Dear Liz: When would you say filing for bankruptcy would be necessary, or is it ever? I have approximately $30,000 in credit card debt, $50,000 in student loans and a $104,000 mortgage. I’m unemployed and can’t find a job that would cover day care for a toddler as well as after-school care for a special-needs child. However, my field is finance — go figure, huh? — and I don’t want to kill my chances of resuming my career with a bankruptcy. What can I do?
Answer: Bankruptcy is sometimes the best of bad options, particularly when you’re facing unsecured debts such as credit card bills that equal more than your annual income or that would take you five or more years to repay. Five years is typically how long you’d be required to chip away at your unsecured debt in a Chapter 13 bankruptcy repayment plan, although given your lack of employment you may qualify for a Chapter 7 liquidation bankruptcy, which would erase your credit card debt.
Your student loans typically can’t be wiped out in a bankruptcy, nor can your mortgage. But you probably qualify for economic hardship options that would allow you to reduce or suspend payments on any federal student loans. Private student loans don’t have similar provisions, but you may be able to work out a payment plan with your lenders or you may have enough financial room to pay them if your other debt is wiped out.
By federal law, a bankruptcy can’t be used against you in employment decisions. Employers may, however, hold against you the late payments, charge-offs and collection accounts that frequently precede bankruptcy, so the protection offered by the federal law may not be of much help.
It’s a tough call to make, and you’d benefit from some advice. Consider contacting a legitimate credit counselor, such as one affiliated with the National Foundation for Credit Counseling, to see if a debt management plan could help you. But you also should talk to an experienced bankruptcy attorney so you understand all your options and the possible consequences of each.
Dear Liz: Why are child support arrears reported to credit agencies if they cannot be discharged in bankruptcy? And, why is it one can discharge some federal income taxes in bankruptcy but not child support?
Answer: Child support is not a run-of-the-mill debt. It’s a family support obligation, and one of the few debts that can land you in jail if you ignore it.
That’s because the welfare of your kids is at stake. The Internal Revenue Service will still be able to carry on if you negotiate a settlement or discharge some of your debt in bankruptcy, but skipping your child support obligations could doom your children to poverty, poor health and a host of other ills.
Although you can’t erase your obligation in bankruptcy, a Chapter 13 bankruptcy filing — which involves a payment plan — may enable you to catch up on any missed payments. A bankruptcy attorney can provide details.
In any case, the ability to erase a debt in bankruptcy isn’t among the criteria for reporting debts to credit bureaus. Other debts that typically can’t be discharged, such as student loans, also show up on credit reports.
Dear Liz: I felt really bad for the 74-year-old woman whose adult children discovered she had $41,000 in credit card debt. Is bankruptcy really her best option? Maybe she’s “judgment proof” because of her lack of assets. Bankruptcy is expensive to file. If her creditors can’t sue her, she might be better off just not paying.
Answer: She may well be judgment proof, which means she doesn’t have income or assets that can be seized by creditors. Social Security income is exempt from creditors’ claims, for example, and other property (personal belongings, clothing, furnishings) is typically exempt by state law.
Her being judgment proof wouldn’t necessarily stop creditors from suing but would prevent them from doing anything, at least initially, with the judgments they win against her. If her circumstances improve dramatically — if she inherits money or wins the lottery, for example — the creditors could use their judgments to collect.
Some people who are judgment proof file for bankruptcy anyway to stop collector harassment and legally wipe out their debt. Others opt to simply do nothing. The best course depends on her situation, and she’d be smart to consult with a bankruptcy attorney about her options.
Dear Liz: In your column in our Sunday paper, you gave advice with which I strongly disagree. The question to you was whether to pay off a $50,000 credit card debt from retirement funds of $250,000. I found your advice not to use this money, citing tax penalties, loss of retirement income, etc., to be irresponsible. Do you consider encouraging bankruptcy to be ethical financial advice? Once again, another unwise borrower does not have to be accountable and is shown the easy way out. Many people have had to tap their 401(k)s before retirement for various reasons. The money is owed, the borrower has the means to pay it, so he should pay it.
Answer: Why do you think premature withdrawals from retirement funds are so heavily penalized? And why do you suppose retirement funds are protected from creditors in Bankruptcy Court?
It’s because lawmakers have decided that there are some things worse than reneging on your debts, and one of them is an impoverished old age.
Yes, if you take on a debt, you should do your utmost to pay it back out of your current income. If you need to sell otherwise-unprotected assets to do so, then do so.
But tapping retirement funds prematurely is rarely smart, and it’s particularly unwise if there’s a possibility that you’ll wind up in Bankruptcy Court. Advising people of that fact is a long way from encouraging them to file for bankruptcy.
By the way, few people who have been through it would call bankruptcy an “easy way out.” Many people struggle with the decision, put off filing for too long and drain the very resources that could have been protected, only to end up having to throw in the towel anyway.
Dear Liz: I am a 49-year-old single father with two boys, 17 and 12. I had my own business for five years, which I finally gave up last year. I have credit card debt of about $68,000. My credit score is still good and all payments are current. I do not own a house, and I do not own much personal property either. I found a job a few months ago, and with that, I can still make payments every month. But I just figured out that it will take me about 40 months to pay them all off.
I am considering filing for Chapter 7 bankruptcy. My thinking was to file for bankruptcy now to wipe out the credit card debt, so that I can start saving for my retirement and the boys’ college. But I also heard that some student loans are based on parents’ credit, which worries me.
I have a car in good condition, but I will need to replace it in a few years because it is 15 years old. I also would like to start another business on the side, which will be easier if I still have credit.
I’ve read a lot of advice on the Internet, but I’m not sure whether I should file for bankruptcy. What do you advise?
Answer: That you not rely on Internet opinions when making a decision this monumental.
You really need to speak to a bankruptcy attorney about your individual situation. What you’ll probably discover is that you’re not a good candidate for bankruptcy, since you’re able to pay off your debt in less than five years. People who are allowed to file for Chapter 7 bankruptcy liquidation typically have far more debt than they could repay in that time period.
There’s another reason you probably shouldn’t file: You need to learn how to live within your means. You seem to be eager to start the borrowing cycle all over again, even though it ended in disaster last time.
Business-related debt is good debt only if it helps you get ahead. If you use credit just to keep a failing business afloat, it’s bad debt.
Dear Liz: I have almost $250,000 in my retirement accounts. I also have almost $50,000 in credit card debt. Should I take $50,000 from my 401(k) to pay off the debt?
Answer: No, no, no.
In case that wasn’t clear: No.
Of all the dumb financial moves you can make, raiding retirement funds to pay off credit card debt ranks near the top. You’ll pay penalties and taxes that typically equal one-quarter to one-half of any withdrawal, plus you lose the future tax-deferred returns that money could make. If you’re 30 years from retirement, that $50,000 withdrawal would cost you $500,000 in lost retirement income, assuming an 8% average annual return.
The fact that you have that much debt puts you at high risk of bankruptcy. In bankruptcy, your unsecured debt can be wiped out or reduced, while your retirement funds would be protected from creditors.
If you can’t figure a way to pay off your debt without raiding your retirement, you need to make two appointments: one with a legitimate credit counselor (visit the National Foundation for Credit Counseling at www.nfcc.org) and another with a bankruptcy attorney.
Dear Liz: It looks as if I will have to file for personal bankruptcy because of a business failure. (I guaranteed the debts personally, and there are two I know I can never repay.)
I could possibly keep the business open a few more months if I stopped paying a few of the other creditors, thus keeping my workers employed a little longer.
I know my FICO score will drop when I file, but will it drop more if I stop paying bills before I file, or is the FICO drop the same no matter what?
Answer: The end result will be about the same.
If you stop paying some bills, those skipped payments will lower your score substantially. Once you file for bankruptcy, your score will drop some more.
But the effect of bankruptcy on your scores is so profound that you’ll end up in about the same place as you’d be if you had filed without ever having missed a payment. Either way, your scores will be in the basement.
If you believe bankruptcy is inevitable, consult a bankruptcy attorney now. It’s easy to make mistakes that could endanger your bankruptcy filing.
You don’t want to wind up with shattered scores but still owing these impossible-to-pay debts.
Dear Liz: I just received rate increases on two of my credit cards that are together going to send me into bankruptcy. I didn’t think it could happen to someone who has perfect credit, has not maxed out the card and has been steadily reducing the balance and not charging anything, but obviously it can. I had every intention of repaying my debt, but these arbitrary increases — which will add $600 a month to my payments — have made it impossible.
I feel foolish for having this debt at all, but I lost my mortgage business and my husband is in construction. We have had a really bad four years. If they had just allowed me to continue making the payments per our original agreement, I would have been able to continue reducing the balance and they would get their money. This way, they won’t receive any money at all. How does this make sense?
Answer: Credit card issuers know full well that their latest rate increases will send some of their borrowers to Bankruptcy Court. What they’re hoping is that they’ll get enough interest from those who can still pay to offset the losses from those that can’t.
All may not be lost. Many issuers who have instituted these rate hikes offer an “opt out” provision that would allow you to keep your original rate if you agree to close the account. You should contact your issuers to see if this option is available. Closing accounts can ding your credit scores but will cause far less damage than a bankruptcy.
Be realistic about your financial situation, however. The amount of the proposed payment increase indicates you’re carrying substantial debt on those cards. Unless your financial situation improves dramatically, it’s probably only a matter of time until a misstep or another change in terms causes you to fall behind.
If that’s the case, bankruptcy may be a better option than continuing to struggle with debt you’ll never repay.
Dear Liz: My question is whether I should file for bankruptcy or try to settle my debts.
I owe about $50,000 on credit cards, $120,000 in student loans and $701,000 on my home. I have stopped paying on my credit card debt because my issuers increased their rates and were unwilling to work with me, so I am unable to pay even the minimums they now require. My mortgage is being modified, although it has been four months since the process started and I have received a notice of default, which is the first step in the foreclosure process.
I am unsure what to do, but I do know I don’t have anywhere else to go. I have to provide a safe haven for my children and disabled parents. What’s your advice?
Answer: You need to talk to a bankruptcy attorney, pronto.
That doesn’t mean filing for bankruptcy will necessarily be the right choice. You won’t be able to eliminate your student loan debt. If your income is too high, you’ll be put on a payment plan instead of being able to erase the credit card debt.
But it may well be the best of bad options. Debt settlement is typically available only for credit card debt, and you would need a sizable lump sum of cash to persuade your issuers to negotiate.
And even if you get a mortgage modification, your housing problems may not be solved. Borrowers too often agree to a modification of a debt that never has been, and never will be, affordable. That’s why so many mortgage modifications have resulted in default and foreclosure.
What you need is an educated third party to look at your finances and explain your options to you.