If you’re “judgment proof,” you don’t have funds or property that a creditor can reach, making filing for bankruptcy unnecessary if your judgment-proof status is permanent. However, if your financial status will improve, eliminating debt when your income is low enough to qualify for Chapter 7 bankruptcy might be a good idea.
Creditors Can’t Take Assets When You’re Judgment Proof
It's often easy to know when you’re judgment proof—you don’t have anything of value that a creditor could take to satisfy your debt. For instance, if you’re judgment proof, you likely have little or no equity in a home or other real estate and own minimal personal property (things other than real estate). It's also common to be unemployed or make very little income.
Is Your Property Safe From Creditors?
Even if you have assets, you’ll still be judgment proof if it’s the type the law protects from a creditor’s reach. For example, federal law doesn’t allow a creditor to levy against Social Security funds, so a retiree’s Social Security income would be immune to a creditor’s judgment. Other entitlements a creditor won’t be able to reach include unemployment pay, veteran’s benefits, disability payments (SSDI), federal retirement benefits, and child support.
States offer additional property protections, with each allowing residents to protect or exempt a small amount of property from creditors. Common examples of exempt property include household furnishings, clothing, some vehicle and home equity, and certain retirement accounts. Check your state’s bankruptcy exemptions because most also apply in collection actions. However, you’ll want to verify that your property is safe by speaking with a lawyer.
Important tip. You should know that mixing public assistance and federal benefits with other funds in a single account will result in losing the protection. The problem arises because mixing funds makes it impossible to determine or "trace" which funds are entitled to protection. To maintain the exemption status, always keep exempt funds in a separate account.
Learn about bankruptcy planning for senior citizens.
Being Permanently or Temporarily Judgment Proof Matters
If you know that your situation won’t change and are permanently judgment proof, you don’t need to worry about collection actions. Creditors won’t be able to take your property and filing for bankruptcy won't be necessary. However, many people recover after a financial setback, so just because you don’t have much now doesn’t mean you’ll be in the same situation six months later.
When to File for Bankruptcy Chapter 7 or 13
If you suspect that your financial picture will improve, consider filing for Chapter 7 bankruptcy. You can take advantage of your income being low enough to qualify for a Chapter 7 discharge, the order that wipes out debt. You’ll also get your credit back on track sooner than if you were to do nothing.
By contrast, if you wait and your income rises, you might make too much money to qualify for Chapter 7 bankruptcy and find yourself stuck with debt, or you might have to repay a portion of your debt through a Chapter 13 bankruptcy repayment plan.
Ways Creditors Collect Debts
If you own anything of value, it’s a good idea to be familiar with the collection tools at a creditor’s disposal. Typical collection procedures include:
- requiring your employer to take money out of your paycheck (wage garnishment)
- instructing your bank to withdraw money from your account (bank levy)
- selling your home, rental property, or commercial real estate at auction (real estate levy or attachment)
- seizing your car, your boat, your stock, the contents of your safe deposit box, or other property (personal property levy or attachment)
- instructing the sheriff to take money from the cash register of your business (till tap), or
- directing the sheriff to station an officer in your business who will collect all payments made by your customers (keeper).
Not every creditor has the right to use all of these tools or to use them immediately. But all creditors can access them after going through the proper process. Learn more about debt collection.
Steps a Creditor Must Take Before Using Collection Tools
When you owe a past-due debt, any creditor can ask you to bring your account current by calling you on the telephone or sending you an email or letter, but most creditors can’t force you to pay your bill without doing more. Such creditors must first go to court and win a money judgment against you.
Other creditors can skip the court step and instead start garnishing your wages, for instance. The procedure required varies depending on the type of debt you owe.
Creditors Who Don’t Need a Money Judgment
Creditors who aren’t required to go to court can go after your assets almost as soon as you fall behind on payments. Here’s a general overview of creditors with special collection rights.
Creditors with a voluntary lien.
A voluntary lien is a property right you give a lender when you make a large credit purchase. For instance, when taking out a loan for an expensive item, such as a house or car (or even when financing appliances, jewelry, furniture, and computers), the lender will usually have you put up the property you buy as collateral. By agreeing to do so, you give the lender a lien on the property that secures the debt payment.
A secured creditor can take back the collateral if you fall behind on your payment, sell the property at auction, and use the proceeds to pay the loan balance. For instance, a secured lender can repossess your car if you fail to pay. In some states, your mortgage lender can foreclose on your house without filing a lawsuit by initiating a nonjudicial foreclosure if you fail to stay current. However, some states require a mortgage lender to file in court and win a judicial foreclosure action before foreclosing on your home.
Creditors with an involuntary lien.
When you don’t pay certain obligations, some creditors—such as government agencies—get a property right called an “involuntary lien” that allows the creditor to place a lien on your property when you fall behind on a tax or utility bill. For instance, an IRS tax assessment works just like a court judgment, which means that if you owe back taxes, the IRS can wipe out your bank account or force your employer to deduct money from your paycheck without first getting a court judgment. A similar lien is the mechanic's lien. However, with this lien, the creditor usually places it on real estate and gets paid when the owner sells the property.
Learn more in What Is an Involuntary Lien?
Student loans and domestic support obligations.
If you fall behind on a student loan or a support obligation like alimony or child support, the creditor can take steps to collect the debt right away, often through wage garnishment.
Creditors Who Must Get a Money Judgment First
Not all creditors have the rights described above. For instance, suppose a creditor doesn’t have a property lien or a statutory collection right. In that case, the creditor must file a collection lawsuit, prove that you owe money, and get a money judgment against you. Most major credit card companies, healthcare providers, personal loan lenders, and service providers must use this approach.
For these creditors, the money judgment allows them to use collection tools to go after your assets and satisfy the debt. Once the creditor has a money judgment, it can place an involuntary lien on your property. In some states, a money judgment automatically gives the creditor an involuntary lien on certain property.
If you're facing collections and would like to avoid bankruptcy, consider learning how to negotiate credit card debt.
Consult an Attorney
If you’re dealing with collectors and can’t pay, a bankruptcy lawyer can help you evaluate your situation and decide whether responding to the creditor, defending a lawsuit, or filing for bankruptcy makes sense.