Weigh the Costs and Benefits of Bankruptcy

Weigh the costs of bankruptcyCome January, many consumers experience a holiday-shopping hangover that no amount of aspirin or comfort food will alleviate. Failing to set aside gift money ahead of time and charging holiday expenses to credit cards can cause enormous stress, says financial adviser Sarae Kurth. For those in extreme financial pain, bankruptcy can look like the best option.

Despite its negative stigma, filing for bankruptcy yields a lot of benefits for some people. For example, bankruptcy completely wipes out certain debt, stops creditors from garnishing your wages and could help you hang on to your home. Of course, it also comes at a price that affects more than your wallet. Determine whether bankruptcy is right for you.

When to Consider Filing for Bankruptcy

Search online and you’ll find numerous resources that declare bankruptcy the best solution for those who have missed a mortgage payment, make only the minimum credit card payments or use one credit card to pay another. But Denver-based bankruptcy attorney Eric Herr disagrees. He suggests putting some real numbers to the test. If you are feeling the post-holiday pinch and considering bankruptcy, ask yourself the following questions:

Could You Feasibly Pay Off Creditors in Two Years or Less?

Calculate the total amount of dischargeable debt that you owe to creditors. Then divide that value into 24 monthly payments. Can you afford paying this monthly amount consistently for the next two years? If not, can you afford the damage you will continue to inflict on your credit score by lugging this debt around?

When consulting with clients, Herr uses the two-year timeframe because that’s also how long it takes to rebuild your credit score once your bankruptcy goes through. If you could realistically pay off creditors in the same amount of time, and thereby forgo bankruptcy, you could save yourself the expense of filing.

In some cases, debtors can strike a deal with creditors to avoid bankruptcy, particularly when it comes to delinquent accounts. Try calling each creditor directly to discuss lowering your interest rate or the amount owed. Often, if creditors are willing to reduce your balance, they want a lump-sum payment within a short period of time. This can work to your advantage if you fall behind on one account. But if multiple accounts go delinquent, forking over one (or more) settlements to make good might not be possible without strapping your finances elsewhere.

Is Filing Bankruptcy Worth the Expense?

Compare the total amount of your dischargeable debt to the cost of filing for bankruptcy:

  • Filing fees (around $300)
  • Bankruptcy attorney fees (between $1,000 and $5,000)
  • Increased insurance rates (auto, homeowner’s, health, etc.)
  • Negative impact on your credit score for two years

Although more than 1 million Americans filed for bankruptcy last year (according to statistics published by the Administrate Office of the United States Courts), it’s not for everyone. For example, if you’re looking to erase only $2,000 worth of credit card debt, bankruptcy isn’t worth the expense. Or if your creditors are willing to cut you a deal, reducing what you owe by 30 to 60 percent because you offer them an immediate lump sum payment, again, bankruptcy might not be the best route. This is where it really helps to find a reputable attorney who wants to help you explore your options (versus making a pretty penny off of you).

Herr says one of the biggest misconceptions about the cost of bankruptcy is the fact that it stays on your credit report for 10 years.

“What matters most to lenders these days is your credit score. People just aren’t penalized today like they were two decades ago,” Herr says. “In fact, I’ve seen multiple clients get approved for a car loan with a decent interest rate two years after filing, and others, even on their second bankruptcy, able to qualify for a home loan in less time than that.”

Do You Need to Save Your Home from Foreclosure?

If the threat of foreclosure is imminent, determine whether bankruptcy is the best way to keep your home. For example, if you have built significant equity in your house (versus being upside-down), it might be worth saving through bankruptcy. Typically, if you’ve stopped paying your mortgage, and your lender has notified you of foreclosure, you can halt the lengthy process by filing for bankruptcy before the day of the sale.

Although stopping the foreclosure buys you a little time, you’re still on the hook for missed payments. However, if catching up will thrust you back into another financially strapped situation, it could make more sense to let the house go. Again, this is where having a trustworthy attorney is gold.

Are Creditors Garnishing Your Wages and/or Bank Funds?

Take inventory of how much your total garnishments are digging in to your ability to stay above water. If you can’t afford to lose a quarter of your paycheck to creditors, consider using bankruptcy to stop them from garnishing your wages and/or bank account. Once you file, even before the court approves your bankruptcy, an “automatic stay” goes into effect. This instructs creditors to stop any garnishments and halt all attempts at contacting you (by phone, mail, or personally serving you lawsuit papers) or seizing your assets.

Herr adds, “I see people try to keep up with garnishments, sometimes for up to three years, before declaring bankruptcy. But why let it go that far? The sooner you determine whether bankruptcy is right for you, the less you lose.”

And the more quickly you can get back on your feet.

Have You Personally Been Served a Lawsuit?

Act fast when creditors (or their lawyers) personally serve you papers at your door. After such a notice, you might face garnishment of 25 percent of your wages in as little as 45 days. Start by contacting a bankruptcy attorney to immediately guide you on how to answer.

If you ignore the lawsuit, you’ll receive a default judgment against you that legally grants a creditor permission to garnish your wages and/or your bank account or even file a lien on your home. Herr says that, when served a lawsuit by creditors, “People often do nothing because they know they owe. But by failing to answer, you’re making a big mistake. You’re ignoring the processes in place designed to protect you.”

Types of Debt Dismissed by Bankruptcy

A bankruptcy discharge releases you from being personally liable for paying off certain debts. However, not all types of debt qualify as dischargeable. Most commonly, bankruptcy discharges the following debts acquired prior to filing:

  • Credit card debt
  • Medical bills
  • Payday loans
  • Deficiency judgments on repossessions and foreclosures
  • Landlord-tenant judgments (including damages and back rent)
  • Phone and utility bills (for companies you no longer do business with)

This does not include student loans or any tax debt. However, bankruptcy can significantly reduce what you owe to the IRS and fully discharge tax-related interest, penalties and tax debt assessed by tax authorities more than three years ago. For more on what a bankruptcy can and won’t erase from your financial obligations, consult the United States Courts’ resource on bankruptcy basics.

How to Find Financial Help

Talking money can be tough, but the sooner you seek a solution, the better. Get the conversation rolling by consulting a few bankruptcy attorneys to compare advice and get a sense for whom you can trust to be your best advocate. Also check local credit unions for free classes or one-on-one financial coaching offered by financial education advisers such as Kurth.

“Money is an emotional topic, often tied to self-worth. We need to do more as a society to break down stigmas about discussing money and our personal finances,” Kurth says. She suggests getting “better equipped to prioritize financial goals and plan for spending and saving to avoid holiday hangovers altogether.

[Any reference to a specific company, commercial product, process or service does not constitute or imply an endorsement or recommendation by the National Endowment for Financial Education.]