Personal Decisions About Bankruptcy
Whether or not to file bankruptcy is a big decision. It is important to weigh both the benefits and the drawbacks to the process. Every individual situation is different. That is why it is important to get an experienced bankruptcy attorney to review your own personal file and help you with your decision-making. Bankruptcy is not the best solution for everyone. However, once they weigh the options, many consumers are surprised to find how much declaring bankruptcy will benefit them, and allow them to get a new financial start.
Benefits of bankruptcy
Keep your home or car
Many people are afraid of bankruptcy because they believe that it may mean losing their home or their car. However, bankruptcy allows for numerous ways to keep important assets. Here are some examples of how you can use bankruptcy to help you keep your home or your car:
- Exemptions: Under Chapter 7, many filers are able to exempt their family home and their car from the bankruptcy estate (the dollar value of equity that you can exempt varies state by state).
- Riding through: In some cases, even if the home or car is not exempted, you can keep it by what is known as “riding through”- continuing to make payments on it so your lender may not seize it. The home or car thus remains outside of the bankruptcy. (You can learn more about “riding through” in our article on how Chapter 7 bankruptcy works).
- Repayment plans: Chapter 13 allows for keeping your home and car provided that you can come up with a repayment plan, to catch up on missed payments, that will be completed the next five years.
- Shedding other debts. By shedding unsecured debt, such as credit cards and medical bills, through Chapter 7, your total debt load can be substantially reduced. Suddenly your monthly mortgage payments or car payments may become manageable, now that the other bills are gone.
Stop foreclosure and other collection actions
Filing bankruptcy stops foreclosure in its tracks. The automatic stay prohibits the sale of your home and any other secured assets immediately after you file your petition. Under Chapter 7, creditors may file for relief of the automatic stay, so the stop to collection actions may only be temporary - but at least it gives you a break, and some time to come up with a plan. And Chapter 13 allows for keeping your home, provided that you can come up with a repayment plan to catch up on missed payments over the next five years.
In either case, if you are behind on your mortgage payments and being threatened with foreclosure, filing bankruptcy provides an immediate stop to the foreclosure process. If you are able to exempt your home from the bankruptcy process, or come up with a repayment plan, that stop becomes permanent: Filing bankruptcy will actually stop the foreclosure process and may allow you to keep your home.
Strip 2nd and 3rd mortgages
Bankruptcy may allow you to strip second or third mortgages. This is a contentious subject, and we discuss it in more detail in the article on bankruptcy strategies. How it works is that, in some cases, if a home is underwater to the point that the home’s value is less than the amount owing on the first mortgage, any junior mortgage may be considered “unsecured” and the lien associated with it may be stripped. Without its associated lien, that junior mortgage then becomes an unsecured debt, which may then be discharged through Chapter 7 bankruptcy.
Once you only have one mortgage to worry about paying, keeping your home and meeting all of your other financial obligations may suddenly become more manageable.
Use it to refinance your home
Filing bankruptcy may allow you to refinance your home, as long as the property is not your primary residence. In some cases, experienced attorneys can use bankruptcy protection to your advantage to get a portion of your principle reduced, or to secure you a lower interest rate and lower monthly payments.
Rebuild your credit score
Many people who are considering the option of bankruptcy are concerned about the impact a bankruptcy will have on their credit rating. While bankruptcy can negatively impact your credit score in the short term, it is not always bad news on the longer term.
Some consumers with very high debt loads actually see an improvement in their credit scores as a result of bankruptcy. This happens because the information as it appears on your credit report regarding late payments or unpaid balances is removed and marked as “Included in Chapter 7 Bankruptcy” or “Included in Chapter 13 Wage Earner Plan”.
Additionally, your credit score is partly based on a comparison against people in similar situations. So, after filing bankruptcy, your credit score is compared against others who have declared bankruptcy, which can actually make your finances seem much better.
Even for those who will see a decrease in their credit score immediately after filing can rebuild their credit quicker than if they had not filed. After your bankruptcy, your outstanding debts are no longer considered delinquent, so they stop weighing your credit score down. Once this happens, you can start to obtain credit with reasonable interest rates again, and work at managing your debt load by obtaining a credit card and paying the balance due on time. If this is done carefully, you can rebuild your credit score into the 700s reasonably quickly.
Stop harassment from creditors
The automatic stay is an extremely powerful tool which stops all collection attempts. This immediately puts an end to harassing phone calls from creditors. The automatic stay goes into effect as soon as you declare bankruptcy. Your creditors receive a letter in the mail about your bankruptcy, and they may not contact you thereafter.
During the pendency of the bankruptcy, creditors may not contact you about these debts. After a debt has been discharged, you are no longer legally obligated to make any payments to that creditor, and they may never contact you again to collect.
Garnishment is a collection action just as much as foreclosure is. Your unsecured creditors can seek to have your wages garnished for unpaid debts. Depending on the state, up to 25% or more of your wages may be garnished to repay non-governmental creditors, and higher amounts can be taken for debts like child support. Once your creditor has entered a judgment against you and the court has ordered it to be repaid through garnishment, there are only two ways to stop that garnishment: repay the debt in full, or file bankruptcy.
The moment you file bankruptcy, the automatic stay is imposed and wage garnishment stops. If your wages are being garnished to make debt payments, the automatic stay immediately puts a stop to that garnishment and provides you with some breathing space by bringing your income back up. (Note, however, that filing bankruptcy will not stop garnishment for debts to the government, including back taxes, child support or alimony).
Keep the IRS away
When the IRS files collection actions against people, they have additional means to collect on debts that are not available to most other creditors. The IRS may garnish wages, attach a lien to your house or even withhold portions of your social security check.
You can eliminate tax debt for filings older than 3 years if you filed your return on time, but were unable to make the payment. This is 3 years from the due date of the taxes, not the date you filed. You may discharge unpaid taxes for late filings 2 years after the date you filed your return. Note that you do not have to file all required returns due before declaring bankruptcy, but you will have to do so within a short time after filing.
For tax debts that you are allowed to discharge, you may also eliminate interest on the principle balance, but not penalties. However, interest on penalties may be discharged in some jurisdictions. This is an unsettled matter of law, and Congress or the Supreme Court may address this issue in the future.
Is bankruptcy right for me?
Bankruptcy is a tool for people who have more debts than they are able to pay.
If you can get your expenses and debts under control simply by selling unnecessary assets or cutting your spending - for example by selling that new car and either buying a cheaper one or taking public transit, or by foregoing a family vacation this year - then “tightening the belt” is a preferable option to declaring bankruptcy.
But if your debts are overwhelming, and no amount of tightening your budget will allow you to pay them off, then you should consider bankruptcy as an option.
Although some people find themselves in financial trouble as a result of many years of living beyond their means, for many people the problem is only bad timing or bad luck. People who were living a middle class lifestyle but were affected by a layoff, or a death in the family, or other loss of income typically need to file bankruptcy because their income has dropped but their expenses have remained high: their debt has become unmanageable.
The “financial crisis” of the last few years has also put undue economic stress on many. Bankruptcy can be an extremely effective tool if the burst of the housing bubble means that your house is now worth less than what you owe. Banks will often cooperate here, as it is in their best interest to find a financial solution that will keep you in your home and avoid foreclosure.
To figure out whether filing bankruptcy may be a good option for you, compare your total unsecured debt to your annual income. Look at where the money is going each month. Here are some of the signs that bankruptcy might be right for you:
- If the debt is a significant portion of your annual income.
- If the relief you would get from filing bankruptcy would make it easier to meet your monthly expenses.
- If quickly mounting fees and penalties make otherwise-normal debt unsustainable.
- If you have fallen behind on your mortgage and want to negotiate a modification.
Payday loans, pawn shops and other consumer lending services often trap people in a cycle of poverty. They provide immediate access to funds - but at high interest rates that mean that the balance owing keeps growing, and you only sink deeper and deeper into debt. Bankruptcy can get you out of that cycle.
Alternatives to bankruptcy
Before committing to any major financial decision - including filing for bankruptcy - it is important to explore all options. For many people dealing with overwhelming debt, bankruptcy is the best solution. However, in some situations there may be alternatives that are more favorable than filing bankruptcy.
If the main cause of your debt is your home mortgage (or mortgages), and if your home is underwater, a short sale may be a better solution. “Underwater” means that your home’s current value is less than what you owe on it.
For example, if you purchased a home for $250,000 and you still owe $200,000 on your mortgage, but your home’s value has dropped to $180,000, you are underwater by $20,000.
The advantage of a short sale over bankruptcy is that none of your other assets are involved, only the home. (Although, if you have a lot of other assets, such as cash in the bank or luxury items such as a boat, your bank may not approve you for the short sale). A short sale will not be your best option, though, if you also have a lot of other debts, or if it is important to you to try to keep the home.
Debt consolidation means moving your debts around to reduce the interest you are paying, so it becomes easier to pay them off.
For example, if you owe $20,000 in credit card bills, and are being charged 22% interest on the card, that means you are paying $4,400 per year in interest. If you can pay off the credit cards through a line of credit which charges 7%, you will be paying only $1,400 per year. You still owe the same amount of money, but by saving that $3,000 in extra interest per year, the debt becomes easier to eventually pay off.
In some cases, your unsecured creditors may actually agree to let you pay off less than the full balance owing. They usually will do this only when they realize that they have very little possibility of ever collecting the full amount from you, and knowing that if you file bankruptcy they may collect nothing at all. In that case, they may be willing to accept either a one-time payment, or a signed promissory note from you, for a fraction of the full amount owing (sometimes mere pennies on the dollar).
Other decisions to make when filing bankruptcy
If you are considering filing bankruptcy, you also must consider which chapter to file under, as Chapter 7 and Chapter 13 each have distinct advantages and drawbacks. You will need to look at what debt you have, and how much of that is secured or unsecured debt, as well as review your long-term goals. We explain more about how to decide which chapter to file under in the next article.
Read on for our next article in this series: What You Need to Know About the Bankruptcy Process