Facing debt on the heels of a divorce can be daunting.
But the two often go hand in hand: financial issues are often a contributing factor in divorce and divorce can often lead to financial strain.
The good news is that a divorce won’t keep you from bankruptcy relief. That being said, timing when you file may be critical.
How bankruptcy works in divorce.
In this article, we’ll cover:
- What are the different types of bankruptcy relief?
- The two main types of debt: unsecured vs. secured
- Things to consider when deciding between Chapter 7 and Chapter 13
- Chapter 7: An Overview
- Which should happen first: divorce or bankruptcy?
- Individual Chapter 7 cases vs. joint Chapter 7 cases
- When it makes the most sense to file a divorce and allow it to conclude before filing a bankruptcy
What are the different types of bankruptcy relief?
When we are talking about an individual bankruptcy (as opposed to a company) the most likely options are a Chapter 7 and a Chapter 13.
Chapter 7. A Chapter 7 bankruptcy is often referred to as a “fresh start” or a “clean slate” bankruptcy. It usually involves selling property to pay off your debts and then erasing whatever eligible debts remain. This is usually ideal for individuals who don’t own expensive property like a house or a car.
Chapter 7 generally allows you to keep most, if not all, of your day-to-day property while also erasing your debts.
Chapter 7 bankruptcy is generally less complex, taking about 4 to 6 months. Although we discuss both bankruptcy Chapters, this article will focus on the relationship between divorce and Chapter 7.
Chapter 13. Chapter 13 bankruptcy will usually allow you to keep your house and your car but involves a 3-to-5 year repayment plan to settle a portion of your debt.
Keep in mind — your Chapter 13 case won’t close until you complete your repayment plan. Failing to do so can void your bankruptcy case.
The two main types of debt: unsecured vs. secured
Unsecured debt is when the money you owe is not tied to something tangible. Debt from credit card or medical bills makes up the bulk of most people’s unsecured debts. These can usually be discharged in a Chapter 7 case.
Secured debts, on the other hand, are directly tied to something specific — like a house or a car.
Your house is directly tied to your mortgage. If you default on payments you could face foreclosure. Your car payment is secured by your car. If you stop paying or get behind on your payments, your car could be repossessed.
Non-dischargeable debts. Please keep in mind that some debts are not dischargeable. This includes debts from alimony or child support. Understanding the type of debt you have before and after your divorce will help you figure out which bankruptcy option is best for you.
Things to consider when deciding between Chapter 7 and Chapter 13
- Eligible for Chapter 7 based on your income? Complete the Means Test. In order to file for Chapter 7 you have to pass the income-based “Means Test.” This is to see that you’re below the area median income in your state and generally can’t cover your expenses.
- Have secured property that you want to keep? Double check with an attorney. If you are behind on payments for secured property that you want to keep, you may need to file a Chapter 13 and not a Chapter 7. Chapter 13 typically gives you the opportunity to catch up.
Although there are instances where people can keep their homes and cars under Chapter 7, if you are in this situation, it would probably be wise to consult with a private attorney or legal aid to review your options.
- Paying alimony and/or child support? These aren’t included. There are certain debts that can’t be erased. This includes alimony and child support. Any missed payments, or arrearages, on these court orders, will survive the discharge order at the end of the case and will still need to be paid.
Chapter 7: An Overview
How does the Means Test work?
The Means Test is the method to see if you qualify to file a Chapter 7 case based on your household income. Chapter 7 is intended for low-income people who cannot afford a payment plan.
In order to file under Chapter 7, you either need to show that your household is below your state’s median income – or- that your expenses exceed your income to the point where it justifies a bankruptcy case. So, what does that mean exactly?
- You make below your state’s Median Income. This calculates any regular income coming into the house (but this does not include your Social Security). So, if your household income for the past six months is below the state’s median income (based on your household size), you will likely qualify for a Chapter 7 case.
Above Median Income? There’s a chance you could still qualify!
- Your expenses far exceed income. If you’re above the Median Income, you can employ the Means Test to see if you can still qualify. Here you will calculate how much you have left over at the end of the month. If your expenses are far more than your income each month, you could still qualify for Chapter 7.
However, if there is enough disposable income at the end of the month you could be pushed into a Chapter 13.
Which Goes First: Divorce or Bankruptcy?
It depends. Deciding when to file will depend on multiple factors — particularly whether you want to file with you or without your spouse. Below we’ll discuss some of the things to consider when deciding whether to seek divorce or bankruptcy first.
Filing a joint Chapter 7 before (or during) a divorce
Presuming that as a couple you still qualify under the means test, and you and your spouse are on good terms, there are a number of benefits to completing the bankruptcy before the divorce.
- Save on court fees. if you are seeking relief with a private attorney you can save on court filing fees (one set of paperwork instead of two) and attorney fees (again paying for one attorney instead of two.)
- Easier division of assets. Resolving debts in advance may lead to an easier division of assets, which in turn could make the divorce quicker.
- Erase most marital debt. Chapter 7 bankruptcy will discharge all eligible marital debt. This can be critical because “marital debt” generally refers to any debt incurred during the marriage. So, for example, if your spouse incurred a lot of medical bills from an injury while you were married, those bills could be considered marital debt, not simply personal to the individual receiving treatment.
This means that if he or she does not pay (or files their own separate bankruptcy case after the divorce) those creditors can, and often will, come after you for payment. Discharging the debt together avoids this scenario.
- Protect more property. Depending on the rules of your state, the exemptions you can claim (essentially the amount you can protect in specific assets) may be more favorable in a joint case rather than two individual cases. Many states allow married couples to use twice the amount of the individual exemptions — allowing you to protect more property than if you were filing alone.
But, don’t forget the Automatic Stay! If you and/or your spouse decide to file for a Chapter 7 bankruptcy after a divorce proceeding has begun, it will trigger the automatic stay. The automatic stay will halt most other court proceedings, including your divorce, while the bankruptcy case is open.
But the stay won’t stop family court proceedings on child custody or child support.
Considering filing for bankruptcy on your own now? Keep reading.
Filing an Individual Case After a Divorce
Consider the following instances where an individual case may be better than a joint case.
- Tension with Spouse. As we mentioned above, the automatic stay provided by the bankruptcy case will temporarily halt your divorce proceedings. This means that if you and your spouse are not on good terms and do not wish to interact even for the duration of the bankruptcy case, it may make sense to finalize the divorce first.
- Ineligible for Chapter 7 due to joint income. Sometimes two spouses together can be over that income threshold as a couple but still qualify for an individual chapter 7 based on their own income.
If your spouse’s income puts you over the Chapter 7 limit, it may be best to complete the divorce first so that you can file the bankruptcy after. This way you can still file for Chapter 7 if, on your own, you make less than your state’s median income.
Bankruptcy and Divorce Often Go Hand-In-Hand
Deciding when to file bankruptcy and whether to file jointly or separately is very personal and specific to your circumstances.
The decision will depend on many outside factors such as income, household size, and status of your marital debts. You also have to take into account your personal feelings about continuing to interact with your spouse and how quickly you would like the divorce to go through.
Be sure to consider your options carefully and always discuss your specific circumstances with an attorney, legal aid, or a nonprofit like Upsolve to determine your best option.
Eva G. Bacevice graduated from the University of Michigan Law School in 2001. She practiced law for close to a decade in the area of consumer bankruptcy. She now works in higher education as an Academic Advisor for undergraduate students at the Stephen M. Ross School of Business, University of Michigan and has recently joined Upsolve as a content writer. She is delighted to have the opportunity to share her knowledge of personal bankruptcy through the lens of her current work in and passion for education.