Is bankruptcy the best option for those with few assets?
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.
Dealing with Mom’s big debt
Dear Liz: My 74-year-old mother was laid off from her full-time job in May. My siblings and I were horrified to learn that she owes $41,000 on 12 credit cards with interest rates ranging from 9.9% to 29.9%. None of the issuing banks is willing to lower her interest rates. With her Social Security benefits and unemployment, she is just barely getting by, but unable to afford more than her minimum payments on the credit cards. She does not own a home and rents a duplex for $650 a month. She has about $70,000 in a retirement fund, $600 in savings and a used car.
One of my siblings has suggested that she stop paying the credit cards altogether and let the debts go to collection. Another has suggested bankruptcy, but we’re uncertain how that would affect her retirement account. Either scenario would affect her credit scores, which would then be a consideration for future employment and could raise her auto insurance rates. Any suggestions?
Answer: If your mother simply stops paying her credit card bills, the issuers or subsequent collectors could sue her over the debt. Because there’s little hope of her being able to pay these bills — her unemployment benefits will end someday, and her prospects of finding another job are probably slim — bankruptcy may be the best of bad options. A Chapter 7 liquidation filing would protect her from creditors, erase the debt and allow her to get a fresh start. Her retirement fund would be safe; whether her small savings account or car would be at risk in a bankruptcy filing depends on state law.
Yes, her credit scores would certainly suffer, and in most states (although not California) that can lead to higher insurance rates. But at this point, her credit scores are probably the least of her worries.
Another option is that the siblings could pitch in to pay off or settle these debts. Although paying off the cards in full would preserve her credit, that may not be the best option. She used these cards to live beyond her means in good times, so she would be tempted to run up more big balances as money gets tighter. If you settle the debt for less than what she owes, the accounts would be closed and her credit would be trashed, so she would have trouble accumulating new debt — at least for a while.
But you may well decide that a better use of your money, if you have any to spare, is to help support her in the future.
It might help to know your mother isn’t alone in her troubles. A Consumer Bankruptcy Project study found the rate of bankruptcy filings more than doubled from 1991 to 2007 for people 65 to 74. For people 75 to 83, the bankruptcy filing rate rose 433%.
Protecting retirement funds: unethical or smart?
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.
Bankruptcy isn’t the easy way out
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.
Don’t raid 401(k) to pay off credit card 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.
