Is Bankruptcy Necessary?
By Anthony E. Cooch Jr., Esq.
Bankruptcy is an effective option that provides debtors with a way to gain control of their lives and obtain a “fresh start” with respect to their debts. Bankruptcy is not the best option for everyone and does not fit every situation. Before considering bankruptcy, it is important to review (1) whether or not it is necessary or (2) whether it will provide you with the remedy you seek. In the paragraphs that follow, I list several considerations that should be taken into account prior to making the decision whether to file for bankruptcy.
Step 1: Evaluate your situation. List your income, debts and expenses. For your expenses include trips to the convenience store, the occasional candy bar and trips to Starbucks. It might be helpful to carry a small notepad with you for a week, tracking every penny you spend.
Once you have all of this information, analyze whether your expenses exceed your income. If the answer is “yes”, examine whether there are adjustments you can make to live within your means. If this is not possible, move on to Step 2.
Step 2: Examine your debts. What are the debts that are giving you the most trouble? If you have mostly credit card debt, you might be able to lower the amount you owe by negotiating with the creditor. Negotiation of course has its downside, including losing future use of the card, possible negative credit reporting, alerting your creditor to your difficulties, etc.
If you have a house payment that you cannot afford, you may have options here as well. It may be possible to negotiate with your lender for a lower rate. Of course, if your lender agrees to this it will likely involve adding that percentage point to your principal which may simply be postponing the inevitable.
Another option in negotiating with your lender is through a short sale. Recently, lenders have become more responsive to borrower requests to sell homes at an amount below what is owed on the loan. Lenders are now agreeing to forgive that portion of the debt that is not covered by the proceeds from the closing. It is important that borrowers who go through the short sale receive assurance from the lender that this debt will be forgiven.
In prior years, the debt that was forgiven was subject to tax as ordinary income. That has changed with the passing of the Mortgage Forgiveness Debt Relief Act of 2007. Now many individuals who go through a short sale of their principal residence are not required to pay taxes on the debt that is forgiven. This act is good for transactions taking place in 2007-2009. See http://www.irs.gov/individuals/article/0,,id=179414,00.html for more details.
Keep in mind that not every person will qualify under the act. It is important to seek counsel from a tax attorney prior to completing a short sale to determine whether the benefit you think you are getting is what you will actually receive. If you will qualify under the Mortgage Forgiveness Debt Relief Act, a short sale may be your best option.
It is important to note that short sales take time – sometimes months – to complete. If you are considering this option, it is important to begin the process as soon as possible. Waiting until you receive a notice that your home is going to foreclosed is often too late. Many lenders will not postpone a foreclosure sale to see if a short sale will go through.
Step 3: Can you liquidate investment accounts to repay debts? This is a possible solution, but one that should be considered very carefully. It is this author’s opinion that it is a bad idea to liquidate IRAs, 401(k)s or other retirement accounts to pay off debts. These assets are often exempt from creditors. This means that if you file for bankruptcy protection, the creditors cannot take or force you to liquidate the accounts to repay your loans. Also, if you liquidate a retirement account you can be subject to penalties and extra income that greatly reduces any financial benefit from such an action.
If you have investment accounts other than a 401(k) or retirement account, make sure you examine whether liquidating and paying down debt will make a difference or if it is just postponing a future bankruptcy. It is important to keep some kind of “safety net” in the event of unexpected expenses.
Step 4: After reviewing the other steps, if you are still unable to pay your monthly bills, bankruptcy may be your best option. At this point you should speak with a bankruptcy attorney about your situation.
The information contained in this website is provided for informational purposes only. No attorney client relationship is created by and between the firm and any persons viewing the content listed within this site. Furthermore, the information presented is not intended to be and is not legal advice. Every potential legal issue is different and all persons viewing content within this website are encouraged to seek competent counsel. Any information contained within this website is not intended as a subsitute for expert counsel on any subject matter.
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