As the nation pushes through the recession, folks have felt the financial strain. For a multitude of reasons, there just doesn't seem to be enough money to meet obligations for many people. So this month "On Our Way to Wealthy" will focus on alternatives to bankruptcy as well as the various chapters of bankruptcy.
Let's begin our discussion with the debtor –someone that owes money to a creditor. When money is tight and the debtor is experiencing difficulties making ends meet or paying bills on time, filing bankruptcy should not be the very first choice. My sentiments may sound strange coming from a bankruptcy attorney. However, if the problem can be worked out through less drastic means, those alternatives should at least be evaluated, reviewed and considered.
Here is a list of alternatives that the debtor may consider prior to filing an actual bankruptcy:
Take no action
Too many people do nothing when they can no longer pay their bills. But avoidance does not fix the problem. The calls and letters will persist. The creditor may even file a lawsuit, obtain a judgment and garnish the debtors' wages unless they are "judgment proof." This means that the judgment has no impact on the debtors' financial situation because they have no assets or income, with no expectation of receiving any and the creditor simply cannot collect any money. After about seven years in most jurisdictions, the debt is removed from the debtor's credit.
Self-imposed money management
Various situations result in debtors not being able to pay their debts – layoffs, cut back hours and overspending, the most common reason. To reduce debts, the belts have to be tightened and spending reduced. The money saved can be used to pay off debts. By creating a budget and sticking to it, the debtor may have even more funds to apply to debts. Common ways to reduce spending would be to avoid shopping and less dining out.
If the debtor has amounts of cash to use toward settlement of amounts owed, debt negotiation is an option. This strategy can be used on large and small debts. Many times creditors are willing to accept less than what is owed instead of risking no payment at all under a Chapter 7 filing. Keep proper records of settlements just in case you have to prove your payment.
Some creditors are willing to restructure the debts owed. Delinquent debts can be reduced and renegotiated for a lower interest rate or longer payment term. In many cases, restructuring the debt is less expensive and preferable to a bankruptcy. Some debtors attempt to negotiate on their own. However, I recommend the debtor obtain the services of a lawyer to negotiate and read the fine print of the new agreement.
Loan workouts or 'short sales'
Debt restructuring can take the form of a loan workout or a "short sale." Short sales are increasing due to the decrease in real estate values nationwide and the inability of the seller to obtain a purchase price for the debt owed. A short sale is a sale of real estate when the proceeds from the sale are less than the balance of the debts secured by the property and the property owner cannot afford to pay the difference. The mortgage company or lien holder agrees to release their lien on the real estate and to accept less than what is owed.
The unpaid balance is known as a deficiency and in jurisdictions such as California, no deficiencies are allowed after a short sale. Tennessee appears to allow deficiencies, which means the mortgage company or lien holder can pursue the debtor for the difference. A successful loan workout or short sale can avoid a foreclosure action.
Some companies offer debt consolidation, which allows debtors to combine their debts into one loan. The benefit of this option is paying one bill rather than many. The downside is making sure that the debtor ultimately is paying less than what was originally owed. Also, take into consideration fees to the consolidation company. Shop around and perform due diligence on any company offering consolidation services.
For those struggling to pay bills, the mortgage is one of the largest and most critical bills to be affected. The first step before filing for bankruptcy is applying for a loan modification, if time permits. Generally, any change in the original terms of the loan is considered a modification. But in this case, we are referring to a change to address the debtor's inability to remain current on the loan. A loan modification usually results in a change to the loan's monthly payment, interest rate, late fees, term or outstanding principal.
Credit counselors will provide advice on how to manage money, offer solutions to financial issues, and may also tailor a personalized plan to help the debtor prevent future financial problems. Credit counseling is mandatory when filing a bankruptcy.
Next week: Bankruptcy 101