COMMON BANKRUPTCY MISTAKES
4 Common Mistake Made By Consumers Before Filing For Bankruptcy
By Charles Ferris, Esq.
If you find yourself under substantial financial distress, with inadequate income to meet your current bills, a chapter 7 bankruptcy filing may be the key to solving these problems. In most instances, consumers who file for protection under Chapter 7 of the bankruptcy laws are able to keep their homes, cars and retirement accounts, and at the same time eliminate many of their debts. The filing allows people to make a fresh start, freed from mountains of debt that they have no chance of ever repaying.
Not all debts are eliminated in bankruptcy filings, but a large majority of them will be. Bankruptcy filings will allow you to eliminate credit card debt, medical debt, personal loans, debts to utility companies, and some tax debts. Certain debts, such as alimony and child support will remain in place after the filing.
In my 25 years of preparing filings for clients I have learned that there are several mistakes that many people make before deciding to file for bankruptcy relief. These are the top 4 errors people who need to file for protection commonly make shortly before they file.
Mistake #1 – The Home Equity Loan
There is nothing wrong with tapping into the equity in your principal residence in order to pay for home improvements or college tuition or any of a number of other expenses. However, if you have inadequate income to pay your current living expenses, even if the bank approves the loan you will have basically converted an asset which was exempt from your creditors into an asset which is now going to be seized by the bank if you are unable to continue making payments on the new loan.
Massachusetts provides a generous homestead exemption to its residents. This exemption can protect between $125,000 and $500,000 of equity in your home, depending upon your age and certain other criteria. The exemption will be doubled if the home is owned by two spouses. But if you first tap into your home equity for a loan and then file bankruptcy a year or two later, you will have lost this home equity protection.
Mistake #2 – Borrowing From Your IRA or 401(k) Account
If you are lucky enough to have built up a nest egg in a retirement account, please think twice before tapping into that account prior to your retirement. It is generally agreed that Social Security benefits alone may not be enough to finance a similar lifestyle once you retire.
Your retirement account is protected from your creditors. Under federal bankruptcy exemptions you may retain over $1 million in an IRA account.
However if you tap in to this nest egg now to pay off credit card debt, and do not have a realistic likelihood of resuming a satisfactory level of income in the near future sufficient to pay ongoing living expenses you may still have to file for bankruptcy. However at that time you will have lost your retirement account.
Therefore, before taking a loan from a retirement account due to financial difficulties you should first consider the opportunity under the bankruptcy laws to eliminate many of the debts which are the cause of your current financial difficulties.
Mistake #3 – Family Loans
If you have family members or friends who have given loans to you there is a tendency to pay them off ahead of your other debts when a bankruptcy seems likely. However, if you file bankruptcy, payments that you made to family members within the year prior to filing can be seized by the court from those family members and re-distributed to all of your creditors.
So if you need to file a Chapter 7 petition and currently have debts from friends or family members, and wish to repay them, the proper strategy is to wait until after you have filed your petition. Then you may voluntarily repay them if you want and your other creditors will have no claim to these payments.
Mistake #4 – Paying A Credit Reorganization Company
Every night when watching the news I see ads from companies that promise to solve credit card problems by reorganizing your debts. They promise to negotiate lower interest rates and make your problems disappear. Unfortunately, in most instances the only thing that disappears is the money you send them every month for a year or two before filing a bankruptcy petition.
Even if the company you are paying is forwarding your payments to your creditors (some are merely scams), the interest rate reductions may not be sufficient to substantially lower your monthly payments. And the length of time it will take to get rid of your debts is usually quite long. Meanwhile your credit score remains low and you may struggle for years before finally coming to the conclusion that a bankruptcy is required.
There is a tendency to resist what some people consider the stigma of a bankruptcy petition. However, I always remind my clients that many prominent people, including some who presently occupy the White House, have used bankruptcy protection to solve their financial problems.
My clients often ask me if bankruptcy will ruin their credit. However, if a bankruptcy filing is necessary, it is likely that your credit score is already quite low. The bankruptcy filing is the first step needed to rebuild your credit.
Charles Ferris is an attorney practicing in Berkshire County with offices in Pittsfield and Great Barrington.
He can be reached through his website: TheBerkshireLawyer.com.
Published in the Berkshire Eagle May 10, 2020