Should you declare bankruptcy? When debt collectors call or bills pile up, many people look or hope for a quick, easy escape. Too many people tell them bankruptcy is that easy way out. Unfortunately, for most people it is neither easy nor a way out. It can be a costly mistake.
There might be better ways. Most people can defend themselves from debt cases (using materials provided by this site) without having to hire an expensive lawyer.
When people are being sued for debts, they often panic and look for the quickest, easiest, or least scary way out. And they often consider bankruptcy as a possible solution. There are often much more effective ways to handle old debt, especially credit card or merchant account debt in the possession of 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 doesyou.
Types of Debt
There are two main types of debt: “secured,” and “unsecured.” 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 “secure” the debt and can be repossessed and sold if you stop making payments.
Unsecured debt is debt that is not secured – no specific assets guarantee the debt’s repayment. Just because a debt is “unsecured” does not mean that a debt collector can’t sue you for it. On the contrary, it means the collector must sue you personally in order to collect any money. The creditor then “enforces” the judgment against you by garnishing wages or attaching accounts. But this can be difficult for various reasons.
Rights of Creditors
Lenders on secured debts are in a much better position than unsecured lenders in general. One of those advantages comes in bankruptcy.
In the bankruptcy law, the law regards an item securing a debt as the creditor’s property (the one who lent the money). If you do not make the payment owed, the creditor can just take it back. 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. That is “foreclosure” as you probably know. The law considers it unjust to allow someone not paying for the property to keep it from the rightful owner. So the lender typically asks the bankruptcy court to “lift the stay” so foreclosure can take place. Although you can sometimes delay the lifting, 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 court simply adds up the debts and pays them out 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 to an extent, but it is slow, time-consuming and expensive compared to defending yourself against the debt collector. And most people who start bankruptcy end the process without getting what they wanted.
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 large amount of paperwork. At the end of the proceeding, at least a year later, the court would “discharge” their debts.
If they make it to the discharge, the bankruptcy will help. But it will remain as a mark against their credit record for seven 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. If the Jones do it right, they can eliminate the debt completely. This does not always 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.
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.