THE BEST MOVES IF YOU'RE BROKE
Bad legal advice left one former entrepreneur saddled with $150,000 in outstanding debt and no way to pay it. Told that it wouldn't make sense to incorporate her new management consulting firm, the woman ended up regretting that decision when business went south. ``I started using my credit cards to keep the company alive,'' she says. In 1991, after seven years in business, she closed the doors. It only got worse, however. Creditors harassed her, and lawsuits ensued. ``I decided to file for bankruptcy to protect my future.''
She is not alone. Well over 1 million people are expected to file for bankruptcy this year, an all-time high, according to the American Bankruptcy Institute (ABI). ``Consumer bankruptcy is not just for deadbeats: It includes a wide range of incomes,'' says Samuel Gerdano, executive director of the ABI, a nonprofit research group. So far, more than 266,000 consumers filed in the first quarter of this year, up 25% over the same period last year. Explains Melvin Kaplan, a Chicago-based bankruptcy attorney: ``Bankruptcy no longer carries as bad a stigma as it once did.''
Easier access to credit, coupled with corporate layoffs, have helped fuel the rise in bankruptcies. Consider the recent explosion of credit availability: There were 5 billion credit-card solicitations, or 32 invitations for each American aged 18 to 64, between 1994 and 1995. As a result, monthly consumer debt service has climbed to a near-record 17% of disposable personal income this year. For many people, the simplest means of getting out from under a growing mountain of debt is to declare bankruptcy. There are two different types of filings for individuals: Chapter 7 and Chapter 13.
QUICK ROUTE. Chapter 7, also known as straight bankruptcy, requires financially troubled folks to submit most of their assets to the bankruptcy trustee, who then sells them and distributes the proceeds to the creditors as partial payment on the debt. Debtors are allowed keep certain non-exempt assets, which are determined by the various state codes or the federal code. These usually include clothing, household appliances, furnishings, life insurance, pensions, and sometimes a home or car. The Chapter 7 process usually takes four to six months, after which the entire debt load is forgiven and the debtor is discharged. Chapter 7 cannot be filed again for another six years.
Chapter 13, which is also called the wage-earner option, is a debt reorganization recipe that can last up to five years. Instead of turning over assets, debtors with a steady income can submit part of that income for distribution among creditors to pay all or a portion of their debts under court protection. The amount that is repaid is negotiated, then court-approved. Once the repayment plan has been completed, the consumer's debt is discharged. There is no restriction on when a person can file again.
The moment any type of bankruptcy is filed with the courts, all collection efforts and legal actions must stop. The consumer gets immediate relief and protection from creditors and the pressures of the mounting debt. ``The individual gets a fresh financial start,'' says Norma Hammes, a bankruptcy attorney in San Jose, Calif. With both filings, however, there are some debts that can't be forgiven, including alimony, child support, the last three years of income taxes, and most student loans less than seven years old.
But there's a downside: A bankruptcy shows up on a credit report for 10 years, seven years if a Chapter 13 repayment plan has been completed. It may be difficult to secure a mortgage, rent an apartment, obtain a credit card, and--despite laws to the contrary--get hired at some companies.
Ironically, once you have filed for bankruptcy, you may still be able to get some credit, but you'll almost certainly pay a steep interest rate--up to eight percentage points higher. In fact, according to a 1990 study by Purdue University's Credit Research Center, 17% of people who filed for Chapter 7 obtained credit within one year of filing. Credit-card companies figure the higher interest rates cover the increased cost of offering credit to riskier consumers.
Determining the best type of protection to seek depends upon the type and total amount of assets and whether or not an individual has a steady income. About 70% of those who go into bankruptcy file under Chapter 7.
STATE LAWS. Chapter 7 is more appropriate for individuals who have few assets to protect. These are people who don't usually own a home or property and have an older, already-paid-for car. Whatever remaining assets they do have are typically exempt. Certain states such as Florida and Texas let people have unlimited home equity protection, although most states put a cap on the exemption. New York, for example, only allows $10,000 of protection for home equity. Creditors can take the home, sell it, and keep whatever proceeds exceed $10,000.
If a creditor is willing, an individual may be able to keep nonexempt assets such as a home or car by agreeing to pay down debt in installments with interest. The good news is that you'll be able to hold onto the property and salvage your credit report. The trade-off is that the debtor may end up paying more than the property is currently worth.
Those with many possessions should probably consider a Chapter 13, which allows debt-laden borrowers to keep all of their assets. But the consumer must pay off at least as much as the creditors would have gotten in a Chapter 7 bankruptcy. That amount is determined in negotiations.
Of course, the difficult question of whether to seek any type of bankruptcy relief should not be taken lightly. All other alternatives for handling problem debt should be considered first. ``Bankruptcy should be the last resort,'' advises David Doyaga, a New York-based bankruptcy attorney.
Indeed, if your credit history isn't wounded beyond repair, it may be possible to take out a large, low-interest loan to pay off higher-interest debt. That way the debt is consolidated into one payment. Another option is to try to negotiate directly with creditors. Debtors may be able to settle for a smaller cash payment, extend the payment period, or suspend additional interest payments while the debt is paid off.
Sometimes creditors won't deal with problem consumers. Under that scenario, it's best to visit a credit counselor at a nonprofit agency who may be able to work out a restructured payment plan with creditors. Counselors can also help consumers learn how to budget and track expenses so debt problems can be avoided in the future. The nonprofit National Foundation for Consumer Credit (800 388-2227), with 1,197 Consumer Credit Counseling Service offices nationwide, can help consumers resolve problems through a debt-management plan for a low-cost fee of about $9 a month. Universities also provide nonprofit credit-assistance programs.
WARNING FLAGS. When the signposts are all too clear--your credit rating is a mess, you've been paying debt for six months without reducing the balance, or you're borrowing off of one card to pay off another--then seeking bankruptcy protection may be prudent. ``For some people, bankruptcy is a sensible decision,'' notes Robert Johnson, senior research associate at the Credit Research Center. At that point, call the nearest bankruptcy court for a list of attorneys who act as trustees and file Chapter 7 and 13 cases. Or contact the American Bankruptcy Board of Certification (703 739-1023) for referrals. Another resource: The American Bar Assn. sells a videotape and accompanying booklet, Dealing with Debt: Bankruptcy and Other Options for $49 (312 988-5522).
The best suggestion, of course, is to avoid excessive debt in the first place. Or try to negotiate with your creditors. You'll feel better about repayment, and so will they.
EDITED BY AMY DUNKIN By Toddi Gutner
Updated June 14, 1997 by bwwebmaster
Copyright 1996, Bloomberg L.P.