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Which debts can’t be discharged in bankruptcy?

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We’ve talked before about bankruptcy in this column, but this week I’d like to simplify things a bit and discuss more specifically the debts that can and cannot be discharged in bankruptcy.

Can credit card debt be discharged?

Like all debt, when it comes to bankruptcy it depends on which chapter you file under. Chapter 7 will discharge credit card debt almost immediately. Chapter 13 will reorganize your debts (likely including your credit card debt), so that at least a portion of that debt will be repaid over time. Once you have repaid the portion of your debts required by the court and based on your income and expenses, the remainder is discharged.

In addition to credit card debt, other debts that can be discharged through a chapter 7 filing include medical debt, personal loans and promissory notes. You should also know that some debts can only be discharged through a chapter 13 filing, which as noted above, will reorganize those debts (meaning they will be at least partially repaid). These include court fees, condo, co-op or HOA fees, loans from retirement plans, debt from non-dischargeable tax debt and debts that could not be discharged in a previous bankruptcy.

What debts can’t be discharged?

As for debts that cannot generally be discharged through bankruptcy, there are three categories: those that are never discharged, those that cannot be discharged because a creditor successfully objects, and those that through legal exception and might be discharged (with a strong enough argument from you and your attorney).

The first category includes alimony and child support, many types of taxes and most tax liens, fines or penalties from government agencies for breaking the law and personal injury debts resulting from a drunk driving incident. The second category includes debts from fraud, debts for items purchased within 90 days of filing, embezzlement, larceny or breach of fiduciary duty debts, and any debts or creditors left off of your petition.

Finally, you may have seen student loans listed as one of those items that cannot be discharged through bankruptcy. This is where that last category comes into play. It is true that student loans are very difficult to discharge through bankruptcy, requiring you to demonstrate undue hardship. This hardship is measured court by court through various tests.

This category also includes income taxes, which includes other legal requirements and the passage of a certain amount of time. As noted above, this final category will require you to make a compelling case to the judge. This is why having a competent bankruptcy attorney on your side is so important, especially if you have student loan or other debts that require you to prove your case.

How bankruptcy affects your credit score

Bankruptcy is a last-resort option for debt, and one of the main reasons for that is the devastating effect it will have on your credit score. Not only will you lose 100, 150 or even 200 points (depending on how high your score was to start with), the bankruptcy will stay on your credit report for 10 years for a chapter 7 filing and seven years for a chapter 13.

And while your score will likely recover before those years are up, the notation on your credit file will be there for lenders, landlords, insurance agents and employers to see for all of that time. This means you may find it harder to qualify for new loans at good rates, you might lose out on a new place to live and you could see your insurance rates go up.

You also might lose out on a promotion at work or a new job opportunity. I knew a young lady who refused to get serious with a young man until they had exchanged credit reports. Explaining a bankruptcy could have had a chilling effect on a fragile new relationship.

Bankruptcy alternatives

If you think bankruptcy is just about dumping some debts and annoying creditors, think again. Its financial and personal impact is more on the scale of getting divorced to end a relationship. In other words, it is a step you take only after all the alternatives have been tried and exhausted.

Evaluate your budget

For all these reasons (not to mention the emotional toll a bankruptcy can exact), exploring all of your alternatives before you take this step is crucial. Examine your spending and see if you can find places to cut back, consider a second or part-time job to supplement your income or sell something you don’t want or need anymore. Use these funds to put toward your debt.

While you are looking at your spending, be sure that your income will be enough for you to make ends meet once you get rid of your debts. If you can’t live on your income I strongly suggest you delay your filing until you can to avoid being back up a creek, but this time without your bankruptcy paddle!

Contact a credit counselor

If credit card debt and other unsecured debt is your main concern, I suggest you contact one of the good guys at the National Foundation for Credit Counseling and see if a debt management plan will work for you. Like a Chapter 13 filing, a DMP will allow you to repay your creditors over time, likely reducing your interest rates and eliminating your late and over-the-limit fees.

But unlike a Chapter 13, a DMP will not show up on your credit report. Your score may drop due to the closing of your accounts, but if you are at the point of considering bankruptcy your score has probably already taken a hit and this would not cause much more of a drop. The bonus is that your on-time payments through the DMP will positively affect your reports and score over time.

Good luck!

Have a credit question for Steve? Drop him a line at the Ask Bankrate Experts page.