Table of Contents

Does Bankruptcy Clear Personal Loans? The Definitive Guide

Yes, generally speaking, bankruptcy can clear (discharge) personal loans. However, the devil is always in the details. Whether or not your personal loan is discharged depends on the type of bankruptcy you file, the specific characteristics of your loan, and your overall financial situation.

Understanding Bankruptcy and Personal Loans: A Complex Relationship

Bankruptcy is a legal process designed to provide individuals and businesses overwhelmed by debt a fresh start. It offers a way to eliminate or reorganize debts, giving debtors a chance to rebuild their financial lives. Personal loans, being unsecured debts in most cases, are typically dischargeable in bankruptcy. But don’t go celebrating just yet – there are several crucial factors to consider.

The Two Main Types of Personal Bankruptcy

In the context of personal loans, two types of bankruptcy are most relevant:

Chapter 7 Bankruptcy (Liquidation): This is often referred to as “straight bankruptcy.” In a Chapter 7 case, the bankruptcy trustee may sell off your non-exempt assets to pay off creditors. However, many debtors have little or no non-exempt property. The benefit of Chapter 7 is that it offers a relatively quick discharge of eligible debts, including most personal loans, usually within a few months.
Chapter 13 Bankruptcy (Reorganization): This is often called a “wage earner’s plan.” In a Chapter 13 case, you propose a repayment plan to your creditors over a period of three to five years. You make regular payments to the bankruptcy trustee, who then distributes the funds to your creditors according to the plan. While you’re still paying on your debts, a successful completion of the Chapter 13 plan still results in the discharge of remaining eligible debts, including typically personal loans.

Key Factors Affecting Loan Dischargeability

While bankruptcy generally discharges personal loans, certain circumstances can prevent or delay that discharge:

Fraudulent Activity: If you took out the personal loan with the intent to not repay it (for example, knowing you were about to file for bankruptcy), the creditor may object to the discharge. They can file an adversary proceeding in bankruptcy court to argue that the debt should not be discharged due to fraudulent intent. This can be difficult to prove, but creditors can and do bring such actions.
Recent Charges: If you incurred significant charges on the personal loan shortly before filing for bankruptcy, the creditor could argue that those charges are non-dischargeable because you obtained credit knowing you couldn’t repay.
Failure to List the Debt: You must list all your creditors in your bankruptcy paperwork. If you intentionally fail to list a personal loan, it might not be discharged. Even if unintentional, it could cause complications and require further legal action.
Secured Personal Loans: While most personal loans are unsecured, some might be secured by collateral (like a car or other property). If that is the case, you might have to surrender the collateral to get rid of the loan, or reaffirm the debt and continue making payments in order to keep the collateral. Reaffirming the debt means agreeing that the debt is not discharged in bankruptcy, and you are still obligated to pay it.
Non-Dischargeable Debts: Certain debts are never dischargeable in bankruptcy, such as most student loans (though this is a rapidly evolving area of law), certain tax obligations, and child support. Personal loans taken out specifically to pay these non-dischargeable debts might also face scrutiny.

The Importance of Bankruptcy Counseling

Before filing for bankruptcy, you are required to undergo credit counseling from an approved agency. These agencies can help you assess your financial situation, explore alternatives to bankruptcy, and understand the implications of filing. Additionally, after filing for bankruptcy, you must complete a debtor education course. Both of these courses are designed to help debtors make informed decisions about their finances and prevent future financial distress.

Frequently Asked Questions (FAQs) about Personal Loans and Bankruptcy

Here are some commonly asked questions about how bankruptcy affects personal loans:

FAQ 1: What is an unsecured personal loan?

An unsecured personal loan is a loan that is not backed by any collateral. This means that the lender does not have the right to seize any of your assets if you fail to repay the loan. Most personal loans fall into this category.

FAQ 2: How does Chapter 7 bankruptcy work for personal loans?

In Chapter 7 bankruptcy, if your personal loan is deemed dischargeable (and most are), it will be eliminated. You will no longer be legally obligated to repay the debt. The creditor will receive a notice of the bankruptcy and will be prohibited from attempting to collect the debt from you.

FAQ 3: How does Chapter 13 bankruptcy work for personal loans?

In Chapter 13 bankruptcy, your personal loan will be included in your repayment plan. You will make payments on the loan, along with your other debts, over a period of three to five years. At the end of the repayment plan, any remaining balance on the personal loan will be discharged.

FAQ 4: What does it mean to “reaffirm” a personal loan?

Reaffirming a personal loan means that you agree to continue making payments on the loan even after your bankruptcy is discharged. You typically do this if you want to keep an asset that is secured by the loan, such as a car. However, reaffirming is a serious decision, as you will be legally obligated to repay the debt even if you later experience financial difficulties.

FAQ 5: Can a creditor object to the discharge of my personal loan?

Yes, a creditor can object to the discharge of your personal loan if they believe that you obtained the loan through fraudulent means or if you have engaged in other misconduct. They must file an adversary proceeding with the bankruptcy court to formally object.

FAQ 6: Will filing for bankruptcy affect my credit score?

Yes, filing for bankruptcy will have a significant negative impact on your credit score. However, it’s important to remember that if you’re considering bankruptcy, your credit score is likely already suffering. While bankruptcy will initially lower your score, it also provides an opportunity to rebuild your credit over time.

FAQ 7: How long does bankruptcy stay on my credit report?

A Chapter 7 bankruptcy will stay on your credit report for 10 years, while a Chapter 13 bankruptcy will stay on your credit report for 7 years.

FAQ 8: Should I talk to a lawyer before filing for bankruptcy?

Absolutely! It is highly recommended that you consult with a qualified bankruptcy attorney before filing for bankruptcy. An attorney can help you understand your options, navigate the complex legal process, and protect your rights. The attorney will review your specific circumstances and advise you on the best course of action.

FAQ 9: What are some alternatives to bankruptcy for dealing with personal loan debt?

Before resorting to bankruptcy, explore alternatives such as:

Debt consolidation: Combining multiple debts into a single loan with a lower interest rate.
Debt management plans: Working with a credit counseling agency to negotiate lower interest rates and payment plans.
Negotiation with creditors: Contacting your creditors directly to negotiate a reduced payment or a settlement.

FAQ 10: Can I file for bankruptcy if I have a cosigner on my personal loan?

Yes, you can still file for bankruptcy if you have a cosigner on your personal loan. However, it’s crucial to understand that your bankruptcy discharge will not protect your cosigner. The cosigner will still be legally obligated to repay the loan. This can obviously strain relationships, so be transparent and communicate with your cosigner about your intentions.

FAQ 11: What is the Means Test in bankruptcy?

The Means Test is used to determine whether you are eligible to file for Chapter 7 bankruptcy. It compares your income to the median income in your state. If your income is below the median, you are generally eligible to file for Chapter 7. If your income is above the median, you may still be eligible, but you will need to pass additional tests.

FAQ 12: Can I take out another personal loan after filing for bankruptcy?

Yes, you can take out another personal loan after filing for bankruptcy, but it may be difficult to qualify, especially in the initial period after discharge. Lenders will view you as a higher-risk borrower. It’s crucial to focus on rebuilding your credit after bankruptcy by making timely payments on all your debts and avoiding new debt. Over time, your credit score will improve, and you will have a better chance of being approved for new loans.

Disclaimer: This information is for general guidance only and does not constitute legal advice. You should consult with a qualified attorney to discuss your specific situation.