Email question I received the other day:
Patrick, I attended your class last year and have purchased your book.
I have a client who has about $70,000 in credit card debt from medical issues. She can no longer work and is planning to file bankruptcy, but doesn’t want to lose her home or retirement accounts.
I suggested she use a non-profit credit association company to work out a payment plan and pay the debt. I don’t want to lead her down the wrong path as I am not a financial advisor. You implied in your book and class that bankruptcy might be the best route for their credit.
What is your suggestion?
There are many things to consider when someone has reached a point of being unable to pay the debts they owe. Speaking to a bankruptcy attorney is a good idea in order to focus on specifics. Here is my short list of details to think about:
- If she has money in an account with a bank she owes money to she needs to close that account. Move the money to a bank she owes no money to. This safe guards her from a set-off. A bank can pull money out of an asset account if the holder owes money to the bank. If she is a joint account holder on a checking or savings with someone else she needs to address this as well. If her income is social security she should have it direct deposited into an account that is only for her social security income and nothing else. Do not co-mingle funds. By doing this, in the worst case scenario of being sued and garnished she should be able to prove this money is judgment proof.
- She most likely can keep her retirement accounts as an exemption (asset a debtor can keep) in a bankruptcy. The statutes in most states give retirement accounts an exemption from creditors. The list of exemptions will be in your state codes/statutes. The legislative websites have search features for locating the information. Check with a local bankruptcy attorney for an exemption planning session to see how the laws would apply specifically. Knowing how exemption planning works for a specific jurisdiction is very important.
- As long as they continue to make the payments they can most likely keep the house. This decision needs to be weighed carefully. Do they really want to keep the house, can they afford it? Another consideration is how much equity they have. The exemptions in most states allow for a decent amount of equity to pass through bankruptcy untouched by creditors.
- People who go through Chapter 7 bankruptcy will generally have better credit within two to three years. Whereas people in Chapter 13 or credit counseling repayment plans can be in bad credit shape for three to five years. They may not be eligible for Chapter 7, so a repayment plan might be their only option. It is important to speak with a bankruptcy attorney to determine eligibility, it is not always a straight forward calculation, get help.
- Through Chapter 7 bankruptcy, if she is eligible, she would likely discharge the entire $70,000 balance. The fresh start without overwhelming monthly debt payments can be a life saver.
- A bankruptcy is a permanent public record in the court system. It falls off the credit report within 10 years. Qualifying for a mortgage after bankruptcy can vary from one day to seven years. The safest assumption is within three years using an FHA mortgage.
- Credit counseling (debt settlement) is not part of the permanent public record. It will fall off the credit report in seven years generally (this is the way to go for people with political aspirations or wanting to stay private). The reference to the counseling is limited to the individual accounts included in the plan. It is not listed under public records or as a stand alone issue on the credit report. There are circumstances where it makes sense to go through settlement instead of bankruptcy. Generally for smaller amounts. The $70,000 owed may be negotiated down to a smaller amount.
- A major consideration is tax consequence when it comes to debt settlement. If they owe $70,000 in credit card debt and settle for half, they are going to be taxed on $35,000 as income. Depending on her tax bracket this could be a major shock if she is are not aware of the tax implications. An important thing for consumers to realize is that even if they do not qualify for a Chapter 7 discharge, going the Chapter 13 route may turn out better than settling. There is no tax consequence. It is also possible the debtor would pay less in Chapter 13 by court order versus what credit would be willing to accept in a settlement. It varies, but it is good to know the options and overall costs. For example, creditors agree to settle for half, but the court may order that the creditors will receive ten cents on the dollar. Bankruptcy can be superior even from a settlement standpoint.
- With debt settlement the consumer does not lose any assets (other than the money they are paying). With a Chapter 7 bankruptcy the debtor would lose any non-exempt assets (personal property, stocks, savings, etc.). MOST DEBTORS DO NOT LOSE ANY ASSETS BECAUSE THEIR ATTORNEY WILL GUIDE THEM ON HOW TO PLAN AHEAD. I cannot stress enough how important it is to work with a reputable bankruptcy attorney to guide you. In a Chapter 7 bankruptcy the non-exempt assets can be auctioned off. These are items beyond basics needed to live, every state has its own set of exemptions. It isn’t a given, the trustee of the case may decide there isn’t enough value to make it worthwhile. Many times the debtors will go to the auction and bid on their own stuff. I witnessed this first hand when I was in law school. It was recommended we attend a bankruptcy auction to get a feeling for the emotional side of the process. The people I encountered were bidding on artwork and other non-essential assets. The possibility of losing personal property is a major factor in making the decision to go the bankruptcy route. Especially if the debtor has cherished keepsakes that would have to go to auction to pay creditors. It is a good idea to sit down with an experienced bankruptcy attorney for an exemption planning session to plan out the bankruptcy thoroughly. If given the choice between a payment plan and discharging the debt it is almost always a better idea to discharge the debt. At the point of discharge the credit begins to heal. Whereas with a repayment plan the damage continues until the account is settled and closed out. It is also important to realize that there are specific laws and procedures for bankruptcy. Along with oversight and professional accountability.
- An excellent measure of whether a credit counseling agency is trustworthy is if they are HUD approved. I have taught for HUD approved counseling agencies for a number of years and have found NeighborWorks organizations to be some of the best around.
- Watch out for the sharing rule. It allows a debt settlement/credit counseling company to receive a commission/cut of the amount they can get the consumer to pay to the creditor. Read your paperwork thoroughly.
- Do your due diligence, if people are complaining about a debt settlement company there is a reason. Go beyond the positive reviews a company plants about itself.
- Don’t fall for the attorney backed trick: we have an army of attorneys in the backroom waiting to fall out on our orders to help you! This is a way debt settlement companies skirt federal and state law that bars them from collecting upfront fees until they settle on at least one debt. However, an attorney may accept an upfront fee for debt settlement. By having an arrangement with a licensed attorney in order to collect upfront fees there are many scams being played in the debt settlement arena. Check out some of the allegations in the debt settlement arena regarding the attorney backed model. Do your own due diligence before giving any person or organization your money:
As you can tell, there are many details to consider Focus on what provides a solid resolution with the fewest strings attached.
About the Author: Patrick Ritchie loves teaching about credit; he is the author of The Credit Road Trip and The Credit Road Map series of books. Check out his free online classes at www.CreditLiteracyProject.com.
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