Get Out of Debt and Do It Right

April 4, 2019

Debt is a big and growing problem with consumers in the United States and there are various strategies you can use in dealing with it. Such effective methods are settling debt, paying off higher interest rate debt first, working out payment plans and lastly, filing for bankruptcy.

Consumers often times make many mistakes when dealing with debt and in this article I will attempt to lead you to the best way to deal with debt in the right way from knowing the causes of debt, avoiding common mistakes in paying off debt and answering questions regarding bankruptcy.

Causes of Debt

Causes of debt that may have gone out of control are numerous.  Some examples for the  cause of  debt are (1) medical problems, an injury or sickness leading to high medical debt, (2) loss of a job or decrease in income, (3) divorce or separation, (4) interest rates on credit cards out of control, (5) adjustable mortgage rates skyrocketing monthly payments, (6) falling behind on mortgage payments, (7) business failures, (8) senior citizens on fixed income with no way to make additional money and (9) permanent disability with no ability to earn money.

The list of causes could go on and on, but most of the time the debt situation is something beyond your control and you must develop a strategy on paying it off or wiping it out.  Do not feel bad or guilty as you try to deal with your situation and not just ignore the problems and hope they go away. Meeting the debt issues head on are always the best way to avoid making mistakes in dealing with debt.

Mistakes on Paying Off Debt

It is important not to make the wrong decisions in paying off debt.  One common and major mistake often seen is to liquidate retirement accounts in order to pay off credit card, medical bills or other unsecured debt. Unsecured debt is the type of debt that does not have collateral to secure the loan. A mortgage or car loan is an example of secured debt and a credit card is an example of unsecured debt. You never want to pay unsecured debt before secured debt unless you are not concerned with losing the  asset you owe money on.

Retirement accounts are exempt in many states and in all bankruptcy cases so you never want to liquidate those accounts to pay off creditors when you are in trouble because creditors will have no way of going after those assets so long as they remain in a qualified retirement account. The problem arises when you convert that retirement account to cash and put that cash in a bank account then it loses the protection it had previously.  

Creditors cannot touch qualified retirement assets so do not create a situation where the creditor can get the money. If you decide to pay creditors and try to reorganize without bankruptcy always focus on paying secured creditors first.  A secured creditor can foreclose on collateral such as a house or repossess a car that the loan is secured by. Therefore, you always want to pay the secured creditor first in order to protect your asset – like a car or house.

Once you have paid secured creditors first and if you still have sufficient funds then you can pay towards your credit cards. It’s worth noting that you should pay credit cards with higher interest rates first before paying credit cards with lower interest rates. Also, try calling your credit card companies and see if they will reduce the interest rate or waive it while you make payments. If you are trying to avoid bankruptcy and work things out, debt arising from medical treatments is usually the most likely to set up a payment plan or settlement. Focus on paying off medical debt after credit cards and other creditors if deciding to avoid bankruptcy all together. 

We never advise that you work with debt consolidation companies as most of them are scams.  Be very careful before agreeing to have a debt consolidation company help manage your debt. At a minimum, research the company first and consult with a bankruptcy attorney in your area to see if the company is reputable. If the debt appears beyond your control, you should consult with a bankruptcy attorney before making any payments. You want to hold off from making payments because if you decide to file bankruptcy you will be throwing money away on any creditors you did pay before the bankruptcy.  Most bankruptcy attorneys offer a free consultation so it is certainly worth at least a call to explore your options.

Pros and Cons of Filing Chapter 11 and 13 Bankruptcy

The most common bankruptcy chapters for consumers are Chapter 7 and Chapter 13.  Chapter 7 is generally for those persons that have no significant assets and are under a certain median income level so that they are eligible. Chapter 13 is primarily used by consumers who do have assets that they wish to save or their income is over a certain median income level so that a percentage of their debt has to be paid.  Chapter 7 or Chapter 13 can be used in dealing with business debt also, but most of the time these chapters deal with consumer debt.

In Chapter 7, you can have assets such as a house or car as long as the value is within your allowable exemptions. Thus, you can still file for bankruptcy, keep your house, car or other assets and wipe out all of your other debt. This all depends on the value of your assets. 

To qualify for Chapter 7, your income must also be below the median income level in your state.  If your income is over the median income level then you must go through means testing, which involves taking your allowable deductions off of your income under the applicable IRS guidelines. Even if you are over the median income level you may still qualify for a chapter 7 bankruptcy if after going through the means test no excess income remains.

The median income level for Chapter 7 may not have to be considered if your debts are not consumer related.  For example, if you have debt arising from a failed business that is not consumer debt it may not matter if you are over the median income level. There are still other legal issues to consider in the business debt situation so consultation with an attorney is essential.

In a Chapter 7 you pay nothing and your creditors are wiped out. Chapter 7 only takes about 3 to 4 months from filing of the case to obtaining a discharge order to wipe out your debt. 

By contrast, in Chapter 13 you typically pay a percentage to creditors over a 36 to 60 month plan.  You make one monthly payment to the Chapter 13 Bankruptcy Trustee and the trustee disburses to creditors on a pro rata basis depending on your percentage plan.  For example, if you are paying 10% to all of your creditors, you make one monthly payment and the trustee disburses money to the creditors. At the end of your plan the remaining 90% you owe to the creditor is wiped out.  So, if you owed $100,000 in credit cards, the creditors would receive $10,000 and $90,000 would be wiped out.

In terms of effect on credit, chapter 13 lasts only 7 years on your credit under the Fair Credit Reporting Act and a Chapter 7 lasts up to 10 years.  Please keep in mind that you will be able to get credit shortly after the bankruptcy but it just means that the bankruptcy may be reported on your credit for this length of time. Stated another way, you will not have to wait either 7 or 10 years to get credit. We have seen clients rebuild their credit scores quickly after bankruptcy. The bankruptcy, however, does have a negative impact on your credit scores under either chapter.

In Chapter 7 or 13, the automatic stay is an automatic court order that is entered as soon as you file for bankruptcy.  All collection efforts of creditors are stopped. Some actions a creditor cannot take are:

  • garnishing and taking money from your pay
  • levying with a court order and turning money from your bank accounts
  • foreclose and take your house by sheriff sale
  • repossess your car or other assets
  • proceeding with a lawsuit and obtaining a judgment
  • placing a lien on your assets

It is critical to explore all of your options and strategies with a bankruptcy attorney to determine your best course of action. Even if you decide against filing bankruptcy it is still worth the call to best discuss how to restructure your debt without bankruptcy. Please feel free to contact our bankruptcy attorneys in one of our New Jersey offices, located in Passaic, Hudson, Essex and Bergen counties by calling us at 888-412-5091.

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