption limit, the bankruptcy trustee may ask you for the property or the cash difference between the equity and the exemption amount. Bottom line: don’t pay off loans before bankruptcy!
5. Cashing out RetirementMost retirement funds are fully protected from creditors and the bankruptcy trustee. That means if you file bankruptcy, you keep your retirement money. Congress wants you to have money for your retirement. Unfortunately, some people are unaware of these broad protections and cash out their retirement savings out of fear that it will be taken during the bankruptcy. Along with the obvious problems associated with losing your future retirement money, cashing out retirement funds is also a huge mistake because:
- Your attorney may no longer be able to protect available retirement money converted into cash; and
- If you used your retirement funds to pay off an unsecured loan, the bankruptcy trustee may be able to undo those payments. Money paid to creditors before bankruptcy does not improve your financial situation or help you recover from bankruptcy.