Debt Diet Part III, Time to File Bankruptcy?
This post is a follow-up to Debt Diets Part I and Part II." Mary Reed and Gerri Detweiler are co-authors of "Debt Collection Answers: How to Use Debt Collection Laws to Protect Your Rights." They also answer debt questions at DebtCollectionAnswers.com
Bankruptcy is a painful choice and a complicated one. But if you’ve trimmed your spending to the bare bones and you’re still weighed down by too much debt, it may be time for the most drastic of our three debt diets.
The beauty of bankruptcy is that once you've filed, all attempts to collect your debts stop. That's why it's sometimes called "bankruptcy protection."
There are two types of bankruptcy: Chapter 7, liquidation, and Chapter 13, reorganization. A bankruptcy attorney can tell you which one may work for you.
Chapter 7, Liquidation: This option is typically best if you have a lot of unsecured debt (e.g. credit card and medical bills), and few assets.
Credit card and medical debt other kinds of unsecured debt are wiped out (discharged). But in return, the court may sell some of your assets—like your car—and give the money to creditors.
Remember that some types of debt—like student loans, unpaid income taxes, and child and spousal support—cannot be erased.
In Chapter 7, you get a choice about how to handle any secured debt you may owe, like your car loan and mortgage. You can:
- Formally agree to continue paying the debt.
- Buy the asset that secures the debt—i.e. pay off your car—assuming you and the lender can agree on its current value, and that you can pay for it with one lump sum.
- Return or surrender the asset to your lender so it can be sold and the cash applied toward what you owe.
You keep your assets in exchange for paying all or some of your debts, depending on the type, under a plan the court must approve. Once you’ve completed the plan—usually in 3 to 5 years—any remaining dischargeable debt is wiped out and your bankruptcy is over.
Filing for bankruptcy can be a huge relief if you’ve got a ton of debt, but it will leave scars: Your bankruptcy will be in the public record for years to come, and your credit history will take a big hit for up to ten years.
However, you can begin rebuilding your credit once your bankruptcy is filed, and you embrace better money habits.
If you need help deciding whether this is the right step for you, read When is Bankruptcy the Right Choice?
Resources
Find a federally-approved credit counseling agency. You must complete a consultation with one no less than 180 days before you file bankruptcy. To find an agency, go to http://www.uscourts.gov/bankruptcycourts/approvedagencies.html.
Find a board certified bankruptcy attorney. Locate one in your area at http://www.abcworld.org/search or at http://www.nacba.org.
Personal Account: Danielli Does the Math
As you may have guessed from my debut post, I'm not the best at setting goals. In fact, it has been hard to live up to my goal of... setting some goals.
To me, setting any kind of goal was always a double-edged sword. On the one hand, they're motivating. Nothing gets me more excited than dreaming about my future house, with bay windows and a treehouse out back for my 2.5 kids. On the other hand, goals are intimidating, serving as a reminder of how far behind I am and how much farther I need to go.
At that point, my optimism gets swallowed by how overwhelmed I feel. So I bail.
But not this time. I'm going to be more realistic. Sure, I can still think big. But I have to think small too—and I've been trying. To avoid setting myself up for failure, I've realized that I must aim for goals within my means. I want to pay off my debts ASAP, but the reality is that while my fiance is still looking for work, I am paying all our bills—and can just cover the minimums on my cards and student loans (he doesn't have debt, thankfully).
The first step last month was to take a critical look at my financial situation, and write down all my expenses. Then I had to assess the whole picture, to see what goals are realistic for me right now.
To see Danielli's budget breakdown, read below.
Monthly Take-Home Pay: $3,600
Regular Monthly Expenses (for me and my fiance):
- Rent: $1100
- Phones: $90
- Car Payment (mine): $336
- Insurance: $90
- Utilities: $150
- Credit Cards: $306
- Student Loans: $280
- Cable/Internet: $99
- Gym membership: $33
Variable Expenses:
- Groceries: $350
- Dog food and supplies: $125
- Gas: $40
- Prescriptions: $75
Upcoming Expenses: $200 (budgeted monthly and put into savings)
Total Spent per Month: $3,274
Remaining: $326!
The $326 was the good news I wasn't expecting. I'm not as broke as I thought!
Two months ago, I would have considered that $326 "free for all" money, and I would have spent it all on happy hour drinks, dinners out, weekend trips, clothes for my English Bulldog.
Those days are gone now. I'm a gal with goals (ahem).
I really want to get out of debt and save some money, so I'm going to put $100 extra toward my credit cards and $100 into savings each month. My goals seem pretty small and insignificant, but I have to start somewhere. And this, I think I can handle. I just have to keep reminding myself that these small moves add up. Even though I'm not making huge leaps, at least I'm still moving forward.
Thank you to my fellow DW readers for the comments and support you all offered on my last post. It was great hearing your personal stories, tips and advice. Let's continue to help and learn from each other. What are some of your goals? How do you plan on achieving them?
Debt Diet Part II: Is Debt Settlement for You?
This post is a follow up to "Debt Diet, Part I."
Gerri Detweiler and Mary Reed are co-authors of "Debt Collection Answers: How to Use Debt Collection Laws to Protect Your Rights." They also answer debt questions at DebtCollectionAnswers.com.
Debt settlement is the “liposuction” version of a debt diet, eliminating the excess debt that’s weighing you down.
If you can’t pay your credit card debt—and if credit counseling fails because the payments are too high—creditors may let you pay less.
But negotiating debt away requires moxie and muscle.
- You must stop paying your credit cards before creditors will even discuss a settlement. (They won’t make a deal if you’re paying on time or making the minimum.)
- Once you stop paying your bills, you must save the cash to build a war chest for settlements. Most settlements are paid in one lump sum.
Or, you can make the first move, once you've fallen a few months behind, by offering to pay what you can. (Caution: If you strike any deals, get them in writing before you pay a penny!)
PROS: When settlement works, it lets you zero out your balances much faster than if you tried to pay off everything on your own.
CONS: Your credit rating will tank, and you may owe taxes on the amount forgiven by your creditors. (If you are insolvent by IRS standards, you may not have to pay taxes on the forgiven debt, but ask a tax accountant first.) Also understand that there is a risk that some creditors won’t settle, and may sue.
If the risks seem worth the possibility of gaining debt freedom, this could be the route for you.
Listen to an interview with debt settlement expert, Mary Reed, here.
Personal Account: Danielli, Part I
She has a good income, heinous debt, she's planning her wedding and—oops!—her fiancé just quit his job. DW reader Danielli wants off the financial rollercoaster, but how? Here the first installment in her new blog for us.
My name is Danielli. I'm 29 years old, living in Florida--and on paper I look great.
I have a master's degree, a full-time job and an above average yearly salary (about $60,000). But underneath the "You go, girl!" exterior lies a bumbling financial idiot.
As I write this, I only have $30 in my savings account; I'm late on three of my monthly bills and I have over $60,000 in debt (yes, that would be the same as my yearly income).
I suppose it could be worse, but I'm having a hell of a time trying to make it better. I'm bipolar when it comes to money management--great one month, absolutely pathetic the next.
I want off the roller coaster.
I'm not looking to be a millionaire--I just want to have the financial freedom and stability to pursue my goals: Start my own business, have kids, have the ability to feed those kids something other than ramen noodles….
Debt Diet, Part I
Gerri Detweiler and Mary Reed are co-authors of "Debt Collection Answers: How to Use Debt Collection Laws to Protect Your Rights." They also answer debt questions at DebtCollectionAnswers.com. Just as the same old diet advice (eat less! exercise more!) can make you want to scream, the standard advice about ditching debt (spend less! double your payments!) can be infuriating, especially if you’re up against a mountain of debt with interest rates that match the calories in a bowl of Ben & Jerry's.
If you want to dig out, but penny pinching isn't enough, you may require an extreme debt diet. Here, the first of three debt diet articles to weigh, if you're deep in the hole. Parts II and III coming soon.
Credit Counseling. This is the packaged meal plan version of a debt diet. (Think Jenny Craig for your budget.) You seek help from a credit counseling agency (resources below), cut up your cards and make one monthly payment to the agency, which in turn pays creditors. Most creditors will reduce your interest rates, which means you pay less in the end.
The big advantage? Zero temptation. With no open accounts, you won’t be able to use a card “just this once.” That's also the challenge. If credit cards have been your back-up plan, you have to survive without your plastic safety net. If you take the credit counseling route, you need to overhaul your spending habits, revise lifestyle expectations and live on what you actually earn. No Visa supplements!
More good news: Most people with overwhelming debt have crummy credit already. Your credit rating will take an additional hit when your accounts close—but not because you're in counseling. Once you are making regular payments, on time, watch it bounce back.
- To find a credit counselor: www.nfcc.org and to www.aiccca.org
- Advice for those in a debt management plan on FTV.gov
- Fourteen questions to ask a credit counselor
Got a question or want to share? Leave a comment below.
Ways to Avoid Foreclosure
Foreclosure rates are at an all-time high: nearly a million homeowners faced the big F in the third quarter of 2009 alone. Millions more are on the brink, because of epic job losses and plunging home values.
If you're finding it hard to meet your mortgage, there are preventive steps you can take, but you must act now to get the snowball rolling.
- Get counseling. A recent study by the Urban Institute found that at-risk homeowners who got counseling were 60% more likely to avoid foreclosure—largely because counseling helped them get loan modifications. Call the HOPE hotline: 888-995-HOPE (4673) www.hopenow.com or go to the HUD website's resource page.
- Consider a short sale. In a short sale, your lender agrees to accept less money than what you owe. The trick is getting your lender to agree to this arrangement—and then finding a buyer willing to do a short sale purchase, which can take months.
When Bankruptcy is the Right Choice
Bankruptcy still has that whiff of shame and failure, but in some cases it's the best possible move under the circumstances. The question is: Which circumstances signal that declaring bankruptcy could be the smartest move for you? Personal bankruptcy filings in October reached a new high, according to the American Bankruptcy Institute, with a 28% increase compared to October 2008.
People often wait too long to file, putting themselves at greater risk than necessary, says Elizabeth Warren, Harvard Law professor and leading bankruptcy researcher (and lately the outspoken head of TARP, the Troubled Asset Relief Program). Bankruptcy is a safety net, designed to clear some or all of your debts while preserving some assets and savings so you can move forward. Ideally, say experts, it's better to file sooner, before you deplete the resources that could help you get back on solid ground.
You may want to consider bankruptcy if:
- ...it would take you five or more years to pay off your debts.
- ...if you're about to take out a home equity loan to get out of debt (and it's not the first time).
- ...if you're about to cash out your retirement fund as a bailout.
- ...if you've cut back every possible expense and you still can't keep up with even the minimum payments on what you owe.
Filing Chapter 7, the most common form of bankruptcy, will erase most consumer debt (credit cards, medical bills), but not student loans or taxes. You may give up some property or home equity as repayment.
Filing Chapter 13 is considered a "reorganization" of your debts. You keep most assets but agree to repay some of your debt over three to five years.
Will bankruptcy ruin your credit rating? For a while, yes, although many people who enter bankruptcy have already wrecked their credit, and filing actually gives them a shot at rebuilding their lives more quickly.
The key thing to remember, DW devotees, is that bankruptcy is just a temporary solution to a much bigger problem (see what I wrote about it in the New York Times last January). Ultimately it's up to you to apply the great advice you get here and elsewhere, to understand how and why you spend and what you really want from your financial life.
A 401k No-No
Dear DailyWorth,
I recently heard that a co-worker used some of his 401k money to pay off a credit card. I am 27, and have $11,000 in credit card debt. Should I do the same?
~ Katie M
Dear Katie,
GACK! NO. And here's why: It will cost you a fortune.
Money you withdraw from your 401k before the age of 59 1/2 is called an early withdrawal, and the IRS doesn't like that. You would pay a 10% penalty, on top of owing state and federal taxes on that money.
(Remember: Your 401k contributions go in tax-free, but you owe taxes whenever you withdraw them.)
Depending on where you live, that means you could lose, say, 30% of your money or more; i.e. that $11,000 would get knocked down to $7,700—possibly less.
Bottom line, you would have to withdraw approximately $16,000 to net the $11,000 you'd need to pay off your card.
But wait, there's more!
Parties Too Pricey?
Dear DailyWorth, It seems like all of my friends are either getting married or having babies. While I love my friends, I can't afford all the parties and gifts that I'm expected to pay for! I am in debt and can't afford my own groceries let alone all of these celebrations. What should I do?
- Natalie, 28, Los Angeles
***
Dear Natalie,
The decade between 25 and 35 is fraught with friend expenses: Weddings and baby showers and new homes, oh my! Here's how to afford the high cost of other people's happiest moments.
Acknowledge the Pressure
It's normal to feel that you are supposed to splurge on a dear friend's wedding or baby shower. It's part of the tradition, right? Wrong.
I've checked with hip etiquette expert Anna Post, and while you should always send a congratulatory card, you're under no obligation to buy a gift or pay for an event that you can't afford. Really.
Be Honest
That said, you may need to be straight with your friends about your circumstances—and there are discreet ways to do that. In some cases, giving a modest gift speaks for itself. A good friend won't fault you for being cheap if you give a $30 wedding gift.
The trouble is when you're invited to a big event, like a weekend celebration, that requires a plane ticket, hotel room or some other big-ticket commitment. At that point, you have to figure out what you can afford, and gently explain it to your friend.
Will that feel uncomfortable? Will you hate missing some of the fun? You bet. But you have to pick your poison: Sadness in the name of financial sanity—or digging yourself deeper into the hole.