As more and more Americans fall victim to rising bills and a slowing economy, a good number of ordinary citizens have been forced to investigate bankruptcy as a final solution to mounting debt-loads. Nearly two million of us went bankrupt last year and the number continues to climb. For consumers who’ve never before fallen behind in their payments, too many simply lose hope and, after the first call from a collection agency, blindly reach out for bankruptcy protection without learning much about the program. In reality, modern bankruptcies aren’t nearly as easy as people have been led to believe, and the consequence for credit report and families’ financial stability can often be disastrous. Furthermore, several alternatives to bankruptcy have emerged in recent years that, for the average borrowers, could make a good deal more sense. Bankruptcy’s certainly more widely discussed and may seem more convenient, but the repercussions of bankruptcy can be truly severe and, for a wide swath of borrowers, the program may not even be available. In this article, we hope to explain the bankruptcy process and illuminate some of the lesser-known pit-falls. For the genuinely desperate, bankruptcy protection may indeed be their last option, but, for the majority of consumers, it’s something to be avoided at all costs even for the few that qualify.
Some form of governmentally-sanctioned bankruptcy protection has been in existence for hundreds of years. Of course, until recently, the drawbacks were rather more severe – debtor’s prisons, thumbs branded with ‘T’ for thief, ears nailed to pillories (and, in Greek and Roman times, slavery). The term itself comes from the Italian banca rotta or broken bench and neatly signifies the often humiliating stigma of helpless debt-loads. It wasn’t until the late nineteenth century that the United States government first implemented legislation meant to help the borrower who, by means not of his control, had fallen behind on payments, and the first laws instituting bankruptcy as we now know it only came into being just over a hundred years ago.
Essentially, bankruptcy protection is intended to assist individuals and corporations in liquidating or re-structuring their debts under the oversight of court-mandated trustees. A number of different statutes and accompanying federal bankruptcy divisions have been erected over the years concerning various types of debtors. Chapter 11, the third most common bankruptcy, is intended for businesses to re-organize while maintaining control of their enterprise (and, perhaps, agreeing to repay funds owed through future earnings). Chapter 9, famously used by Orange County several years ago, extends protection to municipalities and governmental utilities. Chapter 12 is solely intended for family farms and fishermen while Chapter 15 is meant for foreign corporations doing business on American soil. In this article, we’ll just take a look at the bankruptcy options overwhelmingly used by individual consumers: Chapter 7 and Chapter 13.
Chapter 7 protection’s what most people think of when they hear the term bankruptcy. Under certain circumstances, Chapter 7 protection will eliminate most unsecured (leaving aside those loans pegged upon collateral that could be repossessed or foreclosed upon; vehicles and homes, most commonly) debts. Child and spousal support, recent tax liens, fines or penalties assessed from criminal actions, or most student loans would not be dischargeable under current law. 2005 legislation made it considerably more difficult for average borrowers to qualify for Chapter 7 protection. Applicants are now subjected to the so-called ‘means test’ which compares all filers’ incomes and living expenses to an arbitrarily defined state average in order to determine their degree of need, and, should income be too high or expenses too low, the court would instead switch those seeking to declare toward Chapter 13 bankruptcy.
A Chapter 13 bankruptcy isn’t that different from the corporate re-organization plan, really, except it’s dramatically harder for families to follow strict and governmentally-created budgets. Essentially, a trustee will determine what each filer’s income should be (based upon one past stretch and ignoring changes of employment or seasonally-based work) and what expenses are needed (often forcing relocation and pulling children from private schools, for example). Using the same criteria as Chapter 7, up to fifty percent of that debt-load may be eliminated, but the remainder’s lumped together in a payment plan with monthly minimums often higher than the borrower was currently paying (or, as often the case, not paying) with severe repercussions should even a single month’s payment not arrive.
In both cases, filers can expect their unsecured debts to be lessened if not entirely liquidated, but there are more serious disadvantages that aren’t mentioned as often. First of all, absolutely nothing’s as damaging to the borrower’s credit report or FICO score . A bankruptcy will remain on a credit report for up to a decade and in court documents for twenty years. Any future financial transactions will be severely curtailed. Continuing education, home loans (even rentals), even many potential employment opportunities may be near impossible with a bankruptcy on one’s record. Security clearances or personal insurance will often be denied. And, if it needs mentioning, there’s an understandable social stigma surrounding bankruptcy. It’s considered the final option for a very good reason.
Beyond the ruinous effects upon credit and eventual life plans, though, there are the practical drawbacks immediately discernable. With Chapter 7 protection, the newly bankrupt have always faced the threat of property being seized by the government and auctioned for sale with proceeds going to repay creditors, but, in the past, such property was valued purely be re-sale amounts. Under the 2005 legislation, however, all property’s to be valued with regard to replacement costs. Obviously, this makes any total much higher and greatly increases the chance all possessions (including household goods, family heirlooms, toy and hobby equipment, even clothes) could wind up on the auction block. Would elimination of debts be worth the elimination of a life’s collected possessions?
With Chapter 13 bankruptcy, on the other hand, there’s the necessity of submitting the next five years’ existence to federal guidelines and the whims of a court-appointed trustee. Everything depends upon state averages and an arbitrarily-set list of day-to-day needs. Should your child require special schooling or your line of work require a certain type of vehicle (or, simply, should you live in an area of the state with considerably higher rents), none of this would matter. Remember: these new statues were implemented solely to make it less advantageous for the average consumer to declare bankruptcy. And few things could be less desirable than a life lived under IRS statistical dominion.
Leaving aside the popular myth of bankruptcy offering a fresh start (even though, as we’ve shown, most debts aren’t even dischargeable under the current legislation), black-marks against credit reports last up to a decade. There’s a common misconception that, in Chapter 13 bankruptcies, debtors can choose certain credit lines to maintain. Upon threat of imprisonment, though, every single account must be included within the bankruptcy. .If borrowers are somehow able to manage credit card companies or mortgage lenders to again trust them, the interest rates would be sky-high. The very procedure of filing for bankruptcy, even with the well-paid assistance of bankruptcy attorneys – whose importance, as laws grow more complex, cannot be underestimated – has become an incredibly laborious undertaking; almost a second job even before considering the mandated (and borrower funded) debt management classes each filer must complete before discharge.
As unemployment worsens, credit cards become more available to all sorts of borrowers, and (a rarely-discussed but important reason for the rapid increase of filings) the rate of divorce spirals, it’s easy to see why so many Americans still feel the need to declare bankruptcy, but other alternatives do exist. The debt settlement programs combine much of what’s enticing about bankruptcy protection with safeguards against garnished wages or loss of property – and relatively minor credit repercussions compared to the FICO score carnage Chapters 7 and 13 may inflict. Essentially, negotiation professionals talk to each creditor on behalf of the debtor and, in exchange for an easily navigable monthly installment plan, attempt to reduce the overall debt-load toward something more manageable. The creditors themselves, reasonably, worry that persecuted borrowers may attempt a Chapter 7 as a last-ditch solution, and, however unlikely total liquidation of debt this current climate, they still would prefer not to risk the chance. Furthermore, the legal costs too often outweigh the debts they actually collect – and, once accounts go to collection agencies, those rare funds tracked down amount to pennies on the dollar.
For all concerned, it’s a better idea to work out some sort of mutually-beneficial arrangement. Depending on each borrower’s specific financial portfolio or debt-load, the debt settlement professional lowers both payments and balance in amounts exceeding forty percent. Credit reports take a hit, of course, but the effect upon FICO scores is nowhere near as extreme as what happens after a bankruptcy. Borrowers that have successfully followed the debt settlement program may regain top credit scores in only a matter of years. Beyond which, there’s no threat of governmentally-sanctioned budgeting or seized possession – and existing bill collectors must contact the borrowers’ debt settlement officer when attempting to collect monies owed.
Obviously, as with any serious financial issue, one should always consult professionals in the industry before making a final decision. There are more and more debt settlement counselors every day, as the economy continues to worsen and ordinary borrowers begin to understand (especially in light of recent legislative restrictions) the different alternatives available, and it only takes a moment for the professional to analyze a debtor’s credit report and offer advice as to the best option. Certainly, there’s a wide collective of Americans with debts no honest man could pay, and bankruptcy protection’s still needed to help the truly unfortunate. For most of us, though, the negative connotations of bankruptcy, particularly now, far outweigh the chance of debt liquidation. It’s best to investigate all possible scenarios, but the days of guilt-free debt liquidation are over.
