To most people, bankruptcy is a four-letter word. But when all else fails, declaring bankruptcy can be an honest and time-tested legal maneuver to save your house from foreclosure.
If nothing else, filing for bankruptcy protection will buy you some breathing room, which is particularly important in "non-judicial" states where the clock on foreclosure starts as soon as your lender posts a notice that it intends to accelerate your note.
In "judicial" states like California, the process of repossessing a house can take as much as six months, "so you can really see it coming," said Reed Allmand, partner at Allmand & Lee and author of "The Truth About Bankruptcy." But in Texas, a non-judicial state, the clock runs out in 30 days. So "once you are notified," the Dallas attorney said, "it's very difficult to negotiate a deal with your lender because there is not enough time."
The act of filing for bankruptcy results in an automatic stay, meaning your creditors must stop all foreclosure proceedings and debt-collection activities. As a result, Allmand said, the power position shifts from them to you, however briefly that might be.
But whether to file for bankruptcy can no longer be a spur-of-the-moment decision. Under a change in the law that went into effect in October 2005, before you can file you are required to go through credit counseling from a nonprofit agency approved by the Justice Department's U.S. Trustee Program. A state-by-state list of approved agencies can be found at www.usdoj.gov/ust/ eo/bapcpa/ccde/index.htm.
The session includes an evaluation of your financial situation, a discussion of alternatives and a budget plan "to help put you on a more solid financial footing no matter what you decide to do," said Stephanie Osterland, credit counselor at GreenPath Debt Solutions in Farmington Hills, Mich.
Counselors are permitted to charge a fee of about $50. But the fee will be waived if you cannot afford it. The session can take place in person, on the phone or online, and should run no more than 90 minutes. Once it is finished, you will receive a certificate of completion.
Assuming you have exhausted all other options, here's a rudimentary discussion of what you need to know about filing for bankruptcy, which is intended to give a fresh start to people who cannot pay their bills. Nothing that follows should be construed as legal advice. Anyone considering bankruptcy should consult with an attorney.
Under the law, there are two types of bankruptcies that apply to individuals, Chapter 7 and Chapter 13. A Chapter 7 proceeding involves the absolute liquidation of a debtor's property to pay off unsecured debt. With Chapter 13, on the other hand, you set up intermittent payment plans with creditors to pay off some or all of what you owe.
If you earn less than the median income for your state, you can file under Chapter 7, which will allow you to shelter certain assets such as automobiles necessary to get to work, work tools and possibly even your house, depending on the law in your state. All other assets must be sold, and the proceeds will be used to pay your debts. Even if that ends up being less than what you owe, most of your remaining debts will be canceled.
If you earn more than the median and can afford to pay back at least $100 a month based on your income and "reasonable expenses" -- as determined by the Internal Revenue Service, not your budget -- you'll probably have to file under Chapter 13. This will give you a three- to five-year window to repay your debts.
You can keep more property under Chapter 13, but the plan is more difficult to complete. The American Bar Assn. says 2 of every 3 households that file under Chapter 13 don't complete the workout. If that happens, everything is liquidated.
A Chapter 7 liquidation is typically the choice for people with few assets, little income and loads of debt. If you can wipe out enough debt to be able to once again afford your mortgage payments, perhaps you will be able to save your house.
Chapter 7 may also be the best option if you are simply ready to throw in the towel on your house, especially if the lender can hit you with a deficiency judgment for the difference between what you owe and what the house is sold for.
Under a Chapter 13 reorganization, you are required to file a repayment plan showing how you will pay off your debts over the next three to five years. As long as you follow the repayment plan, creditors are prohibited from harassing you and you can keep property subject to security interests, such as your house and car.
Chapter 13 is usually the best choice if you are facing some immediate creditor action -- read: foreclosure -- and you have the income to catch up on what you owe if given enough time. The payments required under the repayment plan will be based on what is owed on the original debt plus whatever extra is required to get caught up on the amount on which you have fallen behind.
It must be mentioned that often it is possible to work out a similar repayment plan directly with your creditors, perhaps with the help of a nonprofit credit-counseling agency, without having to go to the expense of filing for bankruptcy.
One important problem is that bankruptcy destroys your credit standing. But so does foreclosure. So the real question isn't whether you want to ruin your credit, but rather which might do worse damage.
According to Craig Watts, public affairs director at FICO, the company that created the leading credit scoring formula, bankruptcy weighs more heavily because it typically involves more than one account, whereas foreclosure usually involves just your mortgage.
Although both a bankruptcy and foreclosure will remain on your credit report for seven years (10 years for a Chapter 7 bankruptcy), your score will begin to recover from either form of delinquency after a couple of years if you keep your credit clean. And as the delinquency continues to age, it will have less and less of an effect.
Distributed by United Feature Syndicate.