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When Should You Consider Bankruptcy?

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If you’re like most people, when you borrow money, you have every intention of paying it back. But then something happens; perhaps you lose your job or your hours get cut, your small business slows down, you get sick or you have to stay home to care for your children or an elderly parent. Whatever the reason, you find yourself unable to keep up with your payments.

When you find yourself struggling with debt, you’re no doubt searching for solutions. But the one you avoid — bankruptcy — may be the one you need the most. Here are four signs you should consider bankruptcy.

The Hole Just Keeps Getting Deeper

You’re paying and paying on your debts but the balances just won’t go down. Maybe they are even going up. For example, our reader Carrie wrote on the Credit.com blog:

“So I had a judgment against me since 1997, it started off about $3000 dollars. I didn’t start paying on it until 2006 when I made a payment plan of 40 dollars a month, by then with the interest it was $6000 dollars, like I said I’ve been paying on it since 2006, now this new guy is trying to pressure me saying I have to pay it right now 2000 dollars.”

The fact that Carrie’s balance has doubled since she started making payments should tell her that her current strategy isn’t working. “If your debt is such that you can’t afford to pay it off in full over the next 36 months, you may want to consider bankruptcy,” suggests bankruptcy attorney Jay Fleischman.

Similarly, someone who finds themselves unable to make the minimum payments on their accounts should consider getting legal advice. “If your monthly budget leaves you short of being able to make all of your minimum payment on unsecured debts, first find out if you can qualify for payment reductions through a credit counseling agency,” says Michael Bovee, a debt negotiation expert and founder of Consumer Recovery Network. “If the reduced monthly payments you quoted by a certified counselor are still out of reach, talk with a bankruptcy attorney about your options.”

You’re Raiding Your Retirement

Are you tempted to take an early withdrawal from your retirement funds to keep the wolf from the door? Or if you are at retirement age, are you withdrawing retirement funds to pay debts? If so, then it’s a good idea to talk with a bankruptcy attorney first.

The older you are, the more risk raiding your retirement funds to pay debts carries. Cathy Moran, a California bankruptcy attorney, encourages debtors to take a hard look at what they have saved for retirement, adding that “No one but public service sector folks have decent retirement resources.”

“When you raid your retirement funds you are not getting out of debt cheaply, you are stealing money from your 82-year-old self that will depend on that money to get by,” warns Steve Rhode, founder of GetOutofDebt.org. “There can be significant consequences to borrowing from the retirement funds instead of considering learning a lesson from bankruptcy and doing better moving forward. He also warns that just borrowing from a retirement account to pay off debt can cost a retiree far more than the money saved by paying off the loan faster.

Charles Phelan, a debt negotiation expert and founder of ZipDebt.com, agrees:

“The demographic group that is usually the most emotionally resistant to filing bankruptcy is senior citizens, yet they are also under more financial pressure than people with long working careers still ahead of them, and therefore often in need of the relief that bankruptcy can provide. Given that seniors are often retired or about to retire within a few years at most, they should be extremely careful about using precious retirement funds to pay off credit card debts or settlements on such debts.”

He says he always encourages seniors he talks to about settling their debts to consult with a local bankruptcy attorney first.

Others Will Suffer If You Don’t File

Almost a decade ago, bankruptcy researcher Elizabeth Warren — now Sen. Warren (D-Mass.) — described one of the findings from her research into consumer bankruptcy in sobering terms: “Having a child is the single greatest predictor that a woman will end up in financial collapse.”

Whether it is children, a disabled spouse, or an elderly parent, taking care of others financially in addition to trying to meet your own needs can quickly drain your resources. It doesn’t matter if you are female or male, if you are struggling with your debt and weighing your options, consider the “number and age of people dependent on you and emergency fund to care for them if the unexpected happens,” says Moran. “The larger the number of people dependent on the person sitting across from me, the more likely they need an emergency fund, health insurance, etc. rather than paying unsecured creditors,” she observes.

Our reader Katherine writes on the Credit.com blog:

“I received a judgement from something that was back in 1997. (The collector) has spoken to my employer who was upset with me, which (in turn) threatens my job. I don’t have that kind of funds, i am a single mom supporting two kids in college and still 2 small kids at home. I cannot afford to lose my job…How do I pay my rent and feed my children and buy gas for work!”

You’re Upside Down On Your Home

While many in the news are already celebrating a housing recovery, an estimated 7 million Americans remain underwater on their mortgages. Bankruptcy is one of six main options for dealing with an underwater mortgage and it can provide relief in a number of ways. By filing, you may be able to:

  1. Catch up on past due mortgage payments or negotiate a loan modification so you can stay in your home;
  2. Eliminate a second mortgage or home equity loan through bankruptcy;
  3. Erase debt that could be due if the lender foreclosed and sold your home for less than you owed;
  4. Free up money that you were paying on other debts so you can afford your home loan; and/or
  5. Avoid a big tax bill from “cancellation of debt income” that may result if your home goes into foreclosure or if you negotiate a short sale.

Phelan reports that many homeowners he talks with “are shocked to learn that their second mortgages or home equity lines of credit (HELOCs) were not resolved when their property went to foreclosure or was sold short.” He goes on to explain, “Many second mortgages are ‘recourse’ loans, which means that a lender can still try to recover the balance. It’s common to see unresolved balances of $100,000-200,000 on these second mortgage loans, especially in certain parts of the country where property values went sky-high during the real estate boom.”

The Credit.com blog is filled with comments from taxpayers who have received 1099-Cs reporting canceled debt as income and are potentially facing enormous tax liabilities as a result. Some of the largest debts come from homes that have been foreclosed upon or were sold in a short sale for less than the balance due on the loan.

Some consumers will be able to use the Mortgage Debt Forgiveness Relief Act to avoid paying taxes on that canceled debt. But for those who don’t qualify for that exclusion, filing for bankruptcy may have been a wise move, since debts discharged in personal bankruptcy are not taxable.

If you are currently underwater and either facing foreclosure or trying to sell your home via a short sale, talk with a tax professional before you decide on which approach to take. If it looks like you may owe taxes as a result of the foreclosure or short sale, meet with a bankruptcy attorney as soon as possible.

Where to Get Help

A consumer bankruptcy attorney can help you understand how filing may help you. Many offer low-cost or free consultations.

You may also want to talk with a credit counseling agency. “If you were to choose bankruptcy, your counselor can even provide a list of local resources to help you get started,” says Thomas Fox, Community Outreach Director for Cambridge Credit Counseling Services. Before you can file for bankruptcy, you will need a certificate from an approved credit counseling agency showing you have completed a credit counseling session.

“Be sure to ask your counselor if they provide such a service, and if so, if that program is authorized through the Executive Office of the United States Trustee,” Fox advises. If you hope to find another way to pay back your debt, the counseling agency will be able to explain alternatives.

Even though you probably see bankruptcy as your last resort, don’t wait too long to get help if you think you may need it. “Being informed about all debt relief options, even if you do not follow through with bankruptcy, is quite literally a responsible thing to do,” says Bovee.

Image: iStockphoto

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  • http://getoutofdebt.org Steve Rhode

    It’s just a shame that the misperceptions and emotional stigma about bankruptcy holds people back from making the right financial move for them. Great article!

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  • John S.

    Read the very last sentence of this comment if you don’t feel like hearing my whole story. Also, please take notice in the fact that this is only a comment submission. I realize that. Let that be an indication of my desperation and frustration at this point.

    My fiancé and I have been working very hard to keep up with her current debts. Unfortunately we are still sinking. While we have kept up with every bill since we met, The medical bills associated with my recent unforeseen epileptic diagnosis and the outrageously unattainable court fines imposed on her for driving offenses she committed prior to our relationship are bleeding us dry. I am great with living on a budget, paying bills, and saving money. However, my hard earned credit score will not be able to help us after our marriage. All of her old small personal loans, credit cards, cell phone contracts, etc. from her younger years continue to change hands between debt collection agencies. I see several court rulings on her credit reports. Most of her debt I cannot even locate to make payments, if we could even afford them. And so the interest has increased her debt from beyond reach when we met to “We better win the lottery” because our combined income can barely keep up with the current bills.

    I have seen so many bankruptcy and credit consolidation companies out there that say they can help, but the one’s I have spoken with want a retainer, which we obviously can’t afford, just for a consultation. We live South of Tacoma, Washington in the rural areas of Pierce County . If anyone out there has been in debt and found a way out without being scammed, I could really use any advice or resources you might have. I just need something to get me started that doesn’t end up with someone telling me they will help me as soon as I swipe my credit card. Its so hard to find the good guys. I assume its because they don’t overbill, which leaves them with a very small advertising budget.

    I really hope someone reads this and has some ideas for me. For a financially responsible couple who is never late on a single payment, and would have an otherwise perfect credit score for the last four years if it weren’t for these old accounts, I am astonished at how much damage only a few thousand dollars of unpaid debt can do.

    I know this was a lengthy submission, but I want anyone who reads it to understand my frustration. I am looking anywhere I can for proper guidance on what to do. If anything, I hope this is at least a reminder to any of you out there who think that missing payments or ignoring the bill on anything you owe, let it be your first $500.00 max credit card or even a small remaining balance of 12.97 left on your old cell phone bill when you decided to change providers, will come back to haunt you in such a horrible way. The interest just keeps piling on and piling on while they report missed payment after missed payment to the credit bureaus until they just sell your debt to a collection agency. That horrible mark that tells any lender that you’re a liability no matter how well your intentions are now. Missed payments for a year, sent to collections, sold to another collections agency, then another. We wanted to buy a house right before or right after we got married. The wedding date is set. At least we have that. But my hard work to maintain and build my credit score won’t help. She makes more than me and they won’t loan me enough for a house based on my income alone. But you throw in her credit score when we add her income and we are automatically disqualified. Crushed hopes and dreams, all from ignoring your responsibilities towards those who first legally allowed you to borrow from them.

    Thank you if you took the time to read this. I will be eternally grateful if, just this once, anyone can give me a valid lead on company or group that really works to help those in debt and not just Credit Kings serving up McBankruptcies (impersonal bankruptcy lawyers giving out “teaser” advice baiting you into impulsively retaining services that may lead to a decision that isn’t your best option). There!

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