When struggling with debts, many people turn to borrowing money from friends or family. But what happens to those borrowed amounts if you end up filing for bankruptcy protection? Should you formalize your family loans? To help you and your family or friends decide on the best course, here are some answers to your questions.
How Are Personal Loans Treated?
In a bankruptcy, all creditors are treated as official lenders on equal footing with their peers. So secured debts (such as mortgages or car loans) are treated equally in one category and unsecured debts (like credit cards and bank loans) are equal in their category. Generally, loans from family or friends are unsecured debts. If the lender stakes a claim, they will be lumped in with other unsecured creditors.
What Are the Benefits of Formal Loans?
Formalizing your personal loan—writing up an agreement and signing it—allows the person lending you money to assert a claim if you have to declare bankruptcy. Although they can propose a claim even with a formal agreement, it will be easier with one. This means that they have a chance to be paid back in part or full alongside your credit card issuers or payday loan service. This protects them and eases your conscience.
There are a few drawbacks to formalizing your family loan. It doesn't obligate them to assert their right to be paid back. So if they don't want to feel like they helped take away your assets, they can simply not make their claim under bankruptcy rules. And if you have few or no assets to liquidate, it will be a moot point.
How Can You Pay Back Your Family?
Most people would prefer to pay back their parents or siblings rather than their credit card company. But don't let this cause you to pay them preferentially shortly before declaring bankruptcy. The result could be deemed as fraud and the trustee could ask for that money back—or even discharge your case.
Instead, consider declaring Chapter 13 bankruptcy. This type of bankruptcy allows you to set up a repayment plan over three or five years. While it means you will pay back more to other lenders as well, it could make repayment to your loved ones possible as well.
Where Can You Learn More?
Want to know more about borrowing from friends or family before bankruptcy? Do you as a family need to sit down and discuss all your options? Start by meeting with a bankruptcy lawyer in your area today.