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Skipping a Chapter
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November 16, 2001: 6:49 a.m. ET
Consumers should examine all options before the last resort of bankruptcy.
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NEW YORK (CNNmoney) - For a nation already struggling with consumer debt, the current economic slump brings no peace of mind.
Many individuals are fending off creditors as they fall behind on their monthly bills, having poorly managed their cash flow in the heady 1990s. Others are scrambling to file for bankruptcy protection before lawmakers make it harder to wipe the slate clean.
And now, as layoffs gain momentum, insiders expect the number of borrowers who throw themselves upon the mercy of the courts to take a turn for the worse. Unfortunately, much of it could be avoided.
"We've seen record numbers of bankruptcies every year," said Fritz Elmendorf, vice president of communications at the Consumer Bankers Association. "The lending industry feels there are a number of filings that are abusive and could have been avoided."
Proceed with caution
According to the Federal Reserve Board, the average American household holds $9,000 in consumer debt. Much of it comes from high-interest credit cards and personal loans.
To many, bankruptcy feels like the easy way out, providing a seemingly simple solution for getting creditors off their back. In truth, though, experts say it should be your last impulse, rather than the first. They note bankruptcy has long-lasting implications as it mars your credit for seven years, making it tough to buy a car or home with anything but the worst possible interest rate.
It also can also hurt your chances of getting a job if a prospective employer decides to check your credit report while doing a background check.
"More than 50 percent of the people who file bankruptcy file it incorrectly, and it is unnecessary in many of the cases," said Steve Rhode, a financial crisis expert at Myvesta.org. "They have plenty of money to pay their bills, but are too disorganized."
Another way
If creditors are beating down your door and debt seems overwhelming, there are other options to consider.
Elmendorf said the main alternative is credit counseling.
Non-profit credit counseling groups, such as the Consumer Credit Counseling Service, which has regional branches across the country, offer confidential help with debt consolidation.
Such groups "work with the client and the lenders to come up with a budget and spending plan," Elmendorf said.
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You can't live under a teepee of credit cards
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Steve Rhode
Myvesta.org |
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A credit counselor usually negotiates a longer loan term on your behalf, which can lower payments. Many times, they also work with creditors to reduce or eliminate late-payment fees. And in some cases, they even reduce your interest rate.
"Our program takes into account past financial history, current history, and we develop a settlement plan which usually requires concessions from the lenders," Rhode said, noting lenders are free to dictate the terms of their own loans and aren't always open to compromise.
Beyond a quick fix for the here and now, he said consumers with chronic debt troubles should also seek out the help of groups like Debtors Anonymous, which help them address the root cause of their troubles.
Beware putting your house at risk
Another option available to homeowners is a home equity loan, but experts warn there are serious risks to watch out for. Namely, failure to pay back your loan could result in a foreclosure on your home.
"A lot of people get a home equity loan and do it on their own, short of going to a credit counseling agency," Elmendorf said. "You can consolidate your credit card debt and have a lower monthly payment that will maybe get you through a squeeze."
But he said due diligence is necessary before using a home equity loan, as some may be misrepresenting their services.
"There are some outfits promoting themselves as not-for-profit loan counselors that are in essence home equity loan brokers," he said. "Their intent is to sell you a home equity loan as a solution to your credit problems and a lot of consumers can fall into a trap like that."
Rhode said there is often a knee-jerk reaction to tap into the equity in your home in times of trouble, but consumers should not forget the fundamental rule that you can't borrow your way out of debt.
"Unless you address the underlying reasons (of debt) you're putting your house at risk," he said. "You can't live in a teepee of credit cards."
When worse comes to worst
Bankruptcy filings remain on your credit report for seven to 10 years, depending on how you file, but credit reports aren't the only problem. You'd be surprised how many forms ask you to check a box if you have filed for bankruptcy.
Not long ago, Elmendorf said bankruptcy would eliminate you from securing credit, but now it knocks you down to sub-prime lending status.
A number of organizations specialize in lending to customers with sub-prime status, but of course the interest rate is significantly higher.
Where things stand now
Those struggling with consumer debt got an extension of sorts last fall when outgoing President Bill Clinton vetoed legislation that would make it harder for borrowers to file for Chapter 7 personal bankruptcy. In essence, it would have forced those able to pay even a fraction of what they owe to file for Chapter 13, which requires them to set up a schedule for repayment.
The bill also would have required consumers to seek credit counseling six months prior to filing for bankruptcy, providing a deterrent to what the credit industry believes has become a quick-fix remedy, rather than a means of last resort.
The Bankruptcy Reform Act is slated to be reintroduced this session as congressional leaders from the House and Senate meet to iron out its wrinkles. Many believed the bill had a better chance of survival with a Republican in the West Wing.
But the events of Sept. 11 shifted the focus of legislation being considered on Capitol Hill and experts now say the bill looks dead for this year. Even so, Elmendorf insists it will be under active consideration next year.
"It's certainly not given up for dead," he said. 
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