Updated June 1, 2016.
There’s no way around it – dealing with debt is just plain hard. But there are a number of ways to handle it and get your financial health back on track. One of those ways is bankruptcy. It allows you to wipe out your debts and start over fresh. It’s not an easy decision to make and it’s not right for everyone, but it can really make a difference in the amount of debt you have to deal with. You may even end up debt free!
One of the first questions you need to tackle when filing for bankruptcy is whether to file under Chapter 7 or Chapter 13. Under Chapter 13, you’ll work with the bankruptcy trustee to create payment plan for the next five years, after which your remaining unsecured debt will be discharged. You’ll also have to repay your secured debt up to the value of the collateral. Chapter 7 bankruptcy is commonly referred to as “liquidation.” In Chapter 7, the bankruptcy trustee will liquidate, or sell, your non-exempt assets to pay back your creditors.
If you have large amounts of unsecured debt and few assets, you might want to file for Chapter 7. However, the court wants to ensure that only those truly in need of Chapter 7 relief file under that chapter. If you can pay back your creditors in a meaningful way, Chapter 7 is not for you. In other words, you may make too much money to file under Chapter 7. The court will make that decision based on the “means test.”
Step One: Median Income Comparison
The first step of the means test compares your average monthly income over the last six months to the median income in your state. For cases filed after May 1, 2016, the median income for a single earner in Ohio is $44,849 per year, or $3,737 per month. For a 2-person household, it’s $55,771 per year, or $4,648 per month. For larger households, check this chart on the Department of Justice’s website for official median income information.
Now, add up your income over the last six months and divide it by six. If the result is less than $3,737, you qualify for Chapter 7 bankruptcy. If not, you must continue to the next step of the means test.
If you earned more than the median income in your state for the six months prior to filing for bankruptcy, the court is concerned that you might actually be able to pay some of your debts, making liquidation unnecessary and unfair to creditors. To prove that you do, in fact, need to file under Chapter 7, you’ll need to show that you don’t have enough disposable income to make payments under Chapter 13.
Step Two: Disposable Income
Start with your average monthly income from the first step. You’ll subtract your allowable expenses to find your disposable income. Allowable expenses are based on national standards for living, health care, and car ownership costs and local standards for housing and transportation costs. For a single person, national standards allow $570 per month in living expenses for food, housekeeping supplies, apparel and services, personal care products and services, and miscellaneous expenses. That’s further broken down into $307 for food, $30 for housekeeping supplies, $80 for apparel and services, $34 for personal products, and $119 for miscellaneous expenses. A single person under the age of 65 can also deduct $54 for out-of-pocket medical costs and a single person over 65 can deduct $130. For larger families, you can find the allowed living expenses here.
For a single person in Miami County with a mortgage and a car, you can deduct $740 for your mortgage or rent and $457 for other housing expenses, like property taxes and maintenance. and $226 for vehicle operating costs. Here’s the data for other counties and larger families.
You can also take out a deduction for the cost of a car. It’s $471 for a single car and $942 for two cars. If you have one car, you can deduct an additional $191 for the associated expenses; the deduction for two cars is $382. That’s meant to cover things like gas and insurance.
Finally, you can deduct payroll taxes, childcare expenses, court-ordered payments, and certain insurance expenses.
Step Three: Disposable Income and Unsecured Debt
Take your monthly disposable income from the first step and multiply it by 60. This figure represents the total amount you could pay to creditors through a Chapter 13 plan. Then, add up all of your unsecured, non-priority debt (credit card debt, medical debt, etc.). Divide the total by four; this is the court’s standard for significant repayment of your creditors. If the first number is less than the second, meaning that you will not have enough disposable income to repay 25% of your unsecured debt over 5 years, you qualify for Chapter 7. If you will have enough to pay the 25%, you’ll have to file under Chapter 13.
Totality of the Circumstances
Calculations aside, the court may examine your Chapter 7 filing by evaluating the totality of the circumstances surrounding your case. For example, you may drive a luxury car and live in big loft downtown; you might qualify for Chapter 7 by the numbers but you don’t actually need it. The court will probably require you to file under Chapter 13 in that situation. On the other hand, you may have more than $207 in official monthly disposable income and still demonstrate your need for Chapter 7 bankruptcy (due to a family or health matter, for example). In that case the court will allow you to file under Chapter 7 even if you fail the means test by the numbers.
Filing for bankruptcy is complex and you don’t want to make any mistakes. Check out an online means test calculator to see if you might be eligible for Chapter 7 bankruptcy. Before you file, talk to an experienced attorney to make sure you’re filing the right way.