Overview of Types of Debt – Credit Card, Medical, Student Loan, Tax
There is a lot of talk on TV and from financial advisors about “good debt” and “bad debt.” But, money is fungible and debt is debt. That is, at least until bankruptcy enters the picture.
When someone files for bankruptcy, no matter what chapter they are filing under, debts fall into two categories – dischargeable and nondischargeable, although which debts are dischargeable varies under each chapter of the Bankruptcy Code. The reason most people file bankruptcy is to have their debts discharged, or forgiven, so they can start fresh. Many are disappointed when they learn of nondischargeable debts that remain intact during bankruptcy and must be repaid by the debtor.
Below is a list of some common types of debt and an overview of what happens to that debt when the debtor files for bankruptcy.
Credit Card Debt
Courts classify credit card debt as nonpriority debt, so credit card companies are some of the last in line to be paid when the bankruptcy trustee liquidates an estate. Credit card debt is generally no-asset unsecured debt, meaning there is typically no property in the estate that can be sold to pay the creditor back, so credit card companies often recoup nothing as the estate goes through bankruptcy. Then, whatever credit card debt remains after the estate is discharged by the court, with some exceptions.
Credit card debts will not be discharged when the charges were made under false pretenses. The court presumes the debtor was not acting in good faith if:
- Within 90 days of filing for bankruptcy, the debtor was using the card to purchase non-essential items, what the law calls “luxury goods or services.” “Goods or services reasonably necessary for the support or maintenance” of the debtor’s family, food and gasoline for example, are not considered “luxury goods or services.”
- No matter what the money is spent on, if the debtor charges over $925 in cash advances within 70 days of filing for bankruptcy, the debt is presumed nondischargeable.
The point of these presumptions is to prevent debtors from using bankruptcy as a way to a windfall.
Medical debt is one of the most common reasons people file for bankruptcy. Like credit card debt, medical debt is also classified as nonpriority unsecured debt. There is no limit on the amount of medical debt that can be discharged through bankruptcy.
Courts are very reluctant to discharge student loan debt.
Chapter 7 filers may be able to get the court to grant a discharge if they are able to show the debt creates an undue hardship. The test applied to determine if the filer faces undue hardship varies from court to court, and even judge to judge, so there is no clear standard. Recently, some very low income filers have been granted relief, as have debtors who took out loans to attend for-profit schools.
Chapter 13 filers will basically never have student loans discharged. They can, however, get the loan payments reduced during the bankruptcy process.
Tax Debt & Other Debts Owed to the Government
Debts owed to the government are typically not dischargeable. The only government debt that is routinely discharged is income tax debt, but even discharge may not fully wipe the filer’s slate clean.
Debtors can discharge income tax debts if all of the following conditions are met:
- The debt is over three years old.
- All the necessary tax returns have been filed.
- The 240 Day Rule – The IRS must have assessed the tax at least 240 days before the debtor filed for bankruptcy.
- The debtor did not commit fraud or otherwise attempt to evade paying the taxes due.
If all of these conditions are met, the income tax debt will be discharged. However, the debtor may still have to pay the government the full amount of the debt in the future. The government often files tax liens against the property of debtors so that they can recover the money owed when the property is sold. If the government filed a tax lien before the debtor filed for bankruptcy, that lien must be paid when the property is sold even if the debt is discharged. The government is very proactive about filing liens for this reason.
Loans from family and friends are generally dischargeable. However, if payments were made on these loans while other debts went unpaid, the court could rule that the debtor was showing favoritism or committing fraud.
Many debtors worry about what will happen to their vehicle if they file bankruptcy since driving is often a necessary part of daily life. The answer is it depends.
If the debtor does not want to keep the car, he or she can surrender it to the creditor. Surrendering the vehicle wipes out any debt remaining on the loan.
If the debtor wants to keep the vehicle, whether he or she is able to do so depends on whether the he or she has fallen behind on loan payments. If the debtor is not behind on payments, and the owner wants to keep the vehicle, he or she may reaffirm the current loan or redeem the car by paying the creditor the current market value of the vehicle in a lump sum.
If the debtor is behind on payments, whether he or she is able to keep the car often depends on what Chapter the bankruptcy was filed under. Chapter 7 does not provide a way for filers to catch up on payments, so typically cars with back due payments must be surrendered. Chapter 13, however, allows filers to make up back due payments, so keeping the car is possible.
If you are considering filing for bankruptcy and have questions about which debts can be discharged, contact a qualified bankruptcy attorney today.