For Better or Worst-Case Scenario

Bankruptcy attorney Michael Koplen of Koplen Law Firm likens a personal bankruptcy filing to “a geometric math problem. Everything has to fit together exactly right. Every detail counts,” he says. “What goes into that petition has a definite effect on every single asset and every single debt that the person has.” 

So how does your spouse fit into that equation? 

The good news is that in most cases, they don’t, especially if the credit card balance or other debt is in your name only. A Chapter 7 bankruptcy, in which debts are wiped out and assets are sold to repay creditors, has no impact on your spouse’s personal financial status, says Koplen. Filing for Chapter 13—in which you keep your assets but make payments to creditors over the course of three or five years—is a bit more complicated. Still, the nonfiling spouse, even if they’re liable for half the debt, is financially protected for the term of the bankruptcy.

In fact, according to Barbie Lieber, a bankruptcy attorney at Lieber & Lieber in New York City, “The nonfiling spouse may actually benefit from their partner’s Chapter 7 or Chapter 13 bankruptcy. In Chapter 7, discharged debts free up family income that would otherwise be used to pay creditors, while Chapter 13 payments are typically much less than normal credit card payments, also freeing up family income.”

Lieber gives an example of a husband and wife with $40,000 and $30,000 in debt, respectively, together earning around $200,000 a year. The husband and wife are paying around $1,700 and $1,300, respectively, totaling $3,000. “Given their joint income, the filing spouse probably wouldn’t satisfy the means test for a Chapter 7, but could file for a Chapter 13. In that scenario, the maximum amount the husband would pay in a 60-month Chapter 13 plan would be $850—half the amount outside a bankruptcy. If the wife also filed, her maximum payment would be $650, and the couple’s payment would be $1,500—again, half the amount outside bankruptcy. Additionally, no creditor could legally pursue the wife for any consumer debt for which she’s liable with the debtor while the bankruptcy is pending.”

But Lieber warns against debt settlement companies that offer to consolidate your loans in exchange for a monthly payment. Not only do they charge hefty fees, but there can be tax consequences. For example, if you settle a $20,000 debt for $10,000, the IRS considers the “forgiven” $10,000 as income. There’s also no guarantee that all of your creditors will accept the negotiated payments, which means you can still be sued. “Unlike a Chapter 13 or 7 where there’s an automatic stay [that stops creditors from trying to collect], in a debt settlement plan outside of bankruptcy, there is no protection from the court,” Lieber says.

If you’ve accrued significant debt together and are behind on your mortgage payments, filing separately can buy you both some time to regroup—and possibly save your house from foreclosure. “I’ve kept people in their homes for 10, 12 years by filing bankruptcies one after the other,” Koplen says. “Either the bank came around, or at the very least, these people kept a roof over their heads for a really long time.”

Leaving a spouse out of your bankruptcy filing altogether might be a good idea if they’re worried about their credit, own a business, or don’t have much debt of their own. 

Some people mistakenly think that bankruptcy destroys your credit. That’s a myth, says Koplen. “Unless you have absolutely stellar credit, a bankruptcy filing in the United States has a minimal impact and, oftentimes, results in a higher credit score, particularly with someone who has a lot of unsecured debt who files a Chapter 7 bankruptcy. Very often, that credit score can jump up 100, 150 points. If you file a Chapter 7 bankruptcy and get a discharge [that releases the debtor from personal liability], it’s like cutting an anchor off a boat, and the boat can float away.”

Says Lieber, “What they should really be scared about is not filing while drowning in debt and being unable to pay for necessities because of credit card or loan payments that accrue at almost usurious interest rates. They should be petrified of debt settlement companies that often extract large monthly payments and hidden fees without offering protection against lawsuits from creditors. Unfortunately, many people call me after having paid thousands of dollars to debt settlement companies and getting sued by creditors. Bankruptcy is a gift. It’s in our Constitution. It offers people a breathing spell and a fresh start.”