Should I Stop Paying Credit Cards Before Filing Bankruptcy?

Navigating financial distress often leads individuals to consider debt relief options, including bankruptcy. Pursuing bankruptcy requires a careful examination of one’s financial situation and understanding the legal processes. Credit card debt represents a substantial portion of many people’s financial obligations, raising questions about how these debts are handled in bankruptcy. Understanding the implications of actions, particularly regarding credit card payments, is important when contemplating this step.

Understanding Payments Made Before Bankruptcy

When an individual files for bankruptcy, certain payments made to creditors shortly before filing can be scrutinized as “preferential transfers.” A preferential transfer occurs when a debtor pays a specific creditor more than they would have received through the standard bankruptcy distribution process, giving that creditor an unfair advantage. The United States Bankruptcy Code outlines criteria for a payment to be preferential, including that it must be a transfer of the debtor’s property on account of an existing debt while the debtor was insolvent. These provisions ensure all unsecured creditors are treated equitably and that a debtor does not favor one creditor over others just before filing.

Bankruptcy trustees have the authority to “claw back” or recover these preferential payments from the favored creditor. This recovery mechanism aims to return funds to the bankruptcy estate, which are then distributed fairly among all creditors. The law prevents creditors from receiving disproportionate shares of the debtor’s assets before the bankruptcy process ensures an orderly distribution. If a clawback action is successful, the creditor must return the payment for redistribution among all creditors who have filed claims.

The timeframe a trustee can look back at payments varies by creditor type. For most regular creditors, like credit card companies, the look-back period for preferential transfers is 90 days immediately preceding the bankruptcy filing. Any payment totaling $600 or more to a single creditor within this 90-day window may be reviewed by the trustee. However, payments made in the ordinary course of business or financial affairs may not be considered preferential.

The look-back period extends if the payment was made to an “insider.” An insider is defined as a relative, general partner, or a business associate. For payments to insiders, the look-back period is one year prior to the bankruptcy filing. This extended period recognizes the closer relationship and potential for undue influence insiders might have. For instance, if a debtor repays a family member, this payment could be subject to a clawback by the trustee if it falls within the one-year period.

When debtors fill out their bankruptcy paperwork, they must report certain transfers, including payments made to creditors. This disclosure helps the trustee identify potential preferential transfers. If a payment is identified as preferential, the trustee will initiate an action to recover the funds. The recovered funds do not return to the debtor but are added to the bankruptcy estate for distribution among all creditors.

The Treatment of Credit Card Debt in Bankruptcy

Credit card debt is unsecured debt because it is not tied to any specific collateral, unlike a mortgage or car loan. In most bankruptcy proceedings, credit card debt is dischargeable, meaning the debtor is no longer legally obligated to repay it. This discharge provides individuals with a fresh financial start by eliminating their obligation to pay these specific debts. The treatment of credit card debt depends on the type of bankruptcy filed.

In Chapter 7 bankruptcy, credit card debt is discharged within a few months of filing. Eligibility for Chapter 7 depends on meeting certain criteria, including passing a “means test” that evaluates an individual’s income and expenses. Upon filing, an automatic stay goes into effect, immediately halting most collection efforts by creditors, including those related to credit card debt.

Chapter 13 bankruptcy involves a court-approved repayment plan lasting between three and five years. Credit card debts are included in this plan and are classified as non-priority unsecured debt. This means they are paid after priority debts, such as child support or certain taxes, and secured debts like a mortgage. The exact amount paid toward credit card debt in a Chapter 13 plan depends on the debtor’s disposable income and total debt. At the conclusion of the repayment plan, any remaining unsecured debts, including credit card balances, are discharged.

While credit card debt is dischargeable, specific exceptions exist under bankruptcy law, particularly if fraud is involved. Debts incurred through fraudulent activity, such as making false representations to obtain credit, may not be discharged. Certain types of purchases or cash advances made shortly before filing for bankruptcy are presumed fraudulent and may be deemed non-dischargeable.

For example, credit card purchases for luxury goods or services totaling more than $900 made to a single creditor within 90 days before filing for bankruptcy are presumed fraudulent. Luxury goods are items not reasonably necessary for the support or maintenance of the debtor or their dependents. Similarly, cash advances exceeding $1,250 from a single creditor within 70 days of filing are also presumed non-dischargeable. If a creditor objects to the discharge of such debts, the debtor may need to demonstrate no fraudulent intent when the charges were incurred.

Immediate Consequences of Stopping Payments

Stopping credit card payments before a bankruptcy filing can lead to several immediate consequences. One direct impact is a significant decline in one’s credit score. Late payments are reported to credit bureaus, and the longer payments are missed, the more severe the damage becomes. A single missed payment reported after 30 days can cause a substantial drop in credit score points.

Creditors will impose late fees on overdue accounts. These fees accumulate with each missed payment, increasing the overall debt balance. Credit card issuers may also increase the interest rate on the outstanding balance, accelerating the debt’s growth. Promotional interest rates are often revoked upon late payment.

Intense collection efforts from creditors and debt collection agencies are another common consequence. Debtors can expect frequent phone calls, letters, and emails as creditors attempt to recover outstanding amounts. These collection activities can be persistent and cause considerable stress.

Creditors also have the option to initiate lawsuits to collect the debt. While creditors typically exhaust other collection methods first, legal action is a possibility, especially for larger debt amounts. If a creditor obtains a judgment, they may pursue wage garnishment, bank account levies, or property liens, depending on state laws.

These consequences, while impactful, are temporary if a bankruptcy petition is filed. Once bankruptcy is filed, the automatic stay takes effect, providing immediate protection from most collection activities, including lawsuits and collection calls. This protection offers significant relief from the immediate pressures of outstanding debt. The long-term effects on credit are addressed as part of the bankruptcy process, with the opportunity to rebuild credit after discharge.

Preparing for Bankruptcy Filing

Once the decision to pursue bankruptcy has been made, taking specific steps is important for a smoother process. Immediately ceasing the use of all credit cards and refraining from incurring new debt is a practical step. This action demonstrates a clear intent to manage finances responsibly and avoids complications related to new charges that might not be dischargeable. It also prevents the accumulation of further debt that could hinder the bankruptcy process.

Gathering all necessary financial documents is an important preparatory step. This includes:
Recent pay stubs, tax returns for the past two years, and bank statements for the preceding six months.
Current statements for all existing debts, such as credit cards, mortgages, and car loans.
Documentation related to assets, including real estate, vehicles, retirement accounts, and other personal property.
A detailed list of monthly expenses, such as rent, utilities, food, and transportation.

A primary step in preparing for a bankruptcy filing is to seek consultation with a qualified bankruptcy attorney. An attorney can provide personalized advice based on an individual’s financial situation, guiding them through the complexities of bankruptcy law. They can determine the appropriate type of bankruptcy, explain the process, and ensure all required documentation is accurately prepared.

During the initial consultation, the attorney will review the debtor’s financial information and discuss their goals. They can clarify the implications of bankruptcy, including which debts are likely to be discharged and any potential exceptions. Preparing a list of questions in advance can help ensure all concerns are addressed. The attorney serves as an advocate, providing guidance and support throughout the bankruptcy proceeding.