ALTERNATIVES TO BANKRUPTCY

Nobody wants to file bankruptcy unless it is their last option. In my office, I have every client sign a paper indicating that they believe that bankruptcy is their last option. Listed below are some ways to handle debt problems that do not involve bankruptcy.

Pay Creditor As Required By Your Agreement With The Creditor:

Although that is an option, you wouldn’t be reading this if it was really a VIABLE option for you.

Keep Doing What You’ve Been Doing To Handle Your Debt:

This usually involves choosing which bills to pay first, if at all. Although that is an option, it is most likely NOT a viable option for you. If it “doing what you’ve been doing” can work for you, then you wouldn’t be looking into other options. So, you have to do something different.

Do Nothing:

What I mean by this is to simply stop sending any more debt payments to your creditors. Now, this is NOT a perfect solution because not paying your debts can create larger problems later. This is NOT a strategy for secured debts, like a home loan or car loan, because if you want to keep your possessions, you must continue to pay for your possessions. Although this alternative makes it impossible to start financial recovery, this can be a viable option for people that don’t have a lot of cash in the bank, and their source of income is VA Disability or Social Security, and their problem debts are credit card debts.

Enter Into A Debt Management Plan or Debt Settlement Plan:

A Debt Management Plan is one where you make a monthly payment to a debt management company, and that company sends the creditors in the plan a monthly payment. The difficulty with this type of plan is that it requires the agreement of your creditors to work, and certain creditors like home lenders or car lenders will never participate in such an arrangement. About 8 out of 10 people that I see in an Initial Consultation tell me that they have either tried a Debt Management Plan, or a family member has, or they already checked into it. Each person that I see in an Initial Consultation that is already familiar with this option, has told me that a Debt Management Plan requires a large monthly payment, and they found that the Chapter 13 Bankruptcy plan payment to be cheaper. Also, a Debt Management Plan hurts your credit score because you’re not paying as agreed.

A Debt Settlement Plan is one where you make a monthly payment to a debt settlement company, but NO monthly payments are made to creditors. Instead, the debt settlement company holds onto the money until it receives several thousand dollars from you. After that point, the debt settlement company will contact your creditors to negotiate a settlement in the range of 60% less than what is owed. Some credit card companies may agree to that, but they want ALL the payment at once. Most of the people that I see that have tried a Debt Settlement Plan have come to me for help because they have just been sued for a credit card debt that has not been paid in months. If the debt settlement company is actually successful in settling a debt of yours for 60 cents on the dollar, a Form 1099 is going to be filed with the IRS to inform the IRS that you have been relieved of the remaining 40 cents on the dollar of the settled debt. Relief from debt outside of bankruptcy is treated just like income. So, don’t use all your cash settling your debt, or else you won’t have enough money to pay the IRS. The best example of this is the guy who came into my office to say that he was so proud that he was able to settle his $60,000 of credit card debt for the $20,000 he had in savings. He came into my office when he received $40,000 in Form 1099s that were sent to the IRS by the credit card companies that settled for less. I told him that he didn’t have a debt problem, but he had a tax problem with the IRS. He wasn’t happy about the IRS problem, and he became depressed when I showed him how he could have taken care of his debt in a bankruptcy case, while at the same time holding onto his cash. Doing it his way, he had no cash left and he owed the IRS $8,000 on the $40,000 that was written off by the credit card companies in settlement of his debts. Owing the IRS $8,000 is worse than owing credit card companies $40,000 or $60,000, because the IRS can take your stuff and garnish your paycheck.

Get a Home Equity Loan To Pay Bills:

You can get a Home Equity Loan if you have a house with some equity and you still have good enough credit to obtain a loan. For some people this can work well, but a new loan isn’t going to get you debt free. Only paying off the new loan gets you debt free. Clients that obtained a Home Equity Loan to pay bills used the money to pay credit cards because it reduced or eliminated their monthly payments on credit cards. By the time that those clients found me, they learned a HUGE downside to getting a Home Equity Loan to pay credit cards: it replaces unsecured debt (i.e. credit cards) with secured debt (the new mortgage). What that means is that, if you can’t make your credit card payments, then the credit card companies can hound you for payment but they can’t take your home. However, if you ever get in a position where you are unable to make your Home Equity Loan payment, you will lose your house in foreclosure. There is a general rule: if you want to keep your possessions, then you must continue to pay for your possessions. So, it is important to realistically look at your ability to pay a Home Equity Loan over the next 15 to 30 years that you will have the loan. Be sure to consider the possibility of losing your job or getting disabled in the next 15 – 30 years, before you sign-up for a Home Equity Loan.

Borrowing Money From You 401(k), or Taking A Distribution From Your IRA.

If you use retirement funds to pay debts, then you may be left with little or no retirement funds left for retirement.  Relying on Social Security is risky because it may not be there when you need it, and Social Security probably will not provide you the level of income you want.  Right now, the average monthly Social Security Check is under $1,000. 

If you borrow money from your 401(k), you will be required to pay it back.  If you fail to pay it back, then you will be assessed a 10% penalty and have to pay income taxes to the IRS, which may total 40% of the amount taken from the 401(k).  If you take a distribution from you IRA, then the IRS requires payment of a 10% penalty (If you are younger than 59 1/2) any income taxes on the money taken as a distribution.  Like the 401(k) the penalty and taxes could amount to 40% of the money taken from the IRA.

Many people have come to us to file bankruptcy after they have already taken retirement funds to pay debts that could have been discharged in bankruptcy.  After they learn about their alternatives, they regret ever having reaching into their retirement funds. We recommend that you take a realistic look at your financial situation and the alternatives available to you before you take any retirement funds to pay debts.

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