It was the daily flood of phone calls that finally did it. They became so overwhelming that Sabrina Young stopped answering her phone and resolved to give out her phone number to family, friends, and a few chosen others. As many as four creditors a day would call, demanding payment.
Young, a 52-year-old administrative assistant at Tennessee State University, had racked up more than $26,000 in debt and couldn’t figure out how she was going to pay. Her list of financial obligations was long: A 2007 Pontiac G6 worth $18,000, medical bills of about $800, a computer for $1,500, a judgment of $6,000 for a car accident that Young was at fault for, and about $2,000 in credit card debt.
Making matters worse, Young’s paycheck was now being garnished. She feared the garnishments would eat into her wages to the point where she wouldn’t be able to make enough money to meet her basic needs. Young felt there was no other choice but to file for bankruptcy. Consequently, she filed for Chapter 13 protection in August. This type of bankruptcy allows Young to pay a reduced amount of her debts over five years. She’ll pay $500 a month directly from her paycheck, including attorney fees. “I feel a lot of relief. Now, when someone calls I know it’s not a creditor,†says Young. However, she says she regrets getting into this situation and wishes she had handled her finances differently.
Young is among the 850,000 who filed for bankruptcy last year–a number expected to exceed 1 million in 2008. “I’ve seen more people in the last year who have brought me the keys to their houses and cars saying, ‘I just can’t do it anymore,’†says O. Max Gardner III, a bankruptcy lawyer in Shelby, North Carolina.
With the subprime mortgage-sparked housing crisis, high unemployment rates, and shaky financial markets, many have seen their wealth evaporate to the degree that bankruptcy seems like the best option, although in many cases it isn’t. Before you file, take the following into consideration:
Bankruptcy has gotten more difficult–and expensive. It used to be that bankruptcy could be done on your own. But that has become significantly more difficult to do since the 2005 change in the bankruptcy law. First, there’s a lot more paperwork involved. You’ll most likely have to produce six months’ worth of pay stubs, tax returns for four years, bills, bank statements, mortgage origination letters, and collection letters just to name a few.
You’ll also have to pay more than in the past. According to the Government Accounting Office, the typical Chapter 7 bankruptcy involving a lawyer cost a minimum of $700 in 2005and $1,000 two years later. Court fees also increased, and you’ll now have to undergo two educational meetings with counselors. These sessions usually cost $50 to $75 each.
All of your debt will not magically disappear. Under Chapter 7 bankruptcy, which can take up to four months to complete, most of your debts are forgiven–with a few notable exceptions: student loans, alimony, child support, and some taxes. These debts must be paid in full.
Similarly, Chapter 13, which can take just a few weeks, will not discharge you of your debts, but will help you work out a plan to pay them off over the course of three to five years. Often, your debts will be significantly reduced, and you could end up paying just 20 cents on the dollar of what you owe.
You might have to sell your property. Each state has an exemption stating how much equity in your home you are allowed to keep. For example, the home equity exemption in New York is $50,000, but $350,000 in Nevada.
However, when it comes to Chapter 7 bankruptcy, anything above the exemption might result in you and your home parting ways: “If you have property above what you’re allowed to keep, you might have to sell it,†says Henry Sommer, president of the National Association of Consumer Bankruptcy Attorneys and head of the Consumer Bankruptcy Assistance Project, which handles bankruptcy cases on a pro bono basis in Philadelphia. So if you’re in New York, and you have $100,000 equity in your home, you can keep only half of it. Chapter 13, which allows you to keep your home, might be a better choice if you’ve built up a lot of equity in your home and don’t want to be forced to sell.
Your credit will take a hit. Credit scoring experts estimate that a bankruptcy filing can reduce your credit score by as much as 300 points. Unlike other negative marks on your report that take seven years to clear (such as a charged-off account), a bankruptcy filing stays on your report for 10 years before it can be removed.
Waiting too long to file can hurt you. While there’s no exact formula for when to file, most experts agree that it should be prior to legal actions such as a car repossession or property foreclosure. A bankruptcy combined with repossession or foreclosure will mean that your credit will be in even worse shape.
“Because bankruptcy is so often portrayed as the option of last resort, people often wait way too long to consult an attorney,†says Gerri Detweiler, adviser for Credit.com, a credit information Website, and co-author of Stop Debt Collectors (Credit.com; $29.95). “In the meantime, they’ve drained their 401(k) to pay their debt. That doesn’t help solve the problem; it just leaves them with nothing.â€
ALTERNATIVES TO BANKRUPTCY
If you haven’t waited too long–meaning you’re not at the point where your wages are about to be garnished and your home is in foreclosure–there might be other options.
— Work out a deal with creditors. With an increase in the number of people filing for bankruptcy, creditors might be more willing to work out a modification in your payment schedule.
— Seek credit counseling. Go for one session with a not-for-profit credit counselor to get some advice. Nothing will appear on your credit report. Beware of fraudulent credit counselors. Choose a not-
for-profit agency that is accredited by either the National Federation for Credit Counseling or the Association of Independent Consumer Credit Counseling Agencies. You should not be required to pay high up-front fees for their services.— Meet with a bankruptcy attorney. A bankruptcy lawyer might help you identify any unfair lending practices that can be challenged in court. “Bankruptcy attorneys should look at every claim that is there and see if you’re dealing with an abusive creditor or debt collector,†says Gardner. Most bankruptcy attorneys won’t charge you for an initial consultation.
NEXT STEPS
If you determine that filing is your only option,the next step is to decide which type of personal bankruptcy protection is best suited to your situation. In general, both Chapter 7 and Chapter 13 require these steps:
— Prepare and file a petition. Be honest about your assets and liabilities when completing these forms. If you find it too difficult to complete, consult an attorney.
— Get credit counseling. You must go through mandatory credit counseling with a court-approved counselor. A list of approved agencies can be found on the Department of Justice Website (www.usdoj.gov).
— Meet with a trustee. This is an accountant or a lawyer who will review your case to make sure all paperwork is filed correctly and collect any property that will be transferred to the court. In a Chapter 13 filing, the trustee is responsible for arranging your payment schedule.
— Complete a debt education course. You may complete this course only after you have filed for bankruptcy. But you must obtain a certificate of completion for it before you can receive an order of discharge. A list of approved educators can be obtained from the Department of Justice Website at www.usdoj.gov/ust.
Should You File?
DO
— If your wages are being garnished: If several creditors have sued and gotten judgments against you that allow them to garnish your wages, you might be in such a financial straitjacket that bankruptcy would bring you significant relief.
— Foreclosure is imminent: Chapter 7 is the best option to protect your home if you have little equity in your house. (Each state has a different exemption for how much home equity is protected by bankruptcy.) But Chapter 13 will allow you to keep your home if you have significant equity built up while you restructure your debts.
— If you’re raiding your retirement accounts: It’s not a good idea to bankrupt your future to pay debts today. In most states (though not all), retirement accounts are protected in bankruptcy.
DON’T
— If you’re judgment-proof: People of limited means, such as those on Social Security who do not own their homes, are considered “judgment proof.†Creditors won’t recoup much of anything by suing them. Furthermore, Social Security payments cannot be garnished to pay off your debts. In all likelihood, creditors will eventually stop trying to collect.
— If you owe student loans: Money you owe from student loans won’t be protected under bankruptcy laws.
— If you owe taxes: In most cases, tax debt wont be protected either.
— If you have money: The bankruptcy court will look at your assets. If you’ve got a healthy wad of cash sitting in your bank account, you’re not likely to qualify for bankruptcy protection. You should work with your creditors to restructure your debts instead.
Originally published in the December 2008 issue.