Some Bankruptcy Basics

You may have read on the blog, or elsewhere, that many are calling our current economy a "middle class recession." This is because the numbers are way up on bankruptcies filed by those who make more than $60,000 per year, up 6.9 percent from 2008. Bankruptcies on the whole are up 36.5 percent from this time last year.

So why does it matter how much money a person makes when filing bankruptcy? Well, because bankruptcy is often considered an escape route for the financially unreliable or worse yet, "something poor people do." It's just not true.

Today, bankruptcies are increasing among people in the real estate profession, namely developers and agents. When the housing bubble dissolved, so did the incomes for a lot of American families.

There are different types, or "chapters" of bankruptcy for a reason. Basically, some versions are better suited to different situations. Chapter 7, for example, is typically filed by those who may have lost a job or for some reason may not have regular source of income. It wipes out all debts, but also mandates a person dispose of their "non-exempt assets" as a way to repay creditors to whatever extent possible. If you have equity in property beyond available exemption limitations, you may have a "non-exempt asset".  Many states' exemptions, as well as the federal exemptions, provide some measure of protection for everything from your home to retirement accounts. It is not often the case that a family has assets beyond what available exemptions can protect.  Even if available exemptions do not cover all of a person's property, Chapter 13 provides a way to pay the equity above available exemptions to unsecured creditors, so that a person may keep his property, if he can afford to do so.

For those who are still earning a living or at least have a source of money, Chapter 13 creates a three- to five-year payment plan. Your plan payment will largely consist of secured debt, like your car and mortgage payments. Because the plan payment can include your attorney fees, Chapter 13 is an attractive option if you do not have enough up-front money for Chapter 7 attorney fees.

Maybe you're giving some thought to a debt-settlement firm instead of bankruptcy. Sure, it's natural for you to want to negotiate your way out of debt. Unfortunately, many of these companies position themselves as an alternative to bankruptcy that will save your credit. More often, however, these debt settlement companies end up doing far more damage to your credit than if you had simply filed for bankruptcy from the start. Remember, just because you're in a "debt-settlement" program, your creditors will continue to report your missed payments to the credit bureaus. A bankruptcy, while causing an initial hit to your credit score, will stop the negative reporting and allow you to rebuild your credit score faster.

Bankruptcy is an organized, legal process with pre-defined results. Debt settlement firms function under very little regulation and ask for payments before all the debts are settled, therefore the incentive to settle the debt is not as strong as if they were paid based on results or after everything is taken care of.  Thus, your "debt settlement" is by no means guaranteed.

And one more point on debt settlement agencies: the IRS considers forgiven debt as taxable income. In contrast, debt erased as part of a bankruptcy is not taxable.

Another important point about bankruptcy has to do with timing. It's key that you don't file too early or wait too long. Start by simply adding up what you owe and making a simple estimate on what it would take to pay it off yourself. If the discrepancy seems impossible to make up, or would force you to sacrifice your family's needs just to make a dent in your debt load, then consult an experienced consumer bankruptcy attorney.

On the other hand, don't wait until the car has been repossessed or the foreclosure notices start arriving. Use your head, remain calm, and speak with an attorney. The bankruptcy concept itself is fairly straightforward.  The process however, requires a good deal of legal expertise.  Engage it wisely.  Take time to understand the basics of filing.

From the Law Offices of John T. Orcutt.  Helping families through bankruptcy since 1995. Call today to set up a free initial debt consultation in one of our 4 convenient office locations. Raleigh, Durham, Fayetteville and Wilson.