Filing for bankruptcy can cause other problems
BY TERRY SAVAGE SUN-TIMES COLUMNIST Jul 14, 2006
Updated: May 3, 2013 12:14PM
Originally published: February 5, 2004
February is the official start of the bankruptcy season. All that holiday shopping showed up on credit-card bills that arrived in January. And if you didn’t pay those bills off last month, they’ll arrive again in the next few weeks, plus interest. That’s why you’ll be seeing more of those commercials inviting you to escape the burden of credit-card debt by filing for bankruptcy. Last year 1.6 million Americans declared bankruptcy, and more than a million people have filed every year for the last decade.
But think before you make that decision. No matter what the commercials say, bankruptcy is not the easy way out. And there are some things you should know before you take this drastic step.
Bankruptcy stays on your credit report for 10 years, and it has many lingering effects. You can get credit in the future, but you’ll pay much higher rates. On a home mortgage, a person with a discharged (completed) bankruptcy on his or her credit report could pay a rate nearly 4 full percentage points higher than someone with good credit.
Employers notice, too
A bankruptcy on your record affects your ability to get a job and earn more money. Employers face strict restrictions on the questions they can ask job applicants. That’s why almost every job application includes a waiver that allows prospective employers to pull your credit report. A bankruptcy on your record means you may not even get to the interview stage.
Ignore those ads asserting that bankruptcy will “wipe the slate clean.” Many debts actually survive bankruptcy. Child support and alimony are not excused through bankruptcy. Neither are student loans or back taxes, in most cases. So while bankruptcy might wipe out or lower your credit-card payments, it could leave you with debts still required to be paid.
Chapter 7 vs. Chapter 13
There are two forms of bankruptcy used by ordinary individuals. Chapter 7 of the bankruptcy code wipes out all your debts, except those noted above. But it could force the sale of your home and car if you have more than the allowed equity.
Individuals filing for Chapter 7 may keep $7,500 in a home -- or $15,000 if both spouses file. And you can keep your car if you have no more than $1,200 equity in it.
Otherwise, the asset will be sold, and the secured lenders will be repaid. You can keep the allowed equity, but above that amount,any extra proceeds are distributed by the court to your other lenders.
Chapter 13 requires you to pay back a portion of your debt over the next three to five years as determined by the court. But if you can keep making payments on your home and car, they won’t be sold. The big drawback of Chapter 13 is that over the next few years, the court will allow you to keep only as much of your income as is needed for basic maintenance. Then, after reviewing your planned budget, any extra money you earn will be distributed to your creditors.
There’s been a lot of confusion about whether retirement accounts are protected from creditors in a bankruptcy. The confusion arises because you file for bankruptcy in a federal court, yet state law governs what exemptions are allowed. While 401(k) and 403(b) retirement plans are protected under ERISA pension laws, IRAs are not specifically covered under federal law.
The IRA question
Many state courts, including those in Illinois, have ruled that IRA accounts are safe from creditors in a bankruptcy. But bankruptcy professor Charles Tabb at the University of Illinois College of Law in Champaign notes that assets in a Roth IRA may not be protected. A Roth IRA does not have all the characteristics of the traditional IRA, since there are no restrictions on withdrawal of contributions. So that’s still an open issue.
Deciding which type of bankruptcy to file, and what is protected are but a few of the issues that arise during a bankruptcy.
But before you call an attorney, here’s one more suggestion that could save you a lot of time, pain and even money. Call the Consumer Credit Counseling Services at (800) 388-2227 to be connected to the nearest local office. A consultation can be done in person, or over the telephone, and you’ll get straight advice about whether to file for bankruptcy or seek a better way out of debt.
When you consider the cost and pain of bankruptcy, counseling is worth a try. And that’s The Savage Truth.
Terry Savage is a registered investment adviser and is on the board of the Chicago Mercantile Exchange. She appears weekly on WMAQ-Channel 5’s 4:30 p.m. newscast, and can be reached at www.terrysavage.com.