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Bankruptcy Information

Matthew Foley

Matthew Foley

Esq. & MBA

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Frequently Asked Questions (FAQ) about Bankruptcy in Arizona: Debunking Bankruptcy Myths

What are My Rights as an Arizona Debtor?

Debtors have fundamental rights, both via state and federal laws. Debtors are protected from harassment from creditors under the Fair Debt & Collection Practices Act. This federal law allows debtors to request that creditors not call them with a “cease and desist” letter. In the event that a debt has escalated to a judgment, state laws limit attachment of a debtor’s assets, by carving out “exemptions.” As an example, a creditor can only garnish 25% of a debtor’s wages. Finally, the most comprehensive debtor right is the ability to file bankruptcy, which is a Constitutional remedy. Because bankruptcy provides a tremendous benefit/opportunity to debtors, which is often an immediate fresh start, a debtor can only file bankruptcy every 4 – 8 years, depending upon which type of bankruptcy was previously filed and if it was terminated with the entry of discharge.

Do I Need to Hire an Attorney to File Bankruptcy in Arizona?

Yes, it is highly recommended to use an attorney to file bankruptcy. Bankruptcy is complex, the rules are difficult and spread through local and federal rules, exemptions are found in diverse state exemptions & federal statutes, and creditors have representation through an assigned trustee or their own counsel. Debtors often spend more money and resources in losing assets or surrendering funds than they would have spent in hiring a competent bankruptcy attorney. Beyond the complexity of bankruptcy and the cost of an attorney, the intangible benefit of an attorney is peace of mind that your financial affairs are being handled by a professional.

How Does Bankruptcy Affect My Credit?

This is perhaps the largest misunderstanding associated with filing for bankruptcy. For many bankruptcy clients, bankruptcy actually improves their credit score. For others, bankruptcy is merely a derogatory remark on their credit that will not effect their score after two years. The common misconception is that bankruptcy will ruin credit for 10 years. This is completely inaccurate. Bankruptcy eliminates debt and affects a credit score for 2 years. Thereafter, its existence on a credit report is negligible, and creditors do not care of its existence. The only hurdle is mortgage lending guidelines that limit mortgage eligibility until a bankruptcy is more than 3 years old (current FHA guidelines).

Can I File Bankruptcy and Keep My Property in Arizona?

Yes. Arizona has debtor friendly exemptions that consist of state and federal exemptions, coupled with non-bankruptcy exemptions, such as protections of social security income and certain pensions. Arizona exemptions include protections of homestead equity up to $150,000, vehicle equity up to $6,000 per spouse, and $12,000 if the a debtor has handicapped plates. Compared with most other states, Arizona exemptions provide valuable protection to a debtor’s property, and renders most bankruptcies as “non-asset” cases, meaning that the trustee collects no property from the debtor in a Chapter 7 bankruptcy proceeding. These same exemptions enable debtors to comfortably file Chapter 13 as well.

Can Just One Spouse File for Bankruptcy in Arizona?

Yes. Arizona, as a community property state provides an opportunity for either spouse to file bankruptcy, while enabling the non-filing spouses to receive the benefit of the bankruptcy protection and discharge. That said, there are particular situations that warrant only one spouse filing and other scenarios that absolutely warrant both spouses to file. Debtors must consider the impact on their credit, whether they are going to stay married, any non-community assets, and other factors. I would highly recommend speaking with a knowledgeable bankruptcy attorney that fully understands that complexity of community property laws, creditors attempts to collect post-filing on a non-filing spouse, and the bankruptcy codes application of a “split discharge”.

How will Bankruptcy Affect My House and Car?

Bankruptcy will not negatively affect your house or car, however, it does provide a positive opportunity for debtors to improve their outstanding loan obligations. When filing bankruptcy, a debtor must include all assets and liabilities, which includes the houses and cars. For a debtor to keep a house, the debtor must simply remain current on the mortgage payment. This requirement exists independent of whether a debtor files for bankruptcy. For a debtor to keep a car, they must stay current on the obligation and sign a “reaffirmation agreement.” This agreement is a new contract with terms identical or better than the initial purchase contract.

During bankruptcy, and as discussed next, a debtor may “strip” a second mortgage during a Chapter 13 Bankruptcy proceeding, if this mortgage is wholly unsecured. Stated differently, if the home is worth less than the outstanding first mortgage, a debtor can file a Chapter 13 and remove any secondary liens, which are removed after the bankruptcy discharge. Lien stripping is accomplished through filing an adversarial complaint within the bankruptcy and with plan language that places strict requirements on a lender to follow through with loan removal after the bankruptcy has been completed.

With respect to a vehicle, a debtor may negotiate the terms of their reaffirmation agreement, which includes adjustments to the outstanding principal and/or adjustments to the interest rate. This is done in a Chapter 7 Bankruptcy proceeding and works well with particular lenders. However, some lenders will not negotiate terms. The second option for Chapter 7 debtors is to “redeem” the vehicle, which means purchasing the vehicle from the lender at what it is worth, versus what is owed on it. This can be a great benefit to a debtor and there are some loan programs that will even assist debtors with redemption loans. In a Chapter 13 Bankruptcy proceeding, a vehicle can be paid off at what it’s worth if the vehicle has been owned for more than 910 days. This is called a “Cram Down.” Also, in a Chapter 13, the vehicle’s interest rate is always reduced to a very low amount, usually prime plus one percent and is spread out over 3 – 5 years.

Can I Eliminate My Second Mortgage?

Yes, in a Chapter 13 bankruptcy proceeding, a second mortgage can be “stripped” or removed from the home, if it is completely unsecured. This means that if the value of a home is less than the first mortgage owed on the home, any subsequent loan is consequently “unsecured.” As such, the mortgages can be treated as unsecured debt and these liens can be removed from the home. The concept and requirements are straight forward, however, the process is complicated. First, after filing a Chapter 13 bankruptcy, the debtor’s plan must have explicit language of the debtor’s intent and lenders obligations pursuant to this plan. Next, the debtor must either stipulate to the lien strip, or they must file an adversarial complaint with the Court. This complaint is a lawsuit inside of the bankruptcy proceeding and is treated as a separate case that seeks the declaratory relief of lien avoidance. Though lien stripping is currently accomplished in a Chapter 13 proceeding, some bankruptcy jurisdictions outside of Arizona have entertained a debtor’s ability to strip mortgages inside of Chapter 7 bankruptcy as well.

Arizona's Community Property Laws & Debts?

Arizona is a community property state. This means that assets and debts incurred during marriage are presumed to be community property. Arizona does have some exceptions, such as property acquired through inheritance. Debts acquired during marriage are also presumed community property, with some rare exceptions. This is an important concept for several reasons. First, if a couple gets a divorce, and if debts are assigned to each spouse, creditors are not bound by the divorce decree and can choose which spouse to sue, regardless of which spouse actually signed or applied for the debt, and regardless of whom actually benefited from the debt. Second, because creditors do not necessarily know the marital status of a potential defendant, creditors in Arizona always sue the contractually obligated debtor plus an actual or fictitious “Jane Doe” or “John Doe.” During the lawsuit, the creditor can then ascertain the marital status and amend their complaint accordingly. Finally, because each spouse is obligated for each other’s debts that were incurred during the marriage, couples should speak with a debt attorney about the pros and cons of filing bankruptcy jointly or separately in the event they need debt relief.

Bankruptcy Before or After Filing for Divorce?

The general rule is to file bankruptcy prior to divorce. There are two reasons. First, filing while married means that there will be only one attorney fee, versus two. Divorced couples must file separately, and can be then later consolidated. Second, and more importantly, filing bankruptcy prior to the entering of a divorce decree eliminates the need for allocating debt obligations among spouses. Once debts are assigned via a divorce decree, they become court ordered domestic support obligations (“DSO’s”). At this point, the debts become non-dischargeable among each other. In a particularly adversarial or contested divorce, this can become a nightmare. Therefore, the general rule is file bankruptcy prior to divorce.

The exception to this rule is where separated couples can sometimes use the separation as an opportunity to qualify for a Chapter 7 bankruptcy individually, of which they may not have been eligible to file jointly. That said, debtors are not allowed to separate solely for the purposes of defeating or circumventing the bankruptcy code. The other advantage of filing bankruptcy after a divorce, is that couples can properly plan for bankruptcy and assign assets strategically among each other via the divorce decree, which should not trigger any preferential payment or transfer issues. Next, debtors can then file and structure a bankruptcy petition to try and use one spouse’s filing to cover both spouses’ obligations. These types of situations involve precise planning and insight to how a creditor will treat a bankruptcy proceeding.  Always speak to a bankruptcy attorney first.

What are the Bankruptcy Myths?

The largest bankruptcy myths have to do with debtors loosing property and how a bankruptcy affects a debtor’s credit. Both are tremendously inaccurate and are likely promulgated deliberately by creditors to dissuade debtors from seeking bankruptcy relief. The largest opponents of bankruptcy are creditors (because they likely will not get paid) and debt management companies (whom cannot offer bankruptcy and provide a terrible alternative).

First, as discussed above, most debtors do not loose property. This is especially true, if they have an excellent attorney that is versed in the delicate counsel of negative asset planning (pre-petition asset planning), and well versed in the state and federal exemption schemes. If a debtor misses an exemption, or if their attorney fails to claim the exemption, the debtor loses it. This is unfortunately common.

Second, bankruptcy often improves your credit and it has minimal affect on your overall credit score. Most, if not all, debtors are aware that bankruptcy remains on a credit report for 7 – 10 years (the actual answer is 10 years). However, few debtors understand that bankruptcy only affects the credit score for two years, and thereafter, its presence is negligible at best. In addition, most creditors do not care about the existence of a bankruptcy once it has been discharged for more than two years. Finally, credit scoring models compare bankruptcy debtors to other bankruptcy debtors for purposes of generating a credit score, which is an opportunity for debtors that understand how to reestablish credit. These individuals that are motivated and follow through with credit restoration will be compared against other debtors that filed bankruptcy and did nothing thereafter to improve their credit.

The Truth About Bankruptcy & Credit

As a Bankruptcy attorney, probably the most frequently asked question is “how long does bankruptcy affect my credit.” The universal answer is 7 – 10 years. This is inaccurate and misleading. I advise clients that bankruptcy affects a credit score for 2 years. This conclusion is discussed below, and provides consumers with the general mechanics of a credit score and should know that bankruptcy provides one of the most advantageous methods of quickly improving a credit score. The length of time a bankruptcy is on a credit report is irrelevant.

Background in Credit – A Lender’s Perspective

As a former credit analyst and mortgage lender, my perspective on credit is industry driven, i.e. how does a lender perceive a foreclosure or bankruptcy on a credit report. That said, the short answer is that the substantial impact of a foreclosure or bankruptcy on a credit score is approximately two years. Thereafter, the existence of a bankruptcy or foreclosure on a credit report is negligible. The key distinction and the relevant question is how long does a derogatory remark, such as bankruptcy or foreclosure, affect my credit score. The length of time a derogatory remark is actually on your credit is irrelevant, meaning that if a lender does not consider the blemish, why should you? For example, a mortgage lender looks at the length of time between an application for credit and a foreclosure date or a bankruptcy discharge date—the actual loan approval and interest rate are not impacted by the existence of a foreclosure or bankruptcy. Clients need to focus on their credit score – not their “credit.”
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