Bankruptcy: What You Need to Consider Before You File

You probably never expected that you'd be considering bankruptcy - far from it! You've always been good about your money, saving a few bucks when you can, even clipping coupons. Yet here you are - whether because of unemployment, divorce, or illness, you are suddenly mired in debt. Never one to fear picking up the phone, you now jolt whenever you get a call, worried that yet another creditor is going to be on the line.

What should you do if you suddenly find yourself considering bankruptcy? First of all, take a step back. Then, take out all your bills and start analyzing your debt. Bankruptcy can help you, but only if your debt falls under the category of unsecured. Credit card debt, medical bills, and most personal loans are unsecured and can therefore be reduced or completely discharged.

However, there are loans and debts that cannot be discharged, even under bankruptcy filings. Student loans, for example, are federal loans and therefore not subject to bankruptcy filing. The same holds true for debts such as child support payments, criminal penalties, and certain taxes.

The best-case scenario when declaring bankruptcy, in order to gain the maximum benefit from it, is for you to have stable, secured property such as a house or a business. Also, you will want to have owned your home for at least 4 years, since many states won't cover your entire house price if you've recently purchased your home. Unsecured debts, assuming they are mostly credit card bills, are also good, because these debts can be discharged. The same goes for medical bills, since they are not tied to any property and therefore dischargeable.

The worst-case scenario is when you have very little unsecured property and instead have lots of payments to make on things you cannot afford. If you are living in an apartment, for example, and are late on your rent, car, and student loan payments, then declaring bankruptcy won't help you very much. It is almost guaranteed that you will be evicted, have your car repossessed (and you may even have to pay the difference between what is owed and the amount received at the car's sale), and still need to come up with cash to pay your next student loan bill.

What if you find yourself in the middle, holding some intangible assets, like a house, along with car payments, child support duties, and possibly a personal loan to boot? Before you call up a bankruptcy lawyer, see if you first can't eliminate the drains on your income. Get rid of your car and carpool or take public transit. Call up your individual creditors, especially your credit card companies, and explain your financial situation to them. Once your credit card companies hear the word "bankruptcy", they'll be very willing to negotiate lower interest rates and/or amounts.

While you can't get rid of certain debt payments, like on your mortgage, you may be able to enter into a forbearance agreement with your mortgage company. The forbearance agreement allows you to stop making mortgage payments for several months until your financial situation improves. You might also try for a mortgage deferment agreement, where you stop making payments for a specified period of time and then pay a lump sum at the end of the deferment period.

Other plans of action may include the following:

Debt counseling. This is a free service and will help you in your negotiations with your creditors. Look for a debt counselor who belongs to the National Association of Certified Credit Counselors, or to the Association of Independent Consumer Credit Counseling Agencies.

Debt consolidation. It's not ideal, and fraught with shady characters, but if debt consolidation can save you from bankruptcy then it's worth it. Just keep in mind that, without a lot of collateral, you won't obtain a very big consolidation loan.

Mortgage refinance with cash-out/home equity loan. With mortgage interest rates falling, a mortgage refinance with cash taken out and/or a home equity loan may be your best bet for paying off your debts. Just keep in mind that you will subsequently increase your total mortgage, since the closing (and of course the cash-out) isn't free.

It is always best to budget your money and clear out your debts yourself so that you can avoid filing for bankruptcy. The reasons are obvious:

A dismal credit score. Once you file for bankruptcy, you can kiss your good to excellent credit score goodbye. It will take at least 7 years for your bankruptcy filing to leave your credit report, and you'll need around 10 years following your filing to build up enough credit for a new mortgage loan, personal loan, etc.

Lost possessions. Your art collection, fine jewelry, new boat, etc., will more than likely be seized in an effort to pay off at least some of your debts. You'll be left with very little of your former property.

Attorney and court costs. Amazingly, it actually costs money to declare that you have no money! Simply filing the bankruptcy notice costs a few hundred dollars. Meanwhile, attorney and court costs, when combined, run several thousand dollars.

So, is there anything good about filing for bankruptcy? Yes. Here are a few items:

No more creditor harassment. Creditors are not allowed to harass you for payments once you file for bankruptcy. If they do harass you, you can take them to court!

Stops loss of your home. Your house, your business, and items such as your 401(k) or IRA are made exempt from foreclosure and/or seizure. In the grand scheme of things, these are probably your biggest and most important assets.

Longer/better payment terms. Depending on whether you file for Chapter 7 or Chapter 13 bankruptcy, you may need to repay some of your debts. However, bankruptcy payments are much less strict than those of credit cards and other creditors, allowing you some breathing (and even money saving) room.

Blank slate. Some people find themselves almost homeless due to crippling bill and debt payments. Filing for bankruptcy allows you to start fresh and even begin to build equity and savings.In summary, while bankruptcy is not the most desirable thing you will want to do in your lifetime, it can save you from creditors, excessive debt, and the loss of your home. However, consider all your options first before filing.