Bankruptcy: a Drastic Step but Sometimes the Wisest One

By Ilyce R. Glink and Samuel J. Tamkin
Saturday, March 1, 2008

John Ventura is on a mission to inform consumers about their credit, debt and rights in a bankruptcy.

The director of the Texas Consumer Complaint Center at the University of Houston Law Center, where he is an adjunct professor, is also a bankruptcy lawyer with 30 years of experience. He is alarmed by what he sees going on inside and outside bankruptcy court.

Since bankruptcy laws were changed in 2005, the number of filings has increased around 40 percent, Ventura said.

Before the law changed, bankruptcy lawyers would routinely help a consumer for the cost of the filing fees plus $200, he said. But the cost of filing skyrocketed as the law became more complex. The effect is that those who can least afford it must pay more to their lawyers to file the necessary papers.

Part of the problem is that consumers don't understand when they're able to file, or what debt will be discharged if they do go through a bankruptcy. Ventura, author of "The Bankruptcy Handbook: Everything You Need to Know to Avoid Bankruptcy, Get Rid of Debt and Rebuild Your Credit," said consumers are confused and scared by what they see as a last-ditch effort to get on the right side of their debt.

Consumers typically can file for two types of bankruptcy, Chapter 7 and Chapter 13. A Chapter 7 bankruptcy is a complete liquidation of debt. You can file for this kind of bankruptcy to wipe out most of your debt. A Chapter 13 bankruptcy helps you reorganize your debt. Consumers get three to five years to pay off most of their debts.

If you owe more than $336,970 in unsecured debt (such as on credit cards) or more than $1 million in secured debt, you'll have to file for a Chapter 11 reorganization. If you're a farmer, you'll file under Chapter 12 of the bankruptcy code.

Before you are even allowed to file, you are required to get a certificate of compliance, which essentially means you have gone through a pre-bankruptcy counseling session with a certified counselor. This costs about $50, Ventura said.

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 also requires you to go through a debtor education class while you're in bankruptcy. The class lasts two hours and costs up to $100, although you can ask the credit-counseling agency to waive the fee.

While filing won't solve all financial problems, it is the right move for many, Ventura said, especially those facing foreclosure.

He suggests that you "run" to a bankruptcy attorney if you are about to lose your home in a foreclosure, you think you are at risk of having your car repossessed, your creditors are threatening you with legal action, or the IRS is threatening to collect past-due federal taxes by garnishing your wages, putting a lien on one of your assets, intercepting your federal tax refund or taking some other action.

You should also file for bankruptcy if "your wages are already being garnished, and if your state's child-support enforcement office is about to seize one of your assets, take money from your bank account, intercept your state or federal tax refund, or take some other action to collect your past-due child-support debt," Ventura writes in his book.

Filing for bankruptcy stops the clock on such legal actions. They won't proceed until your bankruptcy has been discharged or the court gives a creditor the right to move forward to collect the debt. If you're about to lose your home, Ventura said, filing for bankruptcy stops the lender from evicting you and taking the home.

There are other advantages to filing. Your creditors will have to stop trying to collect from you, which should be a relief, although they may get some of their money through the bankruptcy proceedings. You may also be able to use the process to reduce the amount you owe to some of your creditors.

Bankruptcy will wipe out the outstanding balances on some types of debt, although others, such as school loans and IRS tax liens, will survive and you will still owe the full amount. Bankruptcy also may help you keep your car and house.

But bankruptcy isn't always the right choice, even if you're overwhelmed by debt. For example, if you have no assets, are over 65 years of age, aren't working and are living on your Social Security benefits or cash withdrawn from a qualified retirement account such as an IRA or 401(k), filing for bankruptcy protection won't help.

One thing is certain: Filing for bankruptcy will stain your credit history for a long time, up to 10 years. Your credit score will drop, and you may have a very difficult time getting access to credit for the next few years. You may also have trouble getting a job, especially if that job involves a company's finances or money. Employers routinely pull a copy of a job applicant's credit history.

And finally, your bankruptcy paperwork will become part of the public record, allowing anyone to peer inside your finances.

To find an approved bankruptcy counseling agency, go to the Justice Department Web site http://www.usdoj.gov/ust/eo/bapcpa/ccde/cc_approved.htm.

Q: I purchased a Florida condominium a few years ago while living in Maryland. I later made the condo my permanent residence. While I was still living in Maryland, I created a revocable living trust for my affairs but did not put the Florida condo into the trust.

I now wish to transfer the condo into the trust but don't know how.

Can I do this myself, or do I require a lawyer?

A: What you need to do is retitle the condo into the name of the trust. You can use a deed that would convey your interest in the property to your trust.

Can you do this yourself? Yes, but you had better be careful. You can obtain a deed to transfer your interest from a title company or closing agent in Florida. You can then contact the local recorder of deeds to find out about specific requirements and additional forms for recording documents in the jurisdiction where the condominium is located. After completing the deed and other forms, you will have to pay the fee to record the document, along with any additional fees required by the municipality.

If you make mistakes, you might pay a high price. You might mess up the title to the property, which could haunt you.

A better idea is to pay a lawyer a couple of hundred dollars to transfer the title for you. You can also go to a title company and work with a closing or escrow agent.

We purchased our retirement home in September. We then put our present home up for sale. It's on the market for less than we owe and is priced about $10,000 less than others in the neighborhood.

We are retiring in October. If we go into foreclosure on our primary residence, can they put a lien on our new home? I'm sure we won't sell our current home by then, and when we retire we will not be able to afford two homes.

Do you have to retire in October? Unless this is a mandatory retirement, you and your spouse should not leave your jobs until you have sold your home.

If you stop paying the mortgage, the lender will put your property into foreclosure and that will trash your credit. In addition, if the lender allows you to do a "short sale," in which your home is worth less than the mortgage, and the lender does not agree to accept the amount from the sale to satisfy the debt, the lender can still go after you for the shortfall.

In other words, you will still owe the lender the missing money from the short sale or foreclosure, and you could continue to have legal troubles. That lender could sue you and put a lien on your new home, causing you a major financial headache in retirement.

Because you still have about six months until your planned retirement date, focus on doing what you can to get your home sold. You may need to make some minor changes or lower the price to make it even more attractive.

If you have done all that you can (including hiring a top-notch, aggressive agent), then you will need to find a way to keep bringing in income until conditions improve in your neighborhood.

If the real estate market does not improve in your area, you will have to approach the lender early about accepting a short sale as full payment of the amount you owe. You should also attempt to have the lender agree in writing not to report the short sale as a negative on your credit report. Instead, the loan should be reported "paid as agreed."

I am 63 and decided to buy my first house. I signed with a mortgage company. They promised me everything and told me I was approved for a certain amount of money.

I asked them if I could have that in writing, and they said they would send the form to me. I have since called and e-mailed. They continue to promise to send this approval document but have not sent it. I have been requesting it for almost two months now.

Aren't they supposed to give me this form? They have pulled my credit report twice and continue to tell me what I can afford, but they will not send anything in writing.

Here's my advice: Ask for your money back.

Tell this mortgage company that if they do not refund your money within 48 hours, you will report them to the state agency that regulates banks and mortgage lenders.

Tell them you know that they are in violation of the Real Estate Settlement Procedures Act (RESPA) for not providing you with a written good-faith estimate of closing costs within three business days of signing the application.

There may be other reasons for this behavior, but this lender is not being upfront with you. If they told you that you would receive the documents, you should have received them. Once they did not send them to you, their failure to deliver as promised should have been a big red flag.

Once you get your money back-- oeven before -- you have to move on and find more reputable business partners. Clearly they're having trouble getting investors to buy their loans, and you don't want to be caught up in that.

I have four credit cards. The first has a $5,459 balance (out of a $6,000 credit limit) at 7.9 percent. The second has a $5,433 balance (with a $6,200 credit limit) at 5.99 percent. The third card has an $8,200 balance (and a $9,000 credit limit) at 0 percent interest until the end of October. The fourth has a $5,039 balance (and a $6,000 credit limit) at 3.99 percent.

With my balances so close to my credit limits, my credit score is suffering. Right now, I have $5,000 saved to pay off some cards. Should I pay off one card, or should I use the money to decrease some of my balances so my balance/limit ratio decreases?

Paying off your cards will help your credit score, but because you can't pay off all your cards at once, you need to be strategic in how you allocate your cash.

If you want to improve your credit score, you're best off paying down your balances so that you have as low a balance-to-credit-limit ratio as possible. In your case, you should pay down card Nos. 1, 2 and 4 by $1,500 each. I'd put the final $500 toward card No. 1, since that card has the highest interest rate.

Your balances on each of those cards will still be slightly more than 50 percent of your credit limit, but because the percentage of debt-to-credit limit will decrease, it will help your score. You should continue making the same monthly payments on each of those accounts (to help pay them down faster) and then throw any available cash toward card balance No. 3, even though you aren't paying any interest on that account.

If you're looking to pay off the cards the fastest (which will also improve your credit score), then use your $5,000 to nearly pay off Card No. 1. You'll have just a $459 balance, which you should be able to eliminate in one to two more months.

Then, take all the money you were putting toward paying off that balance (plus your savings) and start paying down Card No. 2. You should be able to pay off that card in less than six months. When that's finished, you'll need to take the extra cash you were spending (on cards 1 and 2) and divide the amount equally between cards 3 and 4.

The good news is that if you have been able to save $5,000, you have extra cash in your budget to make a huge, fast dent in these payments. As long as you have stopped charging on these (and any other) accounts, you should be able to pay off all your cards within 18 months.

That will dramatically improve your credit score.

An additional thing to keep in mind: If your credit score takes a big hit, some credit card companies have been known to change the terms on their cards and increase the interest rate on the outstanding balances. That change, which is known as "universal default," can hit you hard.

Finally, you should consider the low interest rate you have on each of the cards and calculate how long you have until the rates go up.

If you will still have a balance to pay on the card when the interest rate is scheduled to rise, you might want to pay down a greater amount on those cards.

My father passed away in January. He and my mother owned a principal residence, which my mother may want to sell at some point soon. Is my mother still entitled to the $500,000 home sale exemption on their principal residence?

Yes. A new law permits her to take his exemption if she sells in the next two years.

She will be able to shelter up to $500,000 in profit as long as she has lived in the house for two of the past five years.

My grandfather, a lifelong resident of Florida, quitclaimed his house to me before he died a few months ago. In 2006, he took out a second mortgage for $40,000, using the home as collateral. He did not have any insurance on the loan, so I was told by the issuing bank that I would have to continue to make the payments.

What are my responsibilities regarding the loan? I would like to maintain ownership of the home and use it as a rental property or as a second residence, as I will be moving out of state soon. Is this reasonable, or should I think about selling?

I don't own any other property. I have significant student loan debt but no credit card debt. I'm getting divorced and have a 4-year old child.

The home is now yours. Unless you want to lose it to the lender, you will need to continue to make the monthly mortgage payments. If you can get a good price for the home in this market, you might want to consider selling.

If your situation is such that you might move into the home someday and can afford the mortgage, taxes, insurance and upkeep, then keeping it might work out. Also, if the costs are low enough that it would be less expensive to carry the property than to rent another place in the area when you visit, then that's an important consideration.

If you can rent out the property and get enough cash to cover all of your expenses and more, you should consider keeping it as an investment home. Just make sure you find tenants who will maintain the home and take good care of it.

But be prepared for the time you will spend managing the property from out of state. If you won't be living within a few hours of it, selling becomes a better idea.

After all, who will take care of making sure that everything is going well at the property? Who will go by periodically to make sure that the tenants have not destroyed the home? Who will take care of maintenance issues when the tenants tell you that the roof is leaking or the house needs normal repairs?

Your pending divorce might complicate the issue. If this property is considered part of the marital estate, you may have to sell it to give your soon-to-be ex a share of the proceeds. Please consult with your divorce lawyer on what you plan to do so that it doesn't affect your divorce proceedings.

Finally, since you did not inherit the home but received it as a gift from your grandfather, you might have a tax problem.

When your grandfather quitclaimed the home to you, you took title to the home and accepted it as if you had purchased it for the price your grandfather paid. If he owned it a long time and bought it for a little and now it's worth a lot, you may have federal income taxes to pay on the profit from the sale.

If the home were to become your personal residence and you lived in it for two years and then sold it, you might avoid having to pay any federal income tax on the sale. As a single person, you are allowed to exclude from federal income taxes $250,000 of profit on the sale of your primary residence if you have lived in the home for two out of the prior five years.

But because you are moving, you won't be able to use the home as your primary residence now. If you might be able to do so in the future, then renting it for a while until you can move in makes sense.

Please consult with a real estate lawyer, in addition to your divorce lawyer, to sort through these issues and make a smart move.

Ilyce R. Glink is an author and nationally syndicated columnist. Her latest book is "100 Questions Every First-Time Home Buyer Should Ask." Samuel J. Tamkin is a real estate lawyer in Chicago. If you have questions for them, write Real Estate Matters Syndicate, P.O. Box 366, Glencoe, Ill. 60022, or contact them through Glink's Web sites, http://www.thinkglink.comand http://www.expertrealestatetips.net.

Copyright 2008 Ilyce R. Glink and Samuel J. Tamkin

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