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Is Bankruptcy Your Personal Bailout?

Bankruptices on the rise but the choice can have serious consequences

By Fred Yager
ConsumerAffairs.com

October 25, 2008

That's according to the American Bankruptcy Institute which reports American families are now going bankrupt at the rate of 22,000 a week, a figure that is trending upward as the nation falls deeper and deeper into a recession.

Some may see bankruptcy as a personal bailout, their individual version of the government bailout offered to banks. After all, wasn't it too much debt that drove our largest financial institutions into needing a $700 billion dollar bailout? Too much debt is one of the key reasons that more and more Americans are being driven into bankruptcy, along with rising unemployment and unpaid medical bills because of lost health benefits.

But with laws tightening to make bankruptcy filings more difficult, not to mention more expensive, bankruptcies are nothing like bailouts. In fact, there are a few things you need to know if you are considering going down this rough and financially dangerous road.

First and foremost, filing for bankruptcy destroys your credit rating and could make it extremely difficult to borrow money for many years thereafter. Typically, a bankruptcy will stay on a credit report for at least ten years.

Steps you can take prior to bankruptcy

Since bankruptcy is a very serious step with short and long-term consequences, make sure you have exhausted all other options before taking this route. One way to try to forestall it is to try to work out with as many of your creditors as possible partial payment options even if you both agree that it will take months or even years to finally repay the debts that are owed.

Another option is to approach family or friends for monetary gifts or loans. If they turn you down, or if they are tapped out themselves, consider selling whatever valuables you have that might generate revenue such as gold, sterling silver, even heirlooms, art works, furs, bicycles, or cars.

See if you can get a second or even a third job or ask a teen and young adult family members who are able to work, in addition to going to school full-or part-time, if they can contribute to your family household income needs. Renting out a room or part of your apartment or house, if it is allowed in your community, is another possible source of revenue.

Bright spot

If you have exhausted all possible avenues and bankruptcy still seems like the only alternative, there is a small bright side. Some experts say those who file for bankruptcy are already in such bad shape their credit scores are already very low. Therefore, wiping out their debts by filing for bankruptcy may even improve the chances for some people to eventually rebuild their credit ratings.

So, if there are no viable alternatives to bankruptcy, the first step is for you to find a good lawyer who has expertise in bankruptcy filings. If you don't have one, the National Association of Consumer Bankruptcy Attorneys can provide you with a list of names in your area. They'll help you determine what kind of bankruptcy you should be filing because there re two main options. Most personal bankruptcies tend to be either Chapter 7 or Chapter 13.

Chapter 7

Chapter 7 is the simplest and least expensive personal bankruptcy alternative. It's what you do if you can't pay your unsecured debt, such as credit card payments. The process, which takes only a few months, will wipe off your credit card balances. Bankruptcy lawyers say the primary reason people chose Chapter 7 is so they can protect their car and home.

Some assets, such as pension plan, qualified retirement plans like IRAs or 401(k)s, are exempt from Chapter 7 bankruptcy, which means you can keep them. So if you find yourself falling into financial trouble, the one thing you don't want to do is to cut back on pension or retirement contributions.

Chapter 13

The more complicated version is Chapter 13 which is a court-supervised three-to-five year repayment plan that lets you keep more of your assets. It can also help to reduce car or mortgage payments that aren't covered under Chapter 7. In a Chapter 13 filing, your debts are not wiped clean. Instead, during repayment plan, you pay back some of your debts. After that, most of the rest of your debts are forgiven.

Also with Chapter 13, you may be able to alter a car loan or catch up on back mortgage payments. As for other types of assets you may want to keep that aren't protected under Chapter 7, Chapter 13 may apply. But again, this will vary from state to state and there are a number of rules governing how much you have to repay each creditor.

There are other types of bankruptcies, such as Chapter 11, which is corporations use but usually is too expensive for most individuals. Then there is Chapter 12, which works like Chapter 13 but is designed for family farms.

Keep in mind that there are some things no type of bankruptcy will help you with such as student loans, child support, alimony and back taxes.

How bankruptcies work

Declaring bankruptcy can be a long and painful process. Once you find an attorney, you then set up a meeting where you bring your past tax returns, pay stubs, bank statements, and documents showing any assets and debts. You also have to agree to go through credit counseling.

You then file with the bankruptcy court which should issue an automatic stay that stops creditors from harassing you or trying to seize your assets. Shortly thereafter, within four weeks, you may have to meet with what's known as a creditor's trustee to review your situation. Following this, the court may wait another two months to see if any objections are filed to your bankruptcy petition. You'll also need to enroll in a credit education course. Finally, if the court rules in your favor, you will receive an order that discharges you from most of your debts.

Perhaps the most important asset that may be protected from creditors in bankruptcy is your home, provided it is your primary residence. The amount you can protect varies from state to state. Florida and Texas have what's called "homestead exemptions" which means your home is protected. Some states have rules governing occupancy and that you have to actually own the property. Other states only allow you to keep a home, provided you have a certain amount of equity invested in the property.

There also are other assets such as your car and some personal effects that may be protected, but the limits will vary from state to state.

Nobody likes bankruptcies but in these difficult times they are becoming an ever-growing part of American life. One Richmond, VA-based counseling agency, Clearpoint Financial Solutions, recently told the Richmond Times Dispatch that it has seen a 10 percent increase in the number of people seeking help over last year, along with other signs of hardship, including:

• A 25 percent increase in the amount of debt people are placing in debt-management programs, indicating a rise in delinquency rates with consumer credit.

• A 22 percent increase in monthly housing expenses among people seeking counseling.

• A 23 percent increase in the number of clients who are now living with friends or relatives because they can't afford to rent or own a home.

You and any of your family members may be having a hard time dealing with the emotional ramifications of declaring bankruptcy, such as feeling guilty about telling those who performed work for you that you will not be able to pay them, or how your self-esteem is impacted by your grave financial situation. If so, consider seeking out a therapist who can help you deal with those emotions and provide the kind of help you probably won't get from a credit counselor.

Just remember that these are very hard times and you are not alone in having to go down the personal bankruptcy road. It's becoming one crowded highway.

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