Out of control debt is a financial whirlpool, sucking more and more of your money into a swirling vortex that seems impossible to escape. People nearing the edge of the whirlpool can feel powerless as bills grow larger by the month and interest payments gnaw away at their take-home pay.
People caught in this bind often consider bankruptcy. Federal and state laws provide bankruptcy as a remedy to unmanageable debt, but the price you pay to clear away financial obligations has consequences. It can make it much harder to borrow money or even land a job.
Bankruptcy laws allow petitioners to pursue two options: Chapter 7, known as “liquidation bankruptcy” and Chapter 13, known as “wage earner’s bankruptcy.” In 2018, 751,186 personal bankruptcies were filed in the U.S. Just over 60% were under Chapter 7 and almost all the others under Chapter 13.
Yet big debt needn’t lead to financial surrender. There are alternative strategies to bankruptcy. In many cases it’s possible to work with a nonprofit credit counselor to devise a plan that rolls back debt and avoids the dire consequences of bankruptcy.
Before filing any type of bankruptcy petition, it’s important to review your finances with a nonprofit creditor counselor, accountant or tax attorney to determine whether debts can be unraveled without a trip through bankruptcy court.
A financial advisor should be able to evaluate your situation and recommend a course of action. Bankruptcy might be the only option, but in some cases, the better advice might be negotiating a debt settlement or debt consolidation plan that will allow you to avoid the courtroom and do less damage to your credit score.
Whether you use a debt settlement company or do it yourself, you can sometimes strike an agreement with creditors to pay less than what you owe. Debt settlement involves debt forgiveness. Creditors or a debt collector must be willing to accept partial payment for settling the full balance.
For debt settlement to work, you need to be in default. Creditors won’t want to forgive anything if you are making minimum monthly payments. If you’re in default, they face not getting anything, so they might be willing to strike a deal. Only seek settlement of debts that you stopped paying but continue making minimum monthly payments on those you can afford.
Before you consider proposing a debt settlement, think about the impact it will have on your future credit. If creditors agree to write down what you owe them, the unpaid balance is considered income and must be reported on your tax return. The amount you don’t repay will be reported to the nation’s three large credit rating agencies and it could seriously degrade your credit score, an important metric used to assess your worthiness as a borrower.
You should be careful dealing with for-profit debt settlement companies. Many of these businesses have spotty track records. Refuse working with any company that wants you to pay a fee before it negotiates a deal with your creditors. By law, debt settlement companies can’t collect a fee until they’re reached a settlement and you’ve made at least one payment to the creditor. If you have multiple creditors, they can charge a fee for each one they are able to reach a settlement with.
The advantage to settling is speed. You might be able to pay your creditors only half of what is owed and get out of debt in 2-3 years, the time frame usually associated with debt settlement. It also will stop harassing calls from collection agencies and help you steer clear of bankruptcy court.
If you do it yourself, contacting creditors and explaining your financial bind, you also could save money.
Another alternative to bankruptcy is debt consolidation. To use this approach yourself, you’ll need access to a credit line or a loan that allows you to pay off your current debts. That could be a personal loan from a bank or credit union or a home-equity credit line that allows you to borrow against your house.
It’s possible – though extremely unlikely if you’re thinking about bankruptcy – to receive a zero-percent balance transfer credit card that could help consolidate your debts.
You should meet with a nonprofit credit counselor or a financial advisor for advice before you consolidate. With a consolidated payment, you can often save on interest and avoid the headache of paying multiple bills each month.
If you qualify for a credit card that offers to temporarily lower your interest rate on balances, you could transfer debt to that card and use the grace period to pay down principal. Before moving ahead, make sure your other cards allow you to transfer balances without penalties.
A personal loan has advantages if it allows you more time to make fixed payments at lower interest than your credit cards were charging. Home equity lines usually charge far less interest than credit cards, but you must offer your home as collateral and if you can’t make the required monthly payments, you could lose your house. Many financial advisors caution against moving unsecured consumer debt to a secured home loan for that reason.
Finally, you can use a nonprofit credit counseling agency to consolidate your debts through a debt management program. If you go this route, the agency will collect a single monthly payment from you and oversee the payment of creditors.
If your income isn’t enough to make debt payments, consider selling assets. Hold a garage sale or find a buyer for that coin collection you inherited from Uncle Lester. Obviously, the more valuable your assets, the more cash you’ll raise for debt payments.
If you file for Chapter 7 bankruptcy, there’s a good chance you’ll be required to sell many of your assets. If you have valuable assets, you might be able to reduce debts enough not to file bankruptcy. You could direct the money you realize through asset sales to an account you can use to settle debts.
If you have a business, selling assets might help avoid a bankruptcy filing. Of course, you need to come up with a strategy first – you’ll need to keep assets that are essential to operating the business.
If negotiating with creditors yourself doesn’t work, consider contacting a nonprofit credit counseling firm like InCharge Debt Solutions. Credit counselors often can help you develop a debt-management plan with payments you can afford.
If the credit counselor is able to work with creditors to lower your payments and interest rates, it could avert a bankruptcy filing. Even if you decide to file bankruptcy, the law requires that you consult a credit counselor first. Federal bankruptcy courts maintain lists of nonprofit counselors and you should consider contacting one before filing.
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