Bankruptcy Isn't Easy ... or Cheap

Eugene Johnson / January 30th, 2006

Your car conks out and you need it to get to work. But you don't have any money to fix it. Your credit cards are maxed out. You can't even cover minimum payments. "Maybe it's time to go bankrupt and get a fresh start?" you think. Well ... think again. Bankruptcy isn't an easy way out. Bankruptcy is expensive, complicated, and irreversible. It's made even more expensive under the new law that took effect Oct. 17, 2005. The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 makes it harder for certain individuals to qualify for relief under a Chapter 7 bankruptcy. Attorney's fees and court costs that ran $1,000 to $1,200 under the old law may jump another $400. Attorneys have more paperwork and must determine if you meet a "mean's test" to determine if debtors qualify to have some or all debts wiped away. Debtors who earn more than a certain threshold for their area will need to qualify under the test. Applicants who flunk the means test won't qualify for Chapter 7 discharge of debts. Instead, they'll be forced into a Chapter 13 three- or five-year repayment plan, notes Kathryn Greiner, director of credit education with First of Washtenaw, a subsidiary of the University of Michigan Credit Union in Ann Arbor. "The bankruptcy trustee and your attorney collect fees under Chapter 13 repayment plans," she says. Counseling requirements add more fees. The new law says each person has to complete a financial counseling session before applying for bankruptcy and a similar financial education session after filing. One-on-one counseling runs $250 for a two- to four-hour session at First Washtenaw, which is a good deal, especially considering the credit union pays for it. Credit unions refer members who are in financial trouble (see "Find reliable counselors" sidebar).

Recognize hidden costs

In addition to direct costs, going bankrupt brings indirect costs. "Short-term, bankruptcy looks like a good way to wipe the slate clean," but Ken King, executive director of the Consumer Credit Counseling Service in Sheboygan, Wis., cautions, "In the long-run, going bankrupt will cost you money. Here's why: Greiner adds these examples: Bankruptcy may not carry the stigma it once did, but it is a matter of public record. Some newspapers print the names of bankrupts. All creditors listed in the debtor's bankruptcy petition are informed when a person files. And, there's the emotional trauma of explaining to a spouse or family members the depths of your financial problems leading you to consider bankruptcy. The point is bankruptcy isn't the easy way out, and there are alternatives. One-third of the people who seek help from a counseling service can manage things themselves, says the National Foundation for Credit Counseling (NFCC). Another third need the counseling service to help, and the final third need public assistance or bankruptcy relief. "They all need counseling," says King.

Explore your options

The first step is to do a budget analysis. Total your take-home pay for a month. Subtract living expenses and loan payments. "Take stock of assets you could sell to settle debts as well as your ability to earn more money," Greiner advises. "If you can budget and pay off your debts within three years, do it," says Cathy Moran, an attorney with the Moran Law Group, Mt. View, Calif. "If you can't, seek the help of a consumer credit counseling center, which can help negotiate a repayment plan." Or negotiate for yourself. "Creditors are eager to work with people," says Greiner. "But there's a catch: If you call right away, the creditor might say, 'There's nothing I can do for you, you're current.'
Dealing with collection agencies can be intimidating, so you may want a counseling service to go to bat for you.
"If you're three months or more behind, the big credit-card issuers have hardship programs that allow them to waive fees and lower interest rates," says Greiner. "You have a lot of negotiating power when you're past due." "If your consumer debts [don't count mortgages] total between 50% and 150% of your annual income, repaying your debts in full isn't doable," says financial counselor Connie Kilmark, Kilmark & Associates, Madison, Wis. She blames creditors for helping people get in trouble. "They make blanket credit card offers instead of looking at each borrower," she says. "So they should be willing to negotiate repayment plans. "You get game points just for calling your creditors, especially if what you say is accurate, even if it's not good news," says Kilmark. However, dealing with their collection agencies can be intimidating, so you may want a counseling service to go to bat for you. The NFCC-affiliated agencies in Wisconsin, for example, are all nonprofit and are licensed by the Wisconsin Department of Financial Institutions. Counseling fees in most cases are less than $25. The fee to establish repayment plans also is about $25 and about $20 a month to maintain the plan, depending on how many creditors are involved. The fees are low because United Way provides support to several of the nonprofit counseling services in many states. Nationally, NFCC member agencies charge about $15 for credit counseling, while some offer the services free. Debt management plans cost about $50 to set up and $25 a month to maintain. The Association of Independent Consumer Credit Counseling Agencies, which also represents nonprofit counselors, states maximum set-up fees are $75 and $50 for monthly maintenance. These agencies also help debtors find public assistance programs for help with living expenses, medical bills, rent, and utilities. Debtors also have the option to do nothing--if they're judgment proof [Social Security payments, for example]. That is, if your property is exempt from repossession, there's no reason to go bankrupt. You just stop paying. But understand that your credit rating is ruined in the process. Greiner advised an elderly woman to do just that. The woman became disabled and had to stop working. She had no assets worth repossessing. Her sole income from Social Security barely covered the rent and groceries. Greiner explained her situation in a letter to creditors. A few creditors called to confirm her disability and stopped collecting. But a couple creditors dogged the poor woman for a long time.
In addition to direct costs, going bankrupt brings indirect costs.
"Bankruptcy should be your last resort, when all your other options have been exhausted," says Kilmark. "Occasionally, bankruptcy is a necessary shelter when you are forced to choose between your family's survival and paying creditors." But Kilmark cautions debtors not to file in the middle of a crisis. "Say you're undergoing chemotherapy, you wouldn't file when you're still incurring medical expenses," she says.

Find reliable counselors

Critics of the new bankruptcy law say it has a built-in flaw. It sends debtors to credit counseling firms before they're permitted to file for bankruptcy. Counseling firms have an incentive to steer debtors into their debt repayment plans, rather than toward bankruptcy relief. That's because some creditors pay counseling firms a percentage of funds recovered. The percentage ranges from 0% to 10% of funds recovered, reports the National Foundation for Credit Counseling (NFCC). Ultimately, what you want from a credit counselor is an unbiased assessment of where you stand and what your options are. There are some bad apples in the credit-counseling business, including some of the nonprofit firms. But they are being investigated by the Internal Revenue Service and are being weeded out. The Justice Department's U.S. Trustee Program is establishing an approved list of credit-counseling agencies. You may want to cross-check the names on that list with your credit union. Or check with an accredited consumer credit-counseling association. The NFCC and the Association of Independent Consumer Credit Counseling Agencies maintain lists of accredited member agencies. NFCC offers an online Zip Code locator, or you can call 800-388-2227, and NFCC will steer your call to the nearest member office. The AICCA provides state lists of its member agencies and has a toll-free referral line at 800-450-1794.

Beware of debt settlement companies

The new bankruptcy law could force more debtors into the clutches of "debt settlement companies." Their cable TV ads show piles of money being cut in half "without having to go bankrupt."
Some 20% to 25% of applicants will have to pass the means test.
They offer to negotiate debt settlements with creditors and reduce monthly payments. They'll help you settle, but not before they help themselves, says Ken King, executive director of the Consumer Credit Counseling Service in Sheboygan, Wis. He explains how they operate: "They ask, 'What are you paying now?' "If you're making payments of $1,000 a month, they ask, 'How much can you afford to pay?' "You might say, '$700 or $800.' "They say, 'Let's make it $600 and give you some breathing room.' "Then they have you sign a power-of-attorney agreement and debit authorization forms to begin drafting $600 a month from your checking account. "They notify creditors that you're now their client and the creditors are not to contact you except by mail. "For that, they charge you an account setup fee of as much as $1,500, plus a monthly administration fee of around $75. Your $600 monthly payments cover nothing but fees for the first several months. "By then, you're several more months behind with creditors and you're receiving legal notices from them. So you call your settlement company and ask it to settle for you. "That's when you discover after several months you have nothing to settle with. And when you do accumulate enough funds to start settling debts, the settlement company gets 20% of any amount saved. "Say it settles a $3,200 debt for $2,400. That's a savings of $800. The company collects 20% of $800 or $160, saving you $640. "These outfits are the biggest rip-off in the country and people are so embarrassed when they figure it out that they won't tell anyone," says King. "They just call the company and say 'I'm done.' "Settlement companies advertise so they look like debt repayment plans. But, listen closely," King advises. "They don't say 'monthly payments.' They draw comparisons between 'what you would pay and what we can get for you.' " Also be wary of "credit repair companies" that offer to improve your credit rating, warns Kathryn Greiner, director of credit education with First of Washtenaw, a subsidiary of the University of Michigan Credit Union in Ann Arbor. "Your credit report is a history of what happened," says Greiner. "Negative information stays there for seven years. If someone could erase something from your credit report, it would be meaningless."

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