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Paying off your credit cards before bankruptcy

People who are going through personal bankruptcy often ask their financial advisers whether they should attempt to pay off their credit cards before filing. For example, if an individual had small balances on just a few cards, they wonder whether it would be beneficial to pay off those debts before formally declaring bankruptcy.

First, financial advisers tell bankruptcy clients to stop using their credit cards altogether before filing for bankruptcy. Clients should not give the impression that they are amassing large amounts of debt before they file, as this can bias judges. Additionally, some creditors may argue against your decision to pay certain debts. Some of them may have a more solid claim to your assets, and you may have deprived them of their payments.

One expert advises borrowers to use caution when making so-called "preferential payments." Those are typically considered as payments that are larger than $600, generally falling within 90 days of the bankruptcy filing date. All payments of that nature must be disclosed, be it a car payment, mortgage, loans or credit cards.

The expert says that all creditors are supposed to be treated equally in a filing, so making payments to some -- like the credit cards -- and not to others could complicate the bankruptcy proceedings.

In addition, individuals declaring bankruptcy must declare any payments made to an "insider" creditor during the previous year. Those creditors can include family members and close friends with whom formal loan terms were never established.

Borrowers should also be aware that all of their credit card accounts are likely to be closed, anyway, after a bankruptcy proceeding. Even those with zero balance are subject to this action, so paying off a card does not have real value in the face of impending bankruptcy.

Source: Fox Business, "Pay off credit cards before bankruptcy?" Justin Harilek, July 3, 2012

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