When Should You File for Bankruptcy?
Nobody wants to file for bankruptcy, but in certain situations, bankruptcy provides the best solution for your financial situation. This page provides helpful guidance for determining if bankruptcy is right for you.
Examining Your Financial Situation
Many people facing bankruptcy have lost control over their finances. In many cases, the situation is so bad that keeping track of bills and expenses no longer matters. There is simply not enough money to pay everyone.
If you are contemplating bankruptcy, you should examine your current financial situation.
Your finances can be broken down into four categories:
- Assets – everything you own and the liquidation value of each item;
- Debts – all of your secured debts (house, car, etc.) and unsecured debts (credit cards, medical bills, etc.)
- Income – your household’s monthly income (gross and net); and
- Expenses – your household monthly expenses.
Once you review everything, you can determine whether consumer bankruptcy makes sense.
For instance, if you have steady income and a small amount of debt, you may be able to temporarily decrease your expenses or increase your income with part-time work to pay off your debt. On the other hand, if you have a large amount of debt, few assets, and not enough income, bankruptcy may be the better option. Be honest with your assessment. If you truly cannot catch up, you need to address the problem.
What’s the Status of Your Debts?
Debts go through various stages when you fall behind. Bankruptcy becomes a good option as you get to the later stages. You should determine the status of your debts when contemplating a bankruptcy filing.
- Late payment stage. If you are struggling with a debt and fall behind, it will be listed as late in the creditor’s system. At this early stage, you can usually negotiate with the creditor to defer a payment, waive the late fee, and catch up. If you catch up, you can avoid bankruptcy.
- Default stage. Once your account is in default due to several missed payments, the lender is less willing to negotiate a resolution. After default, the creditor may “re-age” the account and restore the original terms, but usually only after a substantial payment and proof of hardship. This re-aging generally does not repair the damage to your credit report, but it does bring the account current. In most instances, the lender will refuse to work with you and send the account to collections.
- Collection stage. If you are significantly behind, the lender will typically forward your account to collections. At this stage, the creditor has washed its hands of the debt. The collection agency is interested in collecting as much as it can — as fast as it can. Your entire debt is now due and accelerated. The collection company will typically request monthly payments (which continue to incur interest at the default rate) that will pay the debt in 18 months or less, or satisfaction of the debt with one or more lump sum payments. If you can pay all at once, the collection agency may reduce the debt to 80-90% of the deficient amount. Many of our clients seek a bankruptcy consultation at this stage, as there are few options available to resolve the debt.
- Bad Debt Stage. After the collection stage, your account will be listed as “bad debt” with the credit bureaus. In this stage, your debt is considered uncollectible, and the creditor may take a tax credit for the loss. If they take the loss, you could end up with tax liability on the forgiven debt. The creditor may also sell your debt to a debt company who purchases the debt for pennies on the dollar. Unfortunately, you are legally obligated to the debt company for the entire debt, including all the penalties, interest, legal fees, etc., which can be significantly higher than the original debt amount.
- Litigation Stage. The final stage of a deficient debt is litigation. It is extremely difficult to negotiate any payment terms at this stage since a lawsuit has already been filed and lawyers are involved. Once a judgment has been rendered against you, the creditor’s attorney can seize assets, freeze bank accounts, and garnish your wages. We file numerous bankruptcies at this stage, as the collection efforts are extremely aggressive at this point.
Debt Settlement: Creating More Problems Than Solutions
You may be wondering if debt settlement is a good option. Unfortunately, debt settlement companies are notorious for defrauding consumers. The basic premise of the debt settlement company is to negotiate a lump-sum payment. Often this is accomplished through monthly payments to the debt settlement company “on account” until there are sufficient funds to negotiate a settlement amount (generally between 30-50% of the present amount owed). Licensed attorneys will sometimes negotiate settlements at better terms (20-40%), but the fee is greater.
Debt settlement is a tricky business and can take many months. The basic tactic is to wear down the debt company until they figure “something is better than nothing” and accept a pennies-on-the-dollar settlement from the debtor. During the settlement negotiation you may still receive harassing calls, and you may be sued (which occurs from creditors that do not choose to participate). Also, after the debt settles, you may receive an IRS Form 1099 to pay taxes on the “forgiven” debt. Your credit report will also take a significant hit, much like a bankruptcy filing.
Learn More About Your Options
Defaulting on your debts can have devastating effects on your life. In some cases, you can work with your creditors to resolve the debt and avoid bankruptcy. However, if your debt is considered “bad debt” or a lawsuit has been filed to collect the deficiency, it may be necessary to file bankruptcy and gain a fresh start.