During the course of an intake interview a new client posed the following question to me – “I have only two payments left on my car. Should I pay it off prior to filing for bankruptcy?”
Logically, paying off a car prior to filing would seem to make sense. In a Chapter 7, you can avoid the hassle of the reaffirmation agreement process and in a Chapter 13, you can avoid tying up your car title for months or years.
Alas, when you enter the alternate universe known as bankruptcy, traditional rules of logic do not apply.
If you must subject yourself to the means test – either because you have chosen to file a Chapter 13 or because your median income exceeds your State average – you must fill out a form called the B22. The B22 generates a budget. The purpose of the B22 budget is to determine whether you have sufficient disposable income to fund a Chapter 13, and what that Chapter 13 payment should be.
More significantly, the B22 budget uses IRS produced numbers for expense categories – things like housing, food, clothing, and transportation. If you actually spend more than the IRS numbers allow, too bad. If, for example, the IRS guidelines say that you should be spending $1,500 per month for housing, but you actually spend $2,000, the B22 will show “disposable income” of $500 that you could use to fund a Chapter 13 repayment plan.
These false “disposable income” readings are the main reason why families in the $65,000 to $100,000 income range are hit so hard under the current bankruptcy law. Most of these families spend more for food, clothing, housing and transportation than the IRS guidelines so they cannot fit into a Chapter 7, but in reality there is no money left over to fund a Chapter 13. These middle class folks often find the door to the Bankruptcy Courthouse locked shut.
What does all this have to do with paying off a car early or not? Because the B22 calculation is so important, you want to use every expense allocation you can. The B22 provides an expense allocation for vehicle ownership and one for vehicle use. If you are still paying on your car, you can claim an expense allocation for vehicle ownership by dividing the remaining balance by 60 (the term of a Chapter 13). If you owe $750 or $1,000, your expense allocation may only total $10 or $20, but I have found that in many cases, that $10 or $20 can make a big difference in determining whether a client can qualify for a Chapter 7 or if he can qualify for a 36 month Chapter 13 as opposed to a 60 month Chapter 13.
Therefore, if you are contemplating bankruptcy, do not assume that it necessarily makes sense to pay off that car, furniture, jewelry or other secured debt prior to filing. Talk to an experience bankruptcy lawyer before making any financial decisions of consequence. You never know when a common sense move could result in painful, unintended consequences in bankruptcy.
Jonathan Ginsberg, Esq.
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Last modified: February 25, 2007