When people are being sued for debts, they often panic and look for the quickest, easiest, or least scary way out. And bankruptcy often occurs to them as the solution. I believe there are often much more effective ways to handle old debt, especially credit card or merchant account debt that has been sold to a debt collector, than bankruptcy.You can defend yourself without hiring a lawyer, and even if that doesn’t work out – which it usually does – you could still file bankruptcy. But if you can avoid bankruptcy, you will reduce the harm the debt does to you.
Panic is not necessary, and bankruptcy—at least at first–is seldom the best solution in a real-world sense. Here’s why.
Types of Debt
Debt is divided into two types: “unsecured,” and “secured.” Secured debt means that the debt has specific assets backing it. If you miss payments, you can have your house foreclosed or your car repossessed. These things “secured” the debt and can be repossessed and sold if you stop making payments.
Unsecured debt is debt that is not secured-it isn’t attached to any specific assets. Just because a debt is “unsecured” does not mean that you cannot be sued for the debt. On the contrary, it means you must be sued in person for the debt collector to collect any money. And it cannot repossess the thing. The creditor then “enforces” the judgment against you by garnishing wages or attaching accounts. But this can be difficult for various reasons.
Lenders on secured debts are in a much better position than those who are not secured. One of those advantages comes in bankruptcy.
In the bankruptcy law, the item securing a debt is really regarded as belonging to the creditor who lent the money if the payment is not made. Specifically, consider a mortgage on a house. The house “secures” the debt, and if you stop making payments the bank can take the house and sell it to pay the debt. In the bankruptcy law, it is considered unjust to allow someone not paying for the property to keep it from the rightful owner. So the lender typically asks for the bankruptcy “stay” to be “lifted” so that foreclosure can take place. Although this can sometimes be delayed, the courts usually “relieve” the lenders and allow them to foreclose on the house and kick the debtor out.
With unsecured debt, on the other hand, the debts are simply added up and paid according to how much money the bankrupt person has. Usually very, very little. And only at the end of the bankruptcy procedure.
Bankruptcy May Not Help When It Applies
What all that means practically is that if you have a large secured debt (mortgage) that you cannot pay, bankruptcy will offer you very little protection. If you have a large unsecured debt, bankruptcy will probably protect you, but it is slow, time-consuming and expensive compared to defending yourself against the debt collector.
Some examples may help make it clearer.
Consider the Smiths. The Smiths have a house and make payments of $2,500 per month. Mr. Smith loses his job and they fall behind in their payments. If the family seeks bankruptcy as their house payments add up, the lender will obtain “relief from the stay” and foreclose on the house. The Smiths are out of luck, and bankruptcy usually does not help.
Now consider the Joneses. If the Joneses have credit card debt of $25,000 and Mrs. Jones loses her job so they can’t make payments, they could seek bankruptcy help. It would probably cost them at least a thousand dollars or more to file, require them to disclose most or all of their finances over the past year or two, and fill out a vast amount of paperwork. At the end of the proceeding, at least a year later, their debts would be wiped out. But so, of course, would their credit reports. The bankruptcy filing will remain a mark against them for ten years.
An Alternative: Defense
The Jones could, however, simply defend themselves against the lawsuits brought by the debt collectors. For reasons I’ve made clear elsewhere, their chances of winning the suit would be excellent, and if the Jones do it right, they can simply get the debt eliminated. This does not usually mean completely cleaning their credit reports, but it can often mean canceling the debt and removal of the recent credit report damage. And it usually will happen in less than six months from the date the debt collector brings suit. They won’t have the bankruptcy on their credit report. They can do it themselves for almost no money at all, and if by chance it doesn’t work, then they could declare bankruptcy.
In addition, if you are facing debt troubles, chances are good the debt collectors have made some mistakes that violate the Fair Debt Collection Practices Act (FDCPA) and give rise to a counterclaim, which increases your chance of fighting the debt.
Better results, less cost. That’s why it’s often better to defend yourself against credit card debt than to seek bankruptcy protection. It’s also true that if for any reason the Jones lost their case against the debt collectors, they could still file for bankruptcy without having lost its protection.