Strategies for Using Personal Loans in Bankruptcy

Can personal loans be discharged with bankruptcy? As any good law student would answer, it depends. There could be situations where a bankruptcy trustee may object to eliminating debts like personal loans or credit cards

Key Points:

• Personal loans like credit cards and medical bills are unsecured debt.
• Usually, credit cards shouldn’t be used 2-3 months before filing for bankruptcy, which includes making payments to unsecured creditors.
• Sometimes, it’s better to delay filing for bankruptcy from a strategic standpoint.

How are Personal Loans Different from Credit Cards

Personal loans are generally considered unsecured debt since the debt is not attached to an asset. For example, a car loan or mortgage is attached to the car or the house. So those are considered secured debts.

Personal loans are a fixed amount and typically have a lower interest rate than credit cards. The loan period depends, but for to five years are common. For example, I last had a personal loan that I applied for during the coronavirus pandemic that was for five years and is set to be paid off this August.

Personal loans can be a great way to save money and pay off debt faster by consolidating credit card debt. For example, if you have multiple credit cards with an interest rate of 22% but get a personal loan of 10%, you will save 12% in interest each month. That will add up to substantial savings.

For example, if you owe $10,000 in credit cards and pay twenty-two percent interest over five years, that is $6,571.35 in interest payments. Your $10,000 debt is $16,571.35 by the time you pay it off at $276 monthly.

However, if you consolidated your credit card debt with a personal loan for $10,000 and the loan was for ten percent interest, the monthly payments would be $212, and the total interest paid would be $2,748.23. That’s a total savings in interest payments of $3,823.12.

Strategic Debt Relief: How Personal Loans Can Help

Before applying for a personal loan, consider using a loan calculator to make sure the numbers work in your favor.

What Happens When You Default on a Personal Loan

When a borrower defaults on personal loans, the creditor can file a lawsuit to collect on that debt. Unlike a car loan, where the lender can take back the car with a personal loan since no asset is attached, lenders have to take other steps to enforce any judgment they may have received in a debt collection lawsuit.

For example, a lender may garnish wages, freeze bank accounts, or place liens on personal property such as a car or home.

Because personal loans are unsecured debt, the same as credit cards and medical bills, they could be discharged in bankruptcy. However, there are always issues to consider when filing for bankruptcy with personal loans.

Personal Loans and Bankruptcy

Generally speaking, at least ninety days before filing for bankruptcy, the debtor should refrain from using their credit cards or making payments.

However, if personal loans are attained shortly before filing for bankruptcy, the issue becomes when those loan funds were received and what the money was used for.

For example, if personal loans were used to pay off credit card debt, and bankruptcy is filed shortly after that, that shouldn’t be a problem. This happened with one of my clients.

Real Case

My client borrowed $28,000 in personal loans and, three months later, filed for bankruptcy. Usually, that would be an issue. The bankruptcy trustee would investigate how the funds were used.

However, in my client’s case, it was quickly proven that the personal loan was used to consolidate and pay off credit card debt.

My client’s bankruptcy filing was three months after receiving the loan, but he lost his job as a waiter at a restaurant due to COVID-19 since the restaurant was closed for several months.

So even though he received $28,000 three months before filing for bankruptcy, it wasn’t a problem, and all his debts, including the personal loan, were discharged with the Chapter 7 bankruptcy.

When Personal Loans and Debt Becomes an Issue with a Bankruptcy Filing

Suppose, in my client’s example, the personal loans were used for something else. For example, the client used $5,000 from a personal loan for travel expenses and filed for bankruptcy shortly after.

Personal Loans and Credit Cards: Dividing Debt in a Divorce

Or like another client of mine who used a personal loan and maxed out her credit card in tens of thousands of dollars in plastic surgery and wanted to file for bankruptcy immediately.

How could I ensure my clients could file for bankruptcy without issues with the trustee?

Delay! Delay! Delay!

Sometimes, the solutions to a complex problem can be quickly resolved. In this case, the solution was to delay the bankruptcy filing. Yes, sometimes a bankruptcy petition has to be filed immediately, but in these cases, it’s best to delay filing for bankruptcy to avoid an objection by the trustee.

For example, returning to my client, who used personal loans and credit cards to pay for plastic surgery, there were only two possible solutions.

If the bankruptcy had to be filed immediately, the first solution would have to be to file for Chapter 13 bankruptcy because a Chapter 7 trustee would object. However, with Chapter 13, there’s a catch.

My client must file what bankruptcy lawyers call a 100% plan. That means paying back 100% of the debt within the next three to five years. That solution was not possible. Leaving only Chapter 7 bankruptcy as the answer, but filing bankruptcy so quickly after getting into debt would result in the trustee accusing my client of bankruptcy fraud.

In this case, I advised my client to make the minimum monthly payments for at least the next 12 months, and at that time, I would reevaluate her case.

One year later, my client filed for Chapter 7 bankruptcy, and her case had no issues.

Be Honest with Your Bankruptcy Attorney

Speaking of being honest, I’ve never had an issue with a Chapter 7 bankruptcy because I review all of my client’s documents and thoroughly question them about specific transactions after reviewing their credit reports, pay stubs, and bank accounts. Every lawyer should, but that doesn’t mean they do.

So it is essential, when you hire a bankruptcy attorney, to make clear to the lawyer potential issues such as a recent increase in debt and how your credit cards were used.

Colleges and universities can purchase my bankruptcy law textbook directly from Routledge Publishing. For paralegals and students buying single copies, you can do so via Amazon books. To access my YouTube channel, click this link.

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• Bankruptcy
• Your Wallet

Please note the information on this site does not constitute legal advice and should be considered for informational purposes only.