If You’re Tempted to File for Bankruptcy . . .
After a brief decline, personal bankruptcy filings are on the rise again. Statistics show 832,415 petitions for personal bankruptcy protection were filed in the 12 months ended September 1995--the most recent period for which data are available--compared with 783,372 for the same period in 1994.
With consumer installment debt hitting all-time highs, it’s little surprise, says Barbara O’Neill, a certified financial planner and professor of family economics at Rutgers University in New Brunswick, N.J.
For someone who is deeply in debt, bankruptcy can seem like a magic wand that can wipe out many debts, protect you from collection agencies and forestall eviction.
However, there are numerous disadvantages to filing for bankruptcy protection. It ruins your credit; it can hinder your ability to get a job or buy an insurance policy; it can wipe out your savings; and, in some cases, it can cause you to lose all control of your financial life.
Consider the case of Larry L., a California real estate agent who had made a fortune in developing rental properties during the 1970s and ‘80s. When he became temporarily short of cash, an attorney suggested that he “reorganize” his affairs under bankruptcy protection. He did. It was the biggest mistake he’s ever made, he says.
Thanks to a series of procedural and technical mistakes Larry and his attorney made, a judge ordered that Larry’s reorganization be converted into a liquidation. Five years later, Larry’s credit was still ruined; his property was gone; and he’d paid an astounding $1 million in legal fees on what was once a $7-million estate.
“We never should have filed bankruptcy,” the 63-year old real estate agent says now. “At this stage in my life, I thought we would have had something and be able to retire. But I’ll have to work for at least another 10 years. My wife and I lost everything we had built up.”
Bankruptcy just for convenience is unwise, says Robin Leonard, a Berkeley-based lawyer and author of “How to File for Bankruptcy.”
Most people opt for bankruptcy only because they are threatened with eviction or foreclosure or liens that hinder their ability to buy and sell property. Many are being harassed on a daily basis by creditors and collection agencies.
A bankruptcy filing does legally bar creditors from calling you about your debts, it stops numerous legal proceedings and it can forestall eviction. However, largely because of the long-term scars it leaves on your credit report, it may not always be the best answer, bankruptcy experts say.
“Bankruptcy should be considered a last resort on a continuum of options that you should explore,” O’Neill says.
What are the other options?
* Consolidate debts. If your debts are on a dozen high-interest-rate credit cards, you might benefit from consolidating these debts into a single loan--or even from putting them all on a single lower-rate credit card. Those who have homes with plenty of equity might consider paying the debts off with a home equity loan. Consolidating this way lets you reduce your interest rate and lower what you’re paying monthly on what you owe. And, in the case of a home equity loan, you may be able to deduct the interest from your income taxes.
However, O’Neill cautions, those who take this course of action must be careful and disciplined. If you consolidate your bills and then continue to overspend, you’ll put yourself on a collision course with either home foreclosure or bankruptcy.
Pay close attention to the interest rate on your consolidation loan--there’s little point in consolidating unless you can get a lower rate--and the security you’re offering. Remember that a home equity loan puts your house at risk.
* Negotiate independently. If you lose a job or suffer some other unexpected and temporary financial reversal, you should immediately contact your lenders and explain the situation, O’Neill says. In many cases, lenders will be willing to work with you, agreeing to a temporary payment hiatus, interest rate relief or by stretching out your payments. When credit problems are likely to be short-term, this option can save your credit rating and prove beneficial to creditors as well, because they don’t have to write off any of the debts.
* Get help negotiating. If you’re in trouble because you’ve simply spent more than you’ve earned over a long period of time, you’re likely to need help reining in your budget and in negotiating with creditors. Call your nearest Consumer Credit Counseling Service and set up an appointment. CCCS is a nonprofit organization that helps the overextended reevaluate or formulate budgets and establish workable payment plans with creditors. Generally speaking, however, O’Neill says, CCCS can only help you negotiate with creditors if you can realistically expect to pay off the bulk of your debts over a span of three to five years.
Those who can’t consolidate their debts and have no hope of paying off creditors within that period of time may have no better option than to file for bankruptcy.
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Facts About Bankruptcy
* Chapter 7 bankruptcy is for those whose debts far exceed their assets and ability to pay. It involves selling all your “nonexempt” assets and using the proceeds to pay creditors. This process is fairly swift. And once it is complete, most unsecured debts are erased regardless of whether creditors received 10 cents or 100 cents on the dollar.
* Chapter 13 is for those who can and will pay off all or a portion of their debts in three to five years. It allows you to keep your property and use your income to pay off certain debts according to a timeline set up by you and the court. This type of bankruptcy can forestall a foreclosure and stop interest from accruing on your debts--even if the debt is owed to the Internal Revenue Service. But it’s less frequently used because it’s more complicated and costly, and people who are able to pay off most of their debts over time may be able to avoid bankruptcy altogether by working out payment plans with their creditors.
* What you can keep. Even in a Chapter 7 bankruptcy, you get to keep some of your income and some assets. The things you legally can keep are called “exempt” assets.
Generally, you retain all or a portion of your personal property, such as clothing and furniture; Social Security and public assistance payments; all or a portion of your pension; and a minimum amount of equity in a car and/or in your personal residence. If you have unusually expensive personal effects--a $10,000 necklace or valuable artwork, for example--these items are usually not exempt and may have to be sold to satisfy creditors. California allows able-bodied individuals to keep $50,000 in home equity.
* Nonerasable debts. Most debts owed to the federal government--such as student aid loans and back taxes--are not dischargeable. You can’t erase spousal or child support or debts that you agreed to pay in lieu of it. Dues and assessments owed to a condominium or cooperative association are not dischargeable in bankruptcy, nor are criminal fines. In addition, if you buy luxury items or take cash advances against a credit card within three months of a bankruptcy, these debts generally cannot be discharged either, says Robin Leonard, author of “How to File for Bankruptcy.”
* Loss of control. With a Chapter 13, you retain a modicum of control over your financial life during bankruptcy, but if you misrepresent conditions to the court, the judge may hand all control to a trustee. If you break the rules, there can be serious repercussions.
* Scars. Bankruptcies remain on your credit record for a decade--longer than the seven years for most credit problems. And even after the bankruptcy is officially “erased,” if you apply for a high-paying job or attempt to take out a large insurance policy, the prospective insurer or employer can see the bankruptcy at any time, says financial planner and economics professor Barbara O’Neill, and neither must inform you that the bankruptcy was a factor in deciding against you.
Kathy M. Kristof welcomes your comments and suggestions for columns but regrets that she cannot respond individually to letters and phone calls. Send messages to kristof@news.latimes.com on the Internet.
