Owing debt to creditors is stressful. Letters fill up your mailbox and you begin screening all your calls. Many people turn to family for help; but consider the choice to borrow money from family carefully. If there is any chance you may file for bankruptcy in the future, then matters may get complex.
When you file for bankruptcy, certain types of debt owed to creditors can be discharged. A discharge means you are no longer legally required to pay specific debts. Types of dischargeable debts include credit card debt, vehicle loans and mortgages to name a few.
Borrowing money to pay a creditor means you are replacing dischargeable debt with family debt. While family debt can be discharged in bankruptcy, it accompanies complicated issues.
When debt is discharged, the entity that provided the loan will not receive full payment. Discharging family debt means that one of your family members will be left feeling high and dry.
Paying family members back before filing for bankruptcy
When filing for bankruptcy, all your creditors will be contacted at once. That does not exclude your family. The law requires that all creditors and debts are treated equally, meaning you cannot give preferential treatment to your loved ones if you owe them money.
How the court handles family debt will depend on if you sign a promissory note. If you do not sign a promissory note for the loan then the court will treat it as a gift, as long as it was given long before you file for bankruptcy. It is important to disclose any cash gifts with your bankruptcy attorney to avoid legal issues.
Family members cannot receive "preferential treatment"
If you sign a promissory note when receiving money from family then the court will treat it as a formal loan. In this case, you will not be able file for bankruptcy and make payments under the table to your family members.
Your debts will be scrutinized and paying back family members instead of creditors is not permissible. Even payments made right before filing for bankruptcy can be considered as “preferential payments to insiders.” If you sign a promissory note for a family loan, then you can always choose to pay them in full back once the bankruptcy process is complete.
If you choose to file for bankruptcy, ensure that your attorney knows about all your debts, including loans from family members.