Will filing bankruptcy ruin my credit?

This is a question I get asked all the time. Rest assured, you can repair your credit after bankruptcy.

It’s a common scenario: You have trouble paying the credit cards. Maybe the accounts go into collections. Maybe you give up on paying for a while. So, your credit is not so good anymore.

What affects your credit score, first and foremost, is late payments. So, if you already have a few or even many missed payments, this has affected your credit.

Now, you want to fix the bad credit. So, you try to settle with some of those collection companies. Sadly, this will not actually fix the problem. The creditors have no obligation to stop reporting the past due payments. And if you settle the debt for less than what was owed after they tacked on late fees and penalties, they add another negative notation, “settled for less than the full balance”. That negative notation will stay on your credit for seven years before it ages off your report. It’s like seven years of bad luck.


But, if you file a bankruptcy, here’s what happens: your credit score goes into limbo while your case is pending. But after the case is over, you have a different credit profile. Sure, there’s a bankruptcy filing on your credit as a public record. But those accounts that had late payments and charge offs and settled balances suddenly go from outstanding balances and bad debt to “discharged in bankruptcy”.

This won’t start repairing your credit all on its own, but it’s your fresh start. Now you can start taking steps to put good notations on your credit report to boost your score.

Often you hear about how filing bankruptcy ruins your ability to get a credit card for ten years. But this just isn’t the case. You’ll get credit offers in the mail even before your case closes. The reason? They know you can’t file chapter 7 bankruptcy again for eight years. They figure they’ll get paid.

So, use credit, use it sparingly, and use it wisely in the year after you file a bankruptcy, and instead of seven years of bad luck, you could have good credit again within months of getting your fresh start.

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How to Avoid Bankruptcy… and End Up Filing Anyway

Every day I with clients who all say the exact same thing.

“I don’t want to file bankruptcy.”

Well, of course you don’t. No one, and I mean nobody, wakes up thinking bankruptcy is a fun thing to do.

So, what do they usually do? Any one of these things…

Debt Settlement: sometimes this works. Sometimes it even saves them money. Until they find out that they pay taxes on the forgiven amount of settled debt. Then they get mad.

Work like crazy to try to pay: sometimes this works. More often, it does not, and the inevitable result is they wasted money trying to pay the creditors when they could have saved that money for retirement, paid their bankruptcy attorney, or bought groceries.

Ignore it: Yes, this is actually a valid course of action. People employ it. And it works… for a while. But eventually, they might sue you. If you get a summons, you should actually do something. Don’t rely on the court date for the case management conference, thinking you just need to show up at that hearing. You will need to file something with the court.

Consult an Attorney: yes, you should do this, even if you think there’s no way you want to file bankruptcy. First off, you may not need to file bankruptcy. But, you should still talk to someone who can explain your legal options. After talking with the attorney, you may still employ one of the above tools, but at least you will do so armed with some knowledge about what creditors can and can’t do and say, and what you can do to react to anything a creditor does or says.

Believe me, the collection guy is not your friend. He will say whatever he has to to get you to pay. That is his singular goal.

Your singular goal should be to protect yourself. And the first step is to get some advice and arm yourself with knowledge. That’s how you avoid bankruptcy.

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What is a Proof of Claim?

One conversation I often have with clients is, “I got a letter in the mail. It says Proof of Claim on it. What is that and do I need to do anything?”

A Proof of Claim are really just the piece of paper a creditor files letting the court know they are owed money from the person filing bankruptcy.

Your attorney might need to do something about it, but you as the bankruptcy client should usually simply file it for your records.

For example, American Express credit card files a proof of claim. They may or may not get any money from the chapter 13 trustee, depending on what your chapter 13 plan provides. If you are paying 100% to your unsecured creditors, your attorney needs to review that claim and see if it is correct. If you are paying zero to your unsecured creditors, it doesn’t matter what the claim says, the trustee’s office will pay based on the plan provision and that creditor gets zero.

Another example is when your mortgage company files a proof of claim. This is a bit more complicated. They will need to list the secured amount of debt. Plus, sometimes there will be an arrears amount listed. This is usually not a problem if you are paying mortgage arrears as part of your chapter 13 case.

Sometimes, the client has other reasons for filing a chapter 13, and no mortgage arrears are provided for in plan. In this scenario, your attorney will need to be paying attention. Your attorney will need to go through the process of objecting to the proof of claim to make the claim match your current plan, or amending your chapter 13 plan to pay this claim.

Proofs of claim can be complicated matters. The objection process can be cumbersome. Make sure you have good legal counsel to defend your rights in your chapter 13 case, so you don’t end up paying creditors more than you have to.

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Why you should file bankruptcy before the end of the year

Everyone is talking about the fiscal cliff, but do you know what they are really talking about?

The fiscal cliff is the name for the fear many are feeling about the failure of Congress to pass a budget in the face of many tax breaks expiring at the end of 2012.

This article does a pretty good job explaining how nearly everyone can expect to pay more in taxes for 2013 because of the fiscal cliff.

So, what is the average person to do?

If you’re considering filing for bankruptcy, you need to do it now. There are a few reasons for this.

1) Bankruptcy attorneys are far busier during the spring. This means they will often charge lower fees in November and December than during the spring when they are as busy as accountants at tax time.

2) You should be spending what money you have on getting your financial situation straightened out, not blowing your money on Black Friday deals. Let’s face it. You’re kids will enjoy the toys you buy them for about two weeks. Most everyone else you know doesn’t much care about presents. If you are struggling financially, you should not be wasting your hard-earned money on presents in an effort to convince yourself you are doing well. Scale back: it’s the mantra of this generation. Embrace it for yourself.

3) If you own a home, there’s a huge problem looming right now. The Debt Forgiveness Act expires at the end of 2012. In California, the bank can only take the house, not demand the deficiency balance from you (the difference between the value of the home at the time they foreclosed and the amount owed on the mortgage). But they are obligated to report that foreclosure event to the IRS. That means you pay taxes on that difference. And right now, you house could be hundreds of thousands of dollars under water. That’s a nasty shock when you have to pay taxes on extra “income” for a house you don’t even own anymore.

Until the end of 2012, if you lose your home to foreclosure, you can apply for debt forgiveness on that amount. But with the start of 2013, all that’s over.

So, again, if you have that nagging feeling that you might need to do something about your financial situation, go get some good advice.

Maybe filing isn’t right for you.  If so, the attorney will tell you so and send you on your way. We don’t do what we do to put people in a worse financial position, or file useless cases. But maybe there are consequences you don’t realize if you continue on the financial path you are on.

Filing bankruptcy is not the worst thing. The worst thing is realizing you could have avoided a financial crisis if you have only done something about it in time.

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Filing bankruptcy on your own

I am often asked, “Do I really need an attorney to file bankruptcy?”

The short answer is no. You can certainly file on your own.

But the question remains, how do you file yourself and do a decent job?

Thus, here are my guidelines for the average simple Chapter 7 in pro per filer:

1) Gather up all your debts. Everything from credit cards to medical debt to car loans to mortgage loans to payday cash advances. Pulling your credit will help with this. You can do it for free at www.annualcreditreport.com.

2) Gather up your paystubs for the past seven months, tax returns for the last two years, and consider whether anyone owes you money or you might get an inheritance in the next six months or so.

3) Assess everything you own. Everything. Clothing, furniture, pots and pans, jewelry, firearms, golf clubs, artwork, collections, cash around your house, bank accounts (even if they have a zero balance), retirement accounts, life insurance policies, annuities, that old oil stock your grandma gave you when you were ten, and make a list of every last thing. Find a value for each and every item.

4) Look up the exemptions for your state. Figure out which statute goes with each and every last thing you own. Don’t mess this up. Failing to exempt means the trustee can take it from you and failing to list the items you own could mean the court decides you don’t get to discharge your debt.

5) If you owe money for something like a house or car, those are secured debts. If you owe money on taxes, child support or alimony, or you hold a security deposit for a tenant, those are priority debts. Everything else is unsecured debt. Put each debt on the right schedule. Even the money you borrowed from mom. Tell mom you are filing so she doesn’t call you when she gets a notice from the court.

5) Start working your way through the forms. There are a lot of them. Read it all. Answer every question.

6) If you are married and filing in California, don’t forget to list everything your spouse owns that has been purchased since getting married. All of that must be listed, too.

7) Read carefully the questions in the Statement of Financial Affairs. Don’t fail to disclose businesses, sold property, garnishments, lawsuits, payments to creditors, and previous addresses and spouses.

8) If you find this overwhelming, get a competent attorney to help you. Not all attorneys practicing bankruptcy will be more competent than you at doing this. Find out if they file regularly. Do they appear well organized? Do they instill confidence in you? If they do and you can come up with the money to pay them, do it. This is your financial life. You need to get a grip on it and get on with the rest of your life.

9) If you still want to proceed, get the paperwork done and take it down to the court. Pay the filing fee and get your copy stamped.

10) Attend the meeting of creditors. Get the required documents to the trustee at least a week before the meeting of creditors. Otherwise, you will have to take another day off work to go back two weeks later because they won’t hold your hearing.

11) Do the exit counseling. File it with the court.

12) When you get your discharge, keep the order. You may need it later to do battle with a persistent creditor.

13) Follow up by pulling your credit regularly to check and see that the discharged debts are properly reported as discharged.

And that is a bare bones list of the tasks you need to accomplish to file a bankruptcy on your own. Remember that help from a competent attorney doesn’t have to cost an arm and a leg. But trying to save a little money could cost you your tax refund, your car, or even your home. Trustees have started selling people’s homes in short sales. Be sure it’s worth the risk before you elect to save $1,000 or $2,000, so it doesn’t cost you far more. 

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Can I Contribute to My Retirement Account During Bankruptcy?

One question clients often have when considering bankruptcy is, “Can I still contribute to my retirement while in bankruptcy?”

The answer used to be, “Yes.”

But the 9th Circuit may have turned that around with the Parks case.

The Parks filed their Chapter 13 case, and by taking a deduction on the Means Test for their voluntary 401(k) contributions, they ended up with a zero percent dividend to unsecured creditors.

The Means Test determines, in Chapter 13, whether the Debtor will have to pay money to their unsecured creditors. This is a monthly amount in addition to other debts that must be paid through the plan, such as mortgage arrears and priority taxes. Simply put, if the number at the end of the Means Test is zero or negative, the Debtor owes no dividend to their unsecured creditors.

In the Parks’ case, the Debtors had a positive number before their 401(k) contribution, and a negative number after they deducted those voluntary contributions.

The Court held that it is impermissible for a Debtor to pay themselves at retirement before paying unsecured creditors in their current Chapter 13.

This raises another question: if a Debtor has a zero percent dividend on the Means test without considering voluntary retirement contributions, yet lists contributions on Schedule I and J, does this mean the trustees will now be objecting that more money should come into plan, no matter what the Means test dictates? We’ll have to stay tuned to find out.

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If I’m Married, Do We Both Have to File Bankruptcy?

This is a common question I hear from prospective clients. And the answer is, no. Even if you are married, you can file your own bankruptcy case.

The corollary to this question is: if I file, will it affect my spouse?

The answers are: yes, no, and no one knows for sure.

Well, that was clear as mud.

Okay, a little explanation. Yes, it will affect your spouse in a good way. In California, there are three ‘people’ in a marriage: one spouse, the other spouse, and the community. When one spouse files for bankruptcy, the community files, too. This means that, even though the other spouse is not a Debtor, any debts of the community (essentially debts that happened during the marriage) are debts that are discharged when the one spouse gets their discharge.

The flip side of that coin is that community claims come into the bankruptcy as well. This means that any creditor who could make a claim against the community can make a claim in the bankruptcy. For example, say one spouse has a tort claim brought against them. Even if the other spouse filed a bankruptcy, that tort claim would be a claim to be discharged (or not) in the bankruptcy case.

So, how does the filing NOT affect the other spouse? Well, theoretically, the other spouse will not have a bankruptcy notation on their credit report as a public record. Of course, mistakes in credit reporting do happen, but generally, the non-filing spouse will avoid the later ramifications of having to disclose that they filed bankruptcy, which can become an issue when trying to get a house or car loan.

The non-filing spouse can keep their credit cards. I often don’t think theyshould, but they can.

Additionally, if the non-filing spouse owns separate property (stuff they received by gift, inheritance, or owned prior to the marriage), that property is protected from a hungry trustee looking for assets to take.

The “no one knows” kicks in when prospective clients ask, “How will my filing affect my non-filing spouse’s credit rating?”

So much has happened in the last few years related to credit and lending that it’s extremely difficult to predict with any accuracy whether your non-filing spouse might take a credit rating hit when you file. For example, if you have joint credit cards, it’s likely those cards will be closed by the credit card company. Closed accounts can ding your score. If accounts are closed, other creditors who do soft pulls on your credit may restrict credit lines because it appears to them you are an increased credit risk. That could, in turn, ding your score.

However, in an effort to continue lending, and lending to subprime borrowers in particular, the credit industry is trying to find new ways to score people to be able to grant credit.

So, can you go it alone. Absolutely. Should you? That will depend on your individual situation. Talk to a good lawyer about your options. The consultation is often free, so get some information before deciding what to do. It’s your financial life we’re talking about here.

P.S. Please, please, please stop caring so much about your credit score. I always end up spending time trying to explain to clients why they should not be concerned with their credit score above other considerations, like living within their means (which means not using credit cards), creating an emergency fund, and saving for retirement. Who cares what your credit score is? It only measures your ability to incur more debt. Why do you need more debt? You need LESS debt. Say it with me people: we need LESS DEBT. And that’s all I have to say about that. 

P.P.S. If you don’t live within your means, have an emergency fund, AND consistently fund a retirement account, please stop giving money to your adult kids. Let them make their own way in the world by giving them the gift of independence rather than the burden of knowing you have spent yourself into the poorhouse giving them money you couldn’t afford to spare.

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5 Myths About Rental Properties and Bankruptcy

A theme I keep running into lately is potential clients who have a home that is their principal residence plus a piece of rental property. It seems there are a lot of misconceptions about the consequences of owning rental property. Thus, 5 myths about rental property and bankruptcy…

Myth #1: If I have rental property that is operating at a monthly loss, I am stuck with it until it has equity.

This could not be further from the truth. But, there are bad ways to dispose of properties and better ways to dispose of properties. For example, say you are nearing retirement and have your own home, plus two small rental properties that do not pay for themselves. Say those properties cost you a net loss (when you calculate mortgage, taxes, insurance, and maintenance expenses) of $300 per month. Of course, this may not seem like much. A few hundred dollars spent per month, but you have property.

Hogwash. Remember I said you are nearing retirement? Why in the world would you spend $300 per month on property that might have a hope and a prayer of having actual equity in about a dozen years when you could be putting that money toward retirement, or in savings, or paying down the mortgage on your own home to eventually eliminate your house payment? Owning those rental properties is just a legal fiction of ownership on paper. You own nothing. In fact, these properties are slowly sucking you dry.

Get rid of it. Stop the bleed.

But, how do you do it? Well, you need to understand how owning a rental property affects you legally. First, remember that if that rental goes to foreclosure, you will likely receive a 1099-C for miscellaneous income on the forgiven debt. What does that mean, exactly? It means the difference between what you owed on the property at foreclosure and the current market value of the property at foreclosure presents a gap. Say the property was only worth $150,000 at foreclosure. You owed $300,000 when they foreclosed. Now, you will have to report to the IRS that you had the difference of $150,000 in income on your taxes. If you are in a tax bracket that results in 14% tax, that’s a tax bill of $21,000, aside from your other income tax.

Yeah. Not so pretty. 

Myth #2: I can’t or shouldn’t file bankruptcy to deal with rental property issues.

Wrong. Now, building off the example above, say you file a Chapter 7 bankruptcy before stopping payments on that rental and surrender that property in the bankruptcy.

What many people do not realize is that, a foreclosure in bankruptcy is fundamentally different than a foreclosure after a property is surrendered in bankruptcy. There are absolutely intricacies and nuances that you should speak with an attorney about, but generally speaking, surrendering a rental property in a bankruptcy will yield a better result than just abandoning the property and letting them have it.

The magic number is 1082. That’s a form that your tax person can include with your tax return that, in essence, says, “hey, I know I didn’t pay this debt, but it wasn’t forgiven debt, it was debt that was discharged in a bankruptcy, so I won’t be required to pay taxes on that.”

That’s pretty powerful stuff. In the scenario above, it’s the difference between paying $21,000 to the IRS or not.

Myth #3: So, if I surrender a property in bankruptcy, it can wipe out all my tax obligations related to that property.

Unfortunately, the bankruptcy can’t do everything for you. And it can’t wipe away all tax obligations.

Most people don’t notice what their tax accountant is doing, but if you pull out your previous tax returns, you’ll probably see that your accountant took a depreciation on that rental property each year leading up to you deciding to dump it.

When that house goes, capital gains tax rears its ugly head.

And the bankruptcy can’t fix that for you. Not before the fact or even if you file after (unless the tax is so old that it is dischargeable and no lien has been filed by the IRS, but that’s a whole other blog post). So, capital gains, you are stuck with. Boo.

But it’s still not as bad as a $21,000 tax bill plus capital gains tax to boot.

Myth#4:  If I do a short sale, this will help me avoid all these problems with foreclosures and taxes.

I disagree. Of course, you’ll find real estate agents who blatantly practice law without a license by espousing the benefits of a short sale over a foreclosure or a short sale over doing a bankruptcy, but you need to remember two things about this conversation with the real estate agent. 1) they want your listing because they will get a commission off the sale, and 2) they are looking at only one aspect of your financial situation, which leads to a simplistic view of your options.

If you have credit card debt, issues with your own mortgage being overly expensive, tax issues, or even a car payment that is expensive for you, you could take care of a whole myriad of issues with a bankruptcy, whereas a short sale only handles the issue of that one property. It’s kind of like putting ointment on a sore when what you really should do is go to the doctor and get an antibiotic that cures the underlying infection. Sure, the ointment will spot treat, but it doesn’t do as much as the medicine that treats the disease itself.

Consult with an attorney. Most bankruptcy attorneys don’t even charge for a consultation, but even if it costs you $150, it’s money well spent.

Myth #5: If I already let a rental property go to foreclosure, a bankruptcy won’t help me.

This may or may not be true, but I would hazard a guess that 9 times out of ten, it’s false.   

The typical scenario I see along these lines is the client who waited until after rental properties foreclosed and does not want to do bankruptcy, so they figure they’ll just keep paying on everything because eventually they will be able to take care of it.

The problem is, if you have a tax debt, you need to address that first (or last, depending on how you look at it.) For example, say you have $40,000 in credit card debt, and now you got your taxes done and are appalled to realize you also have a $20,000 tax debt on a foreclosed rental. You think, well, I’ll just wait to pay the IRS, or pay them $150 a month on an installment agreement while I also pay on the credit card debt. I mean, I borrowed the money so I should pay it.

Yet you also have absolutely no savings, very little or no retirement, and are not currently contributing to a retirement account.


So, let me get this straight… you have no money in case you lose your job, you have no plan for retirement, but you are still paying for that pizza you ordered three years ago, the sheets you bought at Macy’s five years ago and already have holes in them, and a rental property you don’t even own anymore. And the IRS taxes. And interest on all of it. All at the expense of your short-term and  long-term future financial security? 

I’d say doing the dreaded bankruptcy is not as bad as being in financial ruin for an indefinite period and facing the prospect of living on only $1,000 per month social security if you are later unable to work until you die. Bankruptcy is there for a reason: to give you a fresh start. Let it help you accomplish that if you need it.

As a final note: the IRS recently loosened up their requirements for accepting an offer in compromise on tax debt. While a bankruptcy won’t wipe away the taxes, why not wipe away the debt that can be extinguished, and then deal with the IRS to the best of your ability by seeing if you can get an OIC granted. Some attorneys do tax law, bankruptcy, and modifications. Try to find an attorney that has the skills to do more for you, rather than less. 

That would be the ultimate fresh start.

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The High Cost of Credit Card Debt

I love little calculators that help illustrate what we already should know anyway, but tend to ignore.

So, this calculator is my new favorite gadget. I wish I had this calculator embedded on my website for every visitor to use.

It takes you credit card debt and figures instantly how long it will take to pay off your debt, many cups of cappucino you could buy with that money spent on interest, how many tanks of gas you could buy, how many iphones you could buy, and how you compare to the national average for credit card debt. Then, if you like, you can sign up for the free site that will help you develop a plan to get that debt down to zero.

Luckily, I have only $987 in credit card debt, so my numbers are small. But if you have thousands, this is a great way to see what direction you’re headed with that debt. 

And if it will take you many years to pay it off at minimum payments and the “plan” the website devises for you isn’t feasible, you might want to consider getting a fresh start. Chapter 7 isn’t for everyone, but if you have as much credit card debt as your salary for the year, the odds aren’t so good that you can actually pay all that off, no matter how cool the website is.

But it is cool. And you should check it out. What better time than now to get a grip on your finances?

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Credit Scores: Should I Pay to Know How Good (or Bad) It Is?

In keeping with offering tools I’ve found to help you with your finances, I want to share a site that will help you with your credit score.

Don’t get me wrong, I think most people focus too much on their credit score. I hear it from almost every potential client. “But if I file Chapter 13 to cure my mortgage arrears, discharge credit card debt, and get current on taxes, what will (gasp) happen to my credit score?”

That is a loaded question for me. First of all, note that the statement acknowledges the client is behind on their mortgage. What do you think happens to your credit score when you’re behind on your mortgage? It tanks, of course!

Second, let’s think for just a second about what a “good” credit score actually means.

Usually when I ask that, the client blinks at me for a few seconds…

You’re credit score only measures your ability to incur more debt.

That bears repeating: Your credit score only measures your ability to incur more debt.

So what does that mean to the person in front of me who is behind on their mortgage and taxes but current on credit cards and balking at filing Chapter 13 in a vain effort to save their credit score?

It means their credit score really should mean nothing to them. Why? Because they need to get out of debt, not get more. They need to stop paying on unsecured debt and start working on their secured debt and their tax debt.

But I digress.

So back to credit scores. And me being cheap, as I mentioned a couple of posts ago.

I don’t see the point in paying to know my credit score- and now I don’t have to.

As long as I don’t mind the ads, I can see my credit score on Credit Karma for free. They’ll even tell me ways to improve my score, like paying down balances, and they have little charts that show me how my score might improve if I make different changes.

Super cool. And cheap. Free even. And that just makes me happy.

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