Your Options

Deciding whether to file for bankruptcy isn’t easy. Before filing, you should consider the alternatives, including avoiding bankruptcy on your own and getting outside help. If those options don’t work for you, then bankruptcy could be the right choice. Let’s take the options one at a time.

1. Avoiding Bankruptcy on Your Own

If you want to avoid bankruptcy on your own, you first need to create an accurate budget. Figure out your true monthly expenses. Include mortgage and automobile payments in those monthly expenses, but exclude your unsecured debt (like credit card debt). Compare your list of monthly expenses to your average monthly income.

Can you pay off your unsecured debt within three years? In answering that question, you want to ignore those monthly minimums. You want to know if you can pay off the whole balance of all your unsecured debt within those three years.

Note: Some folks are seriously tempted to liquid their retirement accounts (like IRAs and 401(k)s) to pay off this non-mortgage/non-car debt. This is a dangerous way to go, because it creates income tax liability and early withdrawal penalties. Sometimes this strategy does nothing more than replace your existing creditors with the government. You should definitely talk to an accountant to determine how bad things could get in your case should you liquidate your retirement assets.

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2. Getting Outside Help to Avoid Bankruptcy

If you can’t pay off your unsecured debt within three years on the present terms, there might be some options. These include credit counseling, debt settlement, housing counseling, consolidation loans and reverse mortgages. These should be evaluated on a case-by-case basis, meaning that you shouldn’t launch into a strategy until you’ve done your research. Let’s look at the options.

A. Credit Counseling

Before anyone files for bankruptcy relief, the law actually requires that they meet with an approved credit counseling agency. Doing this will help you calculate your budget. Because many consumers are often already too deep in debt, credit counselors are not often able to suggest viable options. Nevertheless, this counseling often helps a person avoid getting into the same mess a second time.

One thing to be watch out for is that credit counselors, even some of the government-approved ones, will recommend a so-called "Debt Management Plan" or "DMP" as a way to avoid
bankruptcy – whether or not it makes sense! A DMP requires that the consumer send a monthly check to the counseling agency for distribution to the creditors. Sometimes the agency is able to get some concessions on the part of the creditors, but usually it’s nothing more than the waiver of late fees and other charges, and perhaps a slight reduction in interest rate.

A DMP generally does not allow you to reduce the principal you owe and it does not deal with secured debt, which a chapter 13 bankruptcy can do. We recommend that you consider obtaining a copy of the Guide to Surviving Debt published by the National Consumer Law Center for more information about DMPs.

B. Debt Settlement/Negotiation

Unlike credit counseling agencies, most debt settlement and debt negotiation agencies are for-profit businesses. They differ from the debt management services described above in that these businesses collect your payments in a separate account until they believe they can settle the debts for less than what you owe.

Debt settlement/negotiation companies often make unrealistic claims about settling your debt for less than what’s owed. Very few customers ever complete a debt settlement program. Sometimes the fees can be so high that consumers never actually accumulate much in the separate account for later payment by the company to creditors. Finally, there might be adverse tax consequences to the consumer whose debt is "written off" by their creditors. Bankruptcy discharges, on the other hand, are not treated like income to the consumer.

C. Housing Counseling

If your only debt issue is the affordability of your home mortgage as a result of a temporary loss of income, the most effective solution could be what’s called a "workout" with the lender. There are three types of workouts: repayment plans, forbearance plans, and loan modifications.

Repayment plans allow you to make your normal monthly payment plus a partial payment for the amount you are in arrears. It’s similar to a cure of arrears that’s possible in a chapter 13 bankruptcy.

Forbearance plans are more formal than repayment plans. They allow payment of an arrearage due to a serious event (i.e., illness, divorce, natural disaster, etc.) over a longer term than a repayment plan (but usually no more than 12 months). They can also offer some options like a reduced or suspended payment to allow recovery from the hardship-creating event.

Loan modifications are permanent changes in loan terms, including interest rates, repayment term, amortization, principal owed, or a combination of any of the foregoing. Someone considering a modification should weigh it against the costs and benefits of filing chapter 13. Chapter 13 does not (as of the time of this writing) adjust the terms of your mortgage, but it can give you more time to repay an arrearage and it will stay many adverse actions against the homeowner, including foreclosure. Bankruptcy court can be an excellent place to raise any counterclaims against the lender. If you are interested in pursuing loan modification, there are (as of this writing) government programs that may help you.

D. Consolidation Loans/Reverse Mortgages

It’s usually a bad idea to mortgage your home to pay of credit card and other unsecured debt. You put your home at risk if something goes wrong. Refinance your home if the terms are better for you.

Reverse mortgages allow senior home owners to borrow on the equity in their homes. Payment is not required until the senior sells, moves out permanently, or dies. They are usually quite expensive. A senior should get counseling from an approved counselor before going this route. More information about reverse mortgages and approved counselors can be found at the Department of Housing and Urban Development

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3. Your Options in Bankruptcy

If there are no alternatives in your case, then a fresh start in bankruptcy might be the right thing for you. Here are the bankruptcy options:

• Chapter 7 is known as "straight" bankruptcy or "liquidation." It requires an individual to give up property which is not exempt under the law, so the property can be sold to pay creditors. Generally, those who file chapter 7 keep all of their property except property which is very valuable or which is subject to a lien which they cannot avoid or afford to pay.
• Chapter 11, known as "reorganization," is used by businesses and a few individuals whose debts are very large.
• Chapter 12 is reserved for family farmers and fishermen.
• Chapter 13 is a type of "reorganization" used by individuals to pay all or a portion of their debts over a period of years using their current income.

Most consumers end up filing under either chapter 7 or chapter 13. Which one is the way to go in your case is a matter for you to decide with your attorney. Either one can be filed by a married couple jointly or by one spouse separately. Call us at 916.273.9040 if you’d like some help.

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