As Monday's deadline neared for the new law overhauling the nation’s bankruptcy code, Americans were filing for protection from creditors at a rate of 20,000 a day, more than eight times the number of people who file in an average week. Bankruptcy courts are expected to be quiet for a bit, but experts say it’s just the calm before the storm – rising interest rates, high energy prices and household debt, not to mention credit card companies raising their minimum monthly payment requirements, will impact a lot of people holding on financially by their fingertips.
Is bankruptcy the right tack for consumers facing a mountain of debt? That depends a lot on your situation.
"It definitely will be a lot harder to file under this new law,” said Alan Kopit, legal editor at Lawyers.com and a bankruptcy attorney based in Cleveland. "So it’s even more important not to file without a thorough vetting of the pros and cons of whether that makes good financial sense for you."
Experts agree that filing for bankruptcy should be the very last option to take, since its effects on your credit last longer than other debt-recovery methods.
“You will have essentially trashed your credit for the ten years,” says John Ulzheimer, vice president of the After Bankruptcy Foundation, a nonprofit organization that teaches people how to recover from bankruptcy. “Recovering is difficult because you have to establish your credit, and in the meantime you’ll be paying usury rates of 20 to 30 percent to creditors.”
But for those who think bankruptcy is a fresh start financially, Kopit advises considering what debts they want to cancel out. “If your debts are a result of childcare-support obligations or divorce alimony, filing bankruptcy won’t help you there because it doesn’t affect those debts but does affects your credit record,” he said.
Many taxes are not dischargable, and the same goes for credit card debt and student loans, which either are not covered or are made harder to cover by the new law.
If bankruptcy is not your intention, the next question to ask is whether you can manage your debts skillfully on your own, says Susan C. Keating, president and CEO of the National Foundation for Credit Counseling, which advises more than a million people annually in its 1,000 offices nationwide.
“If you have more than one or two debts, managing them is harder than you think and it may be time to get help from counseling,” she said. “The majority of clients we see who are in dire financial straits got there because of event-related situation like a job loss or an illness. The emotional component is so overwhelming that it makes managing debt more difficult to deal with.”
If you’re feeling financially in the hole, there are a few steps you can take to dig yourself out.
- Keep track of the paperwork. Regardless of whether one files or not, keeping track of bills, receipts and essential papers is key. Also keep a list of your creditors’ addresses; if you send notices to them asking to negotiate a new payment plan, they must be sent to the same address they use to send bills to you.
- Also keep track of your credit record. To get a good sense of what you owe, pull your credit report to see if there is old debt you forgot about. You are entitled to one free credit report from each of the three major credit agencies per year.
- Make a budget. The first thing credit counselors advise their clients to do is set aside time and look through all their bills. First, look at secured debts such as your home and your car. Then examine the essentials: power, phone, groceries, insurance, etc. Third, take out your credit card statements to see what you owe on each and the interest rate. Finally, look at the expendables items you like, but don't need: Cable, gym membership, dinners out, clothing. Now that you have an idea of what your monthly expenses really are, go through each category and look for ways to cut. The first two areas are essential and everything else is negotiable. Always pay the mortgage first and keep it current. Same with the car loan.
- Go on a cash diet. “Create a allowance system for yourself, says Gerri Detweiler, author of the "Ultimate Credit Handbook" and founder of DebtConsolidationRx.com. “From each check, take out a set amount in cash and agree in advance what that amount will be. It has to carry you to everything you have to do.
- Change credit-card companies. A lot of people carry very high interest rates on cards, but many issuers now offer low rates of three to four percent. Talk to your issuer and ask them to reconsider your interest rate. If they refuse, switch your balance to another issuer who will offer you a better rate.
- Sell assets. What to target: Things that have cash value, not sentimental value. Think antiques, old clothes or collectibles. Check the closets, garage and storage locker and find out what you can live without. EBay, garage sales and consignment shops can all be a source of cash.
- Don’t use your retirement assets to pay bills. One mistake people make to stave off bankruptcy is using funds that are shielded from creditors in bankruptcies, such as IRAs, pension funds and 401(k)s, says Detweiler “Many people have borrowed against their 401(k) or maxed out the equity in the home and have had to file for bankruptcy anyway, losing assets that would have given them a fresh start.” Start with employment income first before you start borrowing from your retirement nest egg.
- Negotiate with your credit lenders. You can do this on your own, but it’s best if you have only one or two debts to deal with. Creditors will be upset if you’re one to two months behind but once you reach four months, they know it’s serious,” says Deborah McNaughton, president of Professional Credit Counselors in Brea, Calif., and author of "The Get Out of Debt Kit". “You have to be the proactive one to negotiate a deal, so it’s better to call them first even if you’re one month behind. If it goes into two billing cycles, then it goes on your credit report.” First, you need to gauge the status of your account – is it nearing the limit, or has it been closed and turned over to collections? If you have an excellent credit score, they will be a little more flexible, but if it’s poor, they probably won’t let you go 90 days past due. If your account is open and you can afford to pay something, creditors can “re-age” the account by lowering the interest rate or payment or doing away with interest temporarily to give you enough time to get back on your feet. Whatever deal you work out, get all the terms, including what will be reported to the credit bureaus, in writing before you start paying.
- See a credit counselor. If you have enough money each month to pay some debts, go to a consumer credit counselor. "This is the best bet if you're current with your house and your car, and you're only dealing with credit-card debt, says Ulzheimer. Find a local affiliate of the National Foundation for Credit Counseling (www.nfcc.org) and get an appointment. Now that credit counseling is mandatory in the new bankruptcy law, the Department of Justice also provides a list of their certified credit counseling agencies (www.usdoj.gov/ust). Once you're there, trained credit counselors will help you look at your situation and draft a budget. They can also take the process a step further and negotiate a pay-back plan with your creditors. While a debt-management plan can have a negative impact on your credit, it’s better than bankruptcy.
- If all else fails, consult an attorney. If you do decide to file, speak with an attorney about your options. “You should never go into bankruptcy without consulting a bankruptcy attorney first to put a schedule of assets and debts together to see if filing makes sense,” says Kopit. Ask for a free consultation, and make sure you find one ready to serve your interests rather than just get a cut of the settlement. Useful sites for finding a lawyer are those for the National Association of Consumer Bankruptcy Attorneys. (http://www.nacba.org/) and your local Bar Association (www.abanet.org/legalservices/lris/directory.html) to find out whether any complaints have been lodged against the lawyer.