Photo (cc) by n0nick
In doing research for my recent book, Life or Debt 2010, I explored virtually every way to deal with debt, from the do-it-yourself method most would prefer to more extreme methods like credit counseling and debt settlement. This story is about the nuclear bomb of debt destruction: bankruptcy.
When I produced the news story you’re about to see, I was just looking for the down-and-dirty facts from some lawyer about who should file bankruptcy and why. What I got was a heartbreaking, personal story from just one of the 1.4 million Americans who filed bankruptcy last year.
Meet me on the other side and we’ll go into more detail about what bankruptcy is about and how it compares to other ways of dealing with a debt dilemma.
So bankruptcy is the ultimate way of dealing with debt, because rather than paying it back, it’s often wiped out, or at least partially so. But as I implied above, it’s not the only way out.
You can try to repay your debts yourself. You can try to repay them in full on better terms by going to a credit counselor. (Here’s a recent story I just did explaining credit counseling.) You can try to satisfy specific debts by paying less than you owe: here’s a recent story I did on debt settlement. Or you can try to take out a new loan to pay off your old ones in process known as debt consolidation.
When is bankruptcy the right choice? That’s going to depend on lots of factors, but ultimately you file bankruptcy because there’s no other way out. For example, in Ron’s case, his monthly payments were higher than his monthly retirement income. He literally had no other option.
But before you even contemplate bankruptcy, understand it. For individuals (as opposed to corporations) there are two types: Chapter 7, which wipes out all your debts, and Chapter 13, where you’ll be required to pay some of your debts back over time.
Which you’ll be eligible to file depends on how deeply in debt you are and your ability to pay, as well as other factors. But even a Chapter 7 won’t rid you of all your debts. You can’t ditch student loans (except in rare cases,) IRS liens (unless you successfully file a tax bankruptcy) child support or alimony. You also can’t use Chapter 7 to discharge debts you incurred through fraud. And you won’t rid yourself of your mortgage either.
It will probably come as no surprise that bankruptcy will also cost you big-time when it comes to your credit score. According to Fair Isaac (creator of the most popular credit scoring model) you’ll lose from 130-240 points out of a possible 850. That’s enough to turn even a perfect score into a sub-prime one. (Here’s a story I did about three ways to improve your credit score.)
Is there credit after bankruptcy? Yes, if you can afford it. There are people who will sell you a car on credit or give you a credit card, but expect to pay exceedingly high rates of interest, since you’ll be a high-risk borrower.
Most credit infractions disappear from your credit history after seven years: a bankruptcy will remain for ten. But a bankruptcy won’t leave you living in the streets. Depending on the state where you file, you might still end up with some home equity, a car and furnishings.
The cost of bankruptcy filing varies, but expect to pay at least $1,500. (Here’s three tips to lower lawyer bills.)
Does all this sound like I’m discouraging you from filing bankruptcy? Not if you’re like Ron.
Bankruptcy is by far the most serious way to deal with debt: you’re hiring a lawyer and going to court. It’s also the method that will cost you the most in time, money and credit repercussions. So it’s certainly a measure of last resort.
But if that’s what you need to do, the mistake isn’t doing it, it’s not doing it soon enough.
Because my news story was so short, you didn’t get to hear much from Ron, the guy who filed bankruptcy. But one thing I’ll never forget from that interview was the relief in his face as he described what it was like to finally put aside his pride and find help. For months before he walked into that lawyer’s door, he’d been verbally abused by creditors, and frozen like a deer in the headlights by shame. He admitted to me that he’d even felt suicidal.
When you’re in major trouble, whether it’s legal, health or financial, hesitation simply causes wasted stress, time and money. Before he got help, Ron wasted all three trying to stay ahead of bills he had no hope of ultimately repaying. Especially since rather than helping him, his lenders chose instead to make his situation untenable by jacking up his rates and fees.
So if you think you might need to enlist this most extreme debt-destroying measure, leave your embarrassment at home and talk to a lawyer or credit counselor sooner rather than later: they can give you advice on your options and if bankruptcy is the right one, they can help with a strategy to maximize what you keep and minimize what you lose.
It may not be your proudest moment, but at least you can take comfort from the fact that you’ll be in the company of millions.