Life after bankruptcy
Road to financial recovery is long but navigable, if you explore your options
NEW YORK (CNNfn) - Let's face it, Americans could use a refresher course when it comes to money management.|
The personal savings rate stands at less than one-half of a percent of household income. Debt levels, fueled by credit card mania and wealth effect optimism, continue to soar.
And last year alone, more than a million cash-strapped consumers made their way to bankruptcy court seeking federal protection from creditors and a chance to begin anew.
Unfortunately, experts say, many could just as easily have solved their problems using alternate means -- and saved themselves lots of headaches down the road.
"The bankruptcy laws were really intended to help out those who were struck by catastrophes, but they've been really used a lot by overextenders to sort of bail themselves out," said Joel Tricknor, a certified financial planner and chairman of a federal credit union in Reston, Va. "There are penalties for this, though, that people don't understand. It really does wreck your credit for a long time and it's going to affect your ability to buy a car and get a mortgage in the future."
Many employers, Tricknor adds, also unearth bankruptcy filings in background checks on prospective job candidates.
"A bad credit rating won't help you out there either," he said.
Joy Thormodsgard, chief operating officer of the National Foundation for Consumer Credit in Silver Spring, Md., agrees, noting anyone facing a financial crisis should first consider their options before making a move.
"We don't like to see people file for bankruptcy unnecessarily," she said. "We don't think it's an evil thing, but it is a last resort and it has the disadvantage of making it more difficult to borrow money at an affordable rate in the future. It also stays on your record a long time. It's not something you want to do unless it's absolutely necessary."
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Keeping up with the Jones'
By definition, bankruptcy is a legal procedure for dealing with debt problems under Title 11 of the U.S. Bankruptcy Code. It provides protection for individuals and businesses who are unable to meet their financial obligations with lenders.
The three main categories are:
Chapter 7: Total liquidation of a company or individual, whereby assets are distributed to creditors.
Chapter 11: This type of filing allows companies or consumers to implement a reorganization plan free from the threat of creditors' lawsuits. These plans generally must be approved by a majority of the creditors.
Chapter 13: Bankruptcy protection available to individuals who prove they can no longer meet their financial obligations and promise to pay as many creditors as possible from all available income.
Federal and state laws govern how much an individual must repay to creditors using existing assets. Some states -- including Florida and Texas -- are generous, allowing bankrupt filers to keep from creditors their homes, certain annuities and other securities and assets. Other states are more rigid, requiring filers to cough up most of what they own to repay their debts.
According to the American Bankruptcy Institute, some 1.3 million personal bankruptcies were filed last year. That number was down more than 8 percent from year ago results when 1.4 million Americans filed -- the first decline recorded in four years.
"The tidal wave of new bankruptcies appears to have subsided somewhat," said Samuel J. Gerdano, executive director of the ABI. "However, the high rate of filing demonstrates that U.S. consumers are still under financial stress, notwithstanding a healthy economy."
Congress is concerned as well.
Lawmakers on Capitol Hill are considering -- and reportedly are close to passing -- legislation that would over overhaul U.S. bankruptcy laws and make it harder for individuals to use the system as a crutch.
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Who files and why?
Contrary to popular belief, the leading cause of personal bankruptcy filings is not financial recklessness or overextension. At least half occur because of divorce or sudden illness, which can lead to a loss of employment.
Tricknor said women, in particular, sometimes have a hard time making ends meet after a divorce.
"The woman may be in a job that is not terrifically high-paying and that was fine when she was married, but as soon as the divorce is settled she finds herself financially stretched," he said. "The car payments and house payments just get (to be) too much."
Other bankruptcy triggers, he said, can be the promise of a bonus that doesn't come through, or a promotion you thought would pull you out of the hole.
Still, though, it's those who rack up the credit card bills and dig their own hole who get the media attention. It may be less forgivable in the minds of many, but fortunately for them, it's also the easiest of the three categories to correct.
"I see quite a number of these people," said Tricknor, who counsels troubled borrowers. "These are the ones who are trying to keep up with the Jones' and they've used their credit cards to the max and they are probably the easiest one to deal with because you can advise the person or couple to seek credit counseling."
Tricknor said there are lots of debt counseling organizations and non-profit groups set up to assist consumers struggling with debt. Indeed, debt levels have a direct effect on bankruptcy filings, rising and falling together. The reason is simple -- consumers saddled with big home and auto bills and little safety net savings are the ones who slip off the financial treadmill fastest when the unexpected strikes.
Among the groups set up to assist individuals is the Consumer Counseling Centers of America, which provides both online and in-person financial counseling at more than 1,500 locations nationwide. The CCCA is operated by the NFCC.
For a nominal fee of about $10, debt counselors will sit down with consumers and map out a financial recovery plan. That often entails guidance on how to create budgets and sometimes requires consumers to consolidate their bills into one low-interest loan. In other cases, the CCCA representative will meet with your creditors and ask them to reduce or eliminate late payment fees and interest charges.
Most creditors, when faced with the option of getting pennies on the dollar under a bankruptcy filing, agree to lower the minimum monthly payments required as well. Such negotiations can help consumers reduce their monthly bills by 30 percent or more, not to mention get them back on their feet.
You can contact your local Consumer Credit Counseling office for financial counseling at 800-388-2227.
"They can learn about budgets, review their debts and see what the causes of their debts are to begin with," Tricknor said. "Spending can be a disease, like alcoholism."
Restoring your credit
For some, filing for bankruptcy is the only way out, giving you get a chance to start over, and put a stop to the persistent phone calls of creditors. But you don't get a clean slate.
Personal bankruptcies stay on your record for seven to 10 years, depending on your jurisdiction. That, in turn, causes your health and auto insurance rates to climb. It also makes it impossible to land anything close to the best available mortgage rate.
"Insurance companies often check credit reports and their rates are based solely on risk," Thormodsgard, of the NFCC, said.
If you're having troubling paying your bills, experts say the first thing you should do is contact your creditors. Let them know what's going on. Again, many are forgiving if it's your first offense and will allow you to set up a lower-payment, but longer-term repayment plan.
If you've already got a bankruptcy filing behind you, and are looking to restore your broken credit rating, you should start by getting a copy of your credit report to determine what went wrong and which areas need the most immediate attention.
"You want to make sure that everything on your report is accurate and then build a plan on how to rebuild your credit," Thormodsgard said.
If you've been denied credit, you have up to 30 days to obtain a copy of your credit report for free. You can call Equifax: 800-685-1111; Experian: 800-682-7654 and Transunion: 800-916-8800.
Second, Barbara O'Neill, a CFP and professor of family sciences at Rutgers University advises consumers to take out a secured line of credit at the bank. That means you'll have to back up your credit line with collateral of $500 to $1,000 in an account, but it's the only way many lenders will give you a second chance.
You can also apply for a few department store credit cards.
"Local stores are more likely to issue you a card than national card companies, and as soon as you get those bills you'll want to pay them promptly from this point on," Thormodsgard said. "Remember, you are the only one who can set the priority and make the choices about financial situations. You want to control your money, not let your money control you."
Once you've secured a line of credit, whether it be bank loans or plastic, be sure you pay your bills and pay on time. It's a good idea, too, to begin paying for as much as you can in cash -- since it's easier to monitor your spending habits when you're shelling out dollar bills.
Set a budget and stick to it. And be sure to begin tucking money away into a rainy day fund in case the unexpected strikes. A good rule of thumb is to save six months of your salary in an accessible account, though that can build over several years.
Lastly, keep in mind that bankruptcy is not the end of the world. With dedication and some fiscal restraint, you'll be back in good graces with the lending community in no time.
"If you are struggling, there are always choices and ways to solve your situation," Thormodsgard said. "For some it could be bankruptcy, but the most important thing is that you review all of your options before making a decision. Bankruptcy isn't the only solution in most cases."