Many debtors considering bankruptcy owe money to family and friends and want to keep them out of the bankruptcy proceeding. To avoid problems with family and friends who have loaned them money, some debtors may choose to pay back a debt owed to family/friends either partially or fully before filing bankruptcy. But doing so may have consequences for debtor or the person who loaned them the money. Things you should consider before you pay off a loan from family/friends:
- Is it allowable? While there is no law prohibiting debtors from settling debt with creditors before they file bankruptcy, any payment made to one creditor over another before filing bankruptcy risks being viewed as preferential treatment. If the bankruptcy court finds that the debtor gave one creditor preference over another, the payment made to the creditor may be voided. What that means is that if you paid your Aunt Sue $500 before filing bankruptcy, and that payment is voided by the bankruptcy court, Aunt Sue may be forced to hand over the $500 to the bankruptcy trustee. In the case of family and friends, the bankruptcy court will usually void any payments (transfer of assets) that date back 12 months prior to your bankruptcy filing.
- Can you settle your debt with all of your creditors? Settling debt with only a few creditors and then filing bankruptcy doesn't make sense. Debt settlement is only logical if it actually helps you avoid bankruptcy by paying off all of your debts.
- Can you really afford it? Even if you have a few thousand dollars available to settle debt, what else is being neglected in your life? Do you have a retirement account, health insurance, college fund for the kids? Think long and hard before you take money away from what's necessary to repay debt that can be discharged in bankruptcy.