The risks of spending money before or after Chapter 7 bankruptcy

A Chapter 7 bankruptcy bars debt collectors from contacting you or garnishing your wages. Once your case is resolved, many of your unsecured debts, such as personal loans and credit cards, can be discharged under a court order.

Bankruptcy is considered a last resort option that should only be pursued when your debts are truly unmanageable. Because your financial situation will be under scrutiny, you should avoid frivolous spending before — or shortly after — filing for bankruptcy. Otherwise, it could look like fraud, which could be detrimental to your case.

What not to do before filing for bankruptcy

It’s important to understand what you should and shouldn’t do when filing for bankruptcy to ensure your case goes smoothly.

When you’re filing Chapter 7, there’s more suspicion if your spending spikes in the months before filing because your unsecured debts can be eliminated. This rings especially true if you were already planning to file for bankruptcy. Chapter 13 doesn’t clear your debt but reorganizes it and puts you on a repayment plan. Each individual has a different spending limit according to their court order.

Here are the spending guidelines to pay attention to when you plan to file for Chapter 7.

Splurging on unnecessary items

While spending money on items necessary to survive is permitted, purchasing items that seem frivolous or luxurious before you file for bankruptcy isn’t the best idea. The court could see your case as fraud if you look like you are overspending before filing.

It’s fine to stock up on grocery items or household goods like toilet paper or cleaning supplies before your file. In some cases, it may even make sense for you to purchase a car if the court will seize your current vehicle. However, stay away from unnecessary large purchases. Keep all your receipts to show what you purchased and why it was necessary.

Transferring property

You must disclose any property transfers you’ve made in your bankruptcy filing. Failing to do so could be considered hiding assets, which could lead to being charged with bankruptcy fraud, not being able to discharge your debt and having the bankruptcy trustee attempt to recover the property you transferred.

Paying back a large sum to family or friends

Matthew L. Alden, a bankruptcy and debt relief attorney at the Columbus, Ohio-based firm Luftman, Heck & Associates LLP, says that settling a balance with a friend or a loved one could get the money revoked.

“Basically, if the dollar amount reaches a certain threshold, the trustee, who is a legally appointed individual that oversees certain aspects of the case, can take the money back from the person or entity you paid it to,” Alden says. “That typically turns out to be a waste of your money.”

Making a large purchase

It’s important to keep in mind that part of filing for Chapter 7 bankruptcy is that a court-appointed trustee will be empowered to sell your nonexempt possessions to help repay your creditors.

“If you make some big purchases ahead of your bankruptcy, the court may just end up selling off those purchases to repay your creditors,” says Jesse Campbell, a financial educator at the nonprofit credit counseling organization Money Management International.

Bankruptcy involves going to court and answering questions about your finances under oath. “If you’ve decided to file for bankruptcy and you’re making decisions about your spending in the meantime, it’s not the worst idea to ask yourself, ‘How comfortable am I going to be trying to explain this decision to a judge?’” Campbell says.

Racking up credit card debt

Frequent use of credit cards and keeping a large balance on them is a bad idea. It looks fishy and might appear that you had no intention of paying off your cards. That could give the credit card company enough of a case to argue that the charges you made can’t be cleared. As a result, you might end up being on the hook for recent charges.

Why it matters how much money you have the day you file for bankruptcy

When you file for Chapter 7, you are granted freedom from certain types of unsecured debt — like credit cards and medical debt.

To get this debt elimination, you grant the court access to a full picture of all of your finances and assets. This happens the day you file. Any money or assets you gain after filing can be sold to pay off your debts.

What happens to your money after you file for bankruptcy

After filing for Chapter 7, the court seizes your money and assets. Certain possessions deemed essential are exempt from this — like your dishes, clothing and some furniture.

You can also exempt some funds in certain bank accounts, but it’s important that you only use these funds for essentials. Talk to a bankruptcy attorney in your state to determine how to exempt any bank account funds.

However, anything that is not deemed essential will be sold and liquidated to pay your creditors. This includes money in your bank accounts. It’s important to note that if you owe the bank money for anything from loan payments to account dues, they can take money from your account to cover what you owe.

Bottom line

If you’re in dire straits financially, filing Chapter 7 bankruptcy could be something to consider. When mulling over whether to spend money, Campbell says it’s best to focus on the essentials — think housing costs, utilities and food — and get in touch with a bankruptcy attorney right away.

But before pursuing this route, explore other options. For instance, a debt consolidation loan rolls your unsecured debts into a single loan. It could help lower your interest rate and, in turn, save you money as you pay off your debt. Plus, you might get a repayment term that is a better fit for your situation without hurting your credit for years to come.