The Frugal Creditnista

Should I File Bankruptcy? 4 Things to Consider Prior to Filing

“Should I file bankruptcy” is the number one question I get when consulting with clients who are overwhelmed with their debts.  In some cases, bankruptcy is a viable option, but in most cases, a solid budget and debt payoff plan is a much better choice.

So, how do you know which option is best for you; Bankruptcy or a good Debt Payoff Plan?

Do Your Homework

This is of the utmost importance.  Most people choose to contact a bankruptcy attorney as their first step who, of course, will advise them to file.  I personally wouldn’t make my first step to be with anyone that benefits from me filing.

And what happens when the consumer files and changes their mind?  

Because they filed, it became a notice of public record and a dismissed bankruptcy gets placed on their credit and stays for 7 years!!!!  They are viewed as more of a risk because creditors feel that they may go ahead and file anyway, and who wants to give someone a product or service on credit knowing there’s a chance they won’t get paid if the consumer decides to file?  I SURE WOULDN’T!!!

The majority of bankruptcy attorneys provide free consultations, if you decide to take advantage of this, go there just to consult.  Leave your banking, credit, and any other currency at home.  You are there to find out your options and nothing more.

Based on the conversation, you’ll know if the bankruptcy attorney is out to make a sale or looking out for your best interest.  They’ll tell you if you should even bother filing, which chapter you could benefit from, or if you should just get with a consumer credit counseling (or some other financial professional) to develop an aggressive plan to pay off your debts.

You can also contact a local Consumer Credit Counseling Agency on your own.  You are doing the exact same thing I advised when consulting with a bankruptcy attorney – talk.  Consumer Credit Counseling Agencies specialize in Debt Management Plans and some will gladly set you up on one of their plans, whether you need to be on one or not.  A good one will give you options, which is what you’re looking for.  Based on those options, you can make the best decision for you.

I personally recommend doing a bit of research on your own.   

Numbers Don’t Lie

Sit down and write out the numbers.  List your take-home pay from all sources and subtract your basic necessities.  What’s basic?  Shelter, Food, Medical Expenses, Transportation to work.  (Yes, you may have some additional necessities, but an expensive cell phone package, high insurance costs, cable, etc are not necessities).  This will give you your discretionary funds – the money left over after covering your basic needs.  These are the funds that will cover your debt obligations.  If it’s positive; keep reading.  If it’s negative, contact that lawyer or consumer credit counselor.

Next, gather your current (non-necessity) and past-due bills, and make sure to pull your credit report as well; list all of your debts. 

Look up your state’s statute of limitations.  The statute of limitations is the amount of time a creditor has to sue you for payment of a debt (judgment).  Find out when the statute of limitations ‘clock’ started ticking and cross off any debts that have passed the statute of limitations (why pay if you don’t have to?).

Look at the debts remaining and ask yourself:  “How the heck did I get into this mess?”

In some cases, illness, job loss, death of a spouse or other loved one caused us to get into debt; in other cases it’s poor money management skills and living beyond our means.  Regardless, pinpointing what led to the position we’re in can prevent us from getting back into it again.

Now that you’ve gathered the numbers, your next step is to create a plan to see if it’s feasible.  If you’re stressed out and can’t think straight, it’s time to consult with a professional, otherwise, keep reading.

Your goal is to see if you can get out from under this debt in 5 years or less; excluding student loans and mortgages.  Are you able to get a 2nd job?  Can you get on a budget plan with your utility providers?  Are you eligible for any state/government funded assistance programs (remember its temporary, let go of the ego)?  Have you cut enough out of your current expenses?  Can you sell some assets? Downsize?  Can you negotiate with any of your creditors – past and present – to settle the accounts for less than the amount owed? Can you get a reduction in monthly payments?  Can you work out a payment arrangement where you can skip a payment or three on your mortgage, credit card, or car payment so that you catch up or settle some other debts? 

Find out all of the hardship and payment programs your creditors offer, start with your current creditors first – this means you will not start off negotiating with a collection agency or charged off account on your credit report if you are behind on your current expenses.  Tackle current obligations first in order to prevent them from going into a charged off or collection status.  Remember, your creditors want customers who can make them money, not debtors who are costing them money; communicate!  And while communicating, make sure you are speaking with the right person.  There is nothing I despise more than an idiot in a call center speaking down to consumers as if they personally borrowed money from them, or even worst that they purposely got behind on the debt.  Don’t stoop to their level, simply escalate.  And if the manager is even more of an idiot, write a letter to the CEO and file a public complaint on their behavior (not the debt). 

Another place I send clients to is the American Bankruptcy Institute’s Consumer Bankruptcy Center.  I like the tips and the Q & A section, it pretty much covers the concerns and inquiries that most people would have when considering if bankruptcy is for them. 

Other Alternatives

When doing your own research and seeking out free consultations; your number one priority is to see what other options you have outside of bankruptcy.  Instead of asking IF you should file bankruptcy, see if bankruptcy is the RIGHT solution for you.

Basically, if you are working a stable, full time job, are meeting your monthly payments obligations (even if it’s just the minimum), and can get from under you debts by cutting expenses and bringing in additional income (2nd job, side business, etc) in 3-5 years, I wouldn’t bother filing. 

If, however, you have gotten notification that you’re getting sued, that your wages are going to be garnished (or already are), that your bank accounts have been levied or are frozen, you’re at risk of losing your home or some other major asset; bankruptcy may be for you.

We’ve already discussed the importance of hardship programs; here are some other alternatives to bankruptcy:

Consumer Credit Counseling – This is basically a debt management plan that can negotiate a lower interest rate, cut some money off of the balance and decrease your monthly payments in order to make your monthly payment obligations more manageable.  However, if you are paying less – even if the balance and interest was decreased – it will take you longer to get from under your debts.  Also, keep in mind that in most cases debt management plans can tank your credit scores.  Debt management plans are best suited for persons who have a consistent income, and who have other credit items that are reporting positively on their credit so that the closed accounts and consumer credit counseling notation won’t have such a detrimental affect on their credit scores.  Most debt management plans are 5 years plus. 

Debt Consolidation Loans – Lets you pay off all of your high interest rate debts by obtaining a lower interest rate loan (debt).  The benefit is that you are paying one monthly payment and it’s at a lower interest rate; thus you are paying less in the short and long term.  The con is you must be approved for the loan (credit must be up to par) and you are merely transferring one type of debt for another, not necessarily eliminating the debt(s).  Home equity loans, private loans, and balance transfer cards are examples of this alternative.

Debt Settlement – Companies offer this type of service, but consumers can certainly create a savings plan, accumulate some funds in order to pay off a high-balanced debt for 20-70% off the original balance (depending on the type of debt and how old the debt is).  This option works best on debts that you have ceased paying on and who are about to charge off your account as ‘uncollectible’.  I wouldn’t worry about your credit much at this point; with all of the late payments being reported, your credit most likely sucks anyway.  The idea is to prevent it from going into an even worst reporting such as a charge off or collections, or to negotiate a better credit reporting:  “If I settle today, can you delete” or “If I settle today, can you update to paid as agreed”.  Will you always get a better credit reporting?  NOPE.  However, just by preventing it from going to a worst reporting or just having Paid versus Unpaid works fine as well.  Plus, debt is stressful, just being able to settle it and never have to worry about it again is worth it in the end.  Credit can always be rebuilt.

Credit Restoration – Most people will not mention this, but it is a viable option. A true credit consultant – meaning they are not worried about deletions but your overall credit-financial health – can assist you on focusing on the debts that are within your statute of limitations, teaching you how to negotiate the other accounts adversely affecting your credit, and coach you on how to rebuild a better credit profile.  Cons – there are some folks in the credit repair industry that are not knowledgeable, are only trained to delete and not to improve or counsel.  As with an attorney and consumer credit counseling firm; pick wisely! 

Things to consider…

Most people will do one of the alternatives above and still not make a dent into their debts; really gather information and see what option works best for you.  Each professional you consult with should have a strategic plan on how to get you from under your debts; it’s your job to ask questions, take notes and to look those notes over prior to making a commitment.

Timing is important as well.  I have some clients who are under stress from medical debts, but they are still sick and still incurring bills and want to file now???? WHY?  You’ll only have a bankruptcy and more collections on your credit report that you’re stuck with for 7 years.  Pick the right time to file if bankruptcy is inevitable.

Do you have any assets?  If so, you should look up your state bankruptcy laws to find out what assets are exempt and what aren’t.  Most non-exempt assets include cash, cars, investments, second homes – if it’s not exempt, it can be liquidated to pay off the creditors you’re trying to discharge in your Chapter 7 bankruptcy.  With a Chapter 13 you can keep all of your property as long as your unsecured debts (i.e. credit cards) are paid and do not exceed the value of your non-exempt assets.  If your unsecured debts exceed the value of your property and other assets, bankruptcy is not for you; basically your monthly payments in the Chapter 13 plan are based on your income, expenses, debts and how much property (assets) you have.

Which bankruptcy type are you eligible for; Chapter 7 or 13?  You will need to pass a Means Test based on your income within the past 6 months to be eligible to file Chapter 7.  This is important because if you are now unemployed, but had an income within the past 6 months; all of that previous income will be considered in the means test regardless of what your income is now!  If your means test shows that you can afford to pay 25% of your unsecured debts (which include credit cards), you are not eligible for Chapter 7, but may be eligible for Chapter 13. 

If you notice, I did not bring up credit in any of this. For most people that file bankruptcy, their credit scores have already been adversely affected by all the late payments, charge-offs and collections reporting, what more can a bankruptcy do?  Yes, it will stay on your credit for 7-10 years, but you can bounce back in 18 – 24mths and recover completely in 5 years. 

If you should file bankruptcy or not is a personal decision, just make sure that it’s a well-educated one.  Don’t file unless it’s absolutely necessary and after you have done your homework, spoken to a professional, and attempted to negotiate with your creditors. 

Hope this helps!

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