When money’s tight and the bills are piling up, you can feel hopeless. Clients tell me over and over how this situation makes them feel like their a failure, how their relationships are negatively impacted, and often how the stress begins to impact health.
Most feel that bankruptcy is a dirty word and should be avoided at all costs. While it’s true that bankruptcy should be approached with caution, it can be a very effective tool to get finances back on track in the face of fiscal crisis.
However, while many lawyers direct potential clients to leap into a bankruptcy as the only solution, it’s important to consider all options and, with the help of a good attorney, choose what road to recovery is the best for your circumstances. So, to keep things in perspective, let’s examine some alternative courses that may be a solution:
1. Set Up Alternative Payment Plans
This first option is basically what credit counselors do. You can contact creditors yourself, explain your financial hardship, and ask for relief. Keep in mind that some creditors are cooperative, to a point, and many are not. In general, an alternative payment plan can reduce monthly payments, but most creditors will require that you make up the difference in the future. Be careful to get alternate payment plan terms in writing and understand the in some cases you may be negatively amortizing your balance. In other words, the creditor may agree to accept a lower payment, but will still charge the full rate of interest to your account. This creates a situation where, even though you are making monthly payments, your balance grows each month, getting larger and larger.
Competent credit counselors can arrange alternative payment options whereby your accounts are consolidated into one payment, and from that monthly payments your individual accounts are paid based on the counseling agency’s contract terms. In some cases principal balances and interest amounts may be reduced. You generally will have to pay fees to the credit counselor to administer the plan.
Beware of unscrupulous credit counselors and law firms claiming to perform these services. In many cases, you pay fees up front to the counselor who does not pay anything to creditors, while your credit score hemorrhages. They may not even contact creditors until after those fees are paid in full, which in most of these arrangements, can take months because the fees are thousands of dollars.
In virtually all situations whether you are working with a reputable credit counselor or not, your credit will be negatively impacted because you are paying your accounts other than as agreed to in the original contract.
2. Offer In Compromise
This process involves negotiating a reduced balance that the creditor accepts as payment in full and “charges off” the unpaid portion of the account. Again, there are professionals that can represent you in these arrangements. As stated above, do your homework. Some are reputable and some are not. In general, for creditor to accept a reduced some, the account must already be in a past due status, meaning, your credit has already been negatively impacted. The typical amount that a creditor is willing to accept varies greatly depending upon the likelihood of collection on the debt. The longer the account is in default status, the more unlikely it is that it is collectible from the creditor’s perspective, thereby giving you a little more leverage in the negotiation. However, creditors will look at your income, including its reliability in terms of a future wage garnishment and your available assets subject to the enforcement of a judgment. Also, keep in mind that in any situation in which any part of a debt is charged off (other than in a bankruptcy case) the amount charged off becomes taxable income to you and will be reported to the IRS and California Franchise Tax Board. The amount will be treated as regular income and you must pay tax on the amount.
3. Do Nothing
In some situations, clients are considered to be “judgment proof.” This is a common terms lawyers use to describe someone who a creditor cannot collect from. Even if the creditor goes to court and wins a judgment against you, if you are judgment proof, there is no viable way for the judgment to be enforced, thus the creditor cannot collect. In short, this situation is akin to the phrase, “You can’t get blood from a turnip.” In some situations your income may be protected from garnishment and you have no assets that the law does not protect. If there is no reasonable likelihood that this situation will change, such as going to work in the future and created garnishable income, inheriting an asset, etc., then it may simply make sense to apologetically notify creditors that you cannot pay, you are “judgment proof” and that you will not be tendering any payment toward the debt. Of course, your credit will feel the effects. So understand the consequence. Keep in mind, as noted above, that at some point the debt may be charged off and you could be taxed, unless you can prove to the IRS that you were insolvent at the time the debt was charged off.
4. Refinance The Debt
There are cases where you may have a lot of equity in a “non-cash” asset such as a home. In general, it is NOT a good idea to do a cash out refinance and use the equity in your home or other asset to pay off debts. However, in some cases there may be no other viable alternative. For example, if you have excess equity in your home that is not legally protected from creditors, then the asset is already potentially at risk of being subject to collection through a lawsuit, judgment, and perhaps (in extreme cases) a court ordered foreclosure sale to pay the judgment lien created by the litigation. This circumstances if very rare, but it is legally possible, and I have personally dealt with clients in this exact situation. If your credit is still good such that you are not burdening yourself with unmanageable new debt, this may be an idea worth exploration.
5. Bankruptcy Maybe?
As I inferred at the beginning, a bankruptcy may be a viable alternative. Without getting into too much detail here, simply keep in mind that there are various types of bankruptcies (called “Chapters”) each having its own positives and negatives. For most individuals and couples, the choice will be between chapter 7 and chapter 13. Chapter 7 is the fastest and easier of the two. It typically takes a few months, and most debts can be discharged (i.e. erased). There are exceptions, including most student loans, some taxes, criminal fines, and alimony / child support. Also, secured debt receives special treatment that must be considered in evaluating the case. Chapter 13, on the other hand, is a court structured payment plan that will allow you reorganize and pay critical debts (typically secured creditors–those who have a claim against your house and car), while altering or perhaps even eliminating unsecured debts. This is all accomplished through a payment plan that must be approved by the court.
Keep in mind that all of these concepts are discussed here in a very general context. There are many legal nuances to consider and an experienced professional is the key to greater understanding. To schedule a free consultation to discuss your specific questions, fill out our contact form or call us to schedule a convenient no cost appointment.