Declare Bankruptcy, or Tough It Out?


One of our readers, Jill, had this question for us:

Mr. Credit Card,

We have kept up all our payments and haven’t been 30 days late in 5 years. However, we are really struggling.

Our parents are helping us since my husband became Underemployed 18 months ago. It is becoming increasingly difficult to make it each month. We have considered just defaulting, credit counseling and bankruptcy. Which one will look better in 7 years?

How will each affect us immediately? If we default, how long before they will go away? What can they really do to us? Can we even file bankruptcy while we are current?

Is the new bailout likely to help us any? We currently owe 38,000 in unsecured debt, 116,000 on two mortgages on our home which is valued around $120,000 and 30,000 on our two vehicles which are needed to contiue to work. Our income in 2006 was $72,000. In 2008 we expect about$30,000. HELP!!! Any advice is appreciated.

Hi Jill, thanks for your question. You’re definitely in a tough situation, but you do have options.

Let’s talk about what not declaring bankruptcy would mean for you and your husband, and how you might go about taking that path first, then we’ll look at the reverse situation.

Right now, you are $184,000 in debt including your mortgage, car payments and credit cards / loans.

So, my first question to you would be, can you still afford to make your house and car payments plus a minimum payment on each of your credit accounts each month? If you are not making enough money to do that, then it will not take long for you to go past due on something and start the collection cycle. This will most likely lead to bankruptcy no matter what you do.

So, that is your first step. Decide whether or not you can make your minimums. If you can, do not declare bankruptcy. Keep making your minimums until you can raise your income again, and start paying off more than the interest.

Please hear me when I say this is the best thing that you could do for your family. Squeak by until you can run forward by upping your income. If there is a problem with that (and I do not know your situation) then you are going to have to look at your other options.

The general rule of thumb for bankruptcy is that if you can pay off all, or most of your debt in seven years (especially if you can do it on time!) then do not declare bankruptcy. This is not counting your entire mortgage – just your unsecured loans and your car payments. If that is possible, pay the debt instead because you will come out of the experience a lot better off, and you will get to remain credit worthy throughout the journey.

I gave you the seven year figure because that is how long a bankruptcy will affect your credit report, a minimum of seven years. It will show up on your credit report for ten years. Most lenders though, will not care after the seven year mark.

So, now I’m asking you to look seven years into the future. That’s a long time to get things straightened out. I do understand that things are bad right now. Given seven years to fix things, pay down your debt and raise your income, could you do it? If the answer is yes, do not declare bankruptcy. If the answer is no, and you need an immediate solution, then you may want to consider bankruptcy.

My best advice would be this: Do not declare bankruptcy, work second jobs, get as much help as you can, and negotiate with every single lender to lower your interest rates. Use balance transfers, refinance your home and car if you can, do whatever it takes. Bankruptcy will affect you more than you think it will. I completely understand that you are worried, and stressed out, and bankruptcy will take all of those worries away in one quick remedy. It is a quick fix, but with a long, long penalty. That does not mean it isn’t your best option right now though, ok? Let’s take a look at the other half of that scenario.

Well, you asked what happens when you default.

>>If we default, how long before they will go away? What can they really do to us?

Well, if you default on any of your payments, this is the order of operations:

  • You start getting collection calls. If you move, or do not answer the phone long enough, the collection company will call your friends, family members, and anyone listed in the phone book with the same last name.
  • Your payments will be reported as late, and will begin lowering your credit score.
  • Your credit card accounts will be closed.
  • Your debt will be charged off and sold to a real collection company, who will do their very best to harass you within an inch of the law. Calling well before and after allowed times, calling at work, and most likely being rude to you if they do manage to speak with you.
  • The collection agency will file a lawsuit, and if they are able to notify you, you will have to go to court.
  • If they successfully obtain a judgment, (which goes on your credit report as well) then they will garnish your wages until you have repaid the debt.

That’s the “completely hands off, I’m going to pretend that this debt doesn’t exist approach.” That’s what happens where your credit cards are concerned. If it’s your house or your car payment instead, you would be looking at repossession or foreclosure very quickly.Best not to do that because it can actually be more damaging to your credit score than the bankruptcy.

If you have no contact with the collections company, and no way for them to garnish your wages, then the debt does eventually disappear thanks to the statute of limitations. You’ve got to be careful on that one though, because even speaking to a creditor can reset the statute and make you liable all over again.

So, let me just say that you do not have to default on anything, nor go through this long, horrible process to declare bankruptcy. If you know you can’t pay your bills, and there is no way that you can possibly repay at least your credit card debt in seven years, then do not default on anything – go straight to a lawyer while you are current and file bankruptcy. That way the only damaging thing on your credit report is the bankruptcy itself, not tons and tons of late or missing payments and charge offs.

You may have missing or late payments reported on your credit report between the time you file for bankruptcy, and the date your bankruptcy is discharged (90 days). If that is the case, be sure to challenge those items as being included in bankruptcy. Get the late notices removed from your credit report, and make sure the accounts show “included in bankruptcy”.

To sum up, and give you the direct answer to which course looks better –

Paying your bills on time, even if it’s just the minimum will always look better. If you know there is no way that you can handle your current level of debt, and no way to change your circumstances, then the best option is to declare bankruptcy before you go past due with everyone.

Have a question for us? Leave a comment below!

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4 Responses to “Declare Bankruptcy, or Tough It Out?”

  1. Matt @ Steadfast Finances Says:

    Jill & Mr. CC,

    This is slightly off the major topic, but I’m curious if either of you saw the news release today where the federal government, Citigroup, Fannie & Freddie, and possibly a few other mortgage lenders are willing to negotiate with homeowners to restructure their current mortgage to prevent foreclosure.

    The subject of your mortgage rate was not brought up in the above article, but I’m just throwing out another potential idea to lend some assistance if you have an obscenely high mortgage rate. If you do, and your lenders are willing to work with you, perhaps you could reduce your mortgage payments and pay down more of that unsecured income without fear of foreclosure.

    I’m not an expert on this plan, but perhaps additional ideas can be generated with this new program.

    Here is one of the many related media stories.

    Jill – Hope all works out for you!

  2. Preston Russ Says:

    I was doing pretty well with real estate until the slowdown hit, then I got stuck with some large payments that made it impossible to keep up. Selling the real estate was impossible and for the past couple of years I used credit cards and robbed Peter to pay Paul. Rather than go through foreclosure I gave my property to the bank via deed in lieu of foreclosure. My credit scores have already nosedived to 546. My credit card balance is around 60k and all of them are current. The rates range from 9.9% to 28.49%. Your blog has been very informative and based on what I have read it looks like I should be negotiating hard with my credit card companies. And if I understand some of your advice, I should even consider not making payments to make the negotiation easier. And since my credit scores have already dropped I wouldn’t be hurting myself by doing this. Am I correct in my observations? Thanks.

  3. Sandy824 Says:

    I am a mortgage lender with over 25 years in this industry. Although, alot has come out about loan modification, some investors will NOT modify your loan or reduce your interest rate, no matter what you do. If you are under water (owe more on your mortgage than the house is worth) like many of us here in California and PAY your bills, even though it is depleteing savings to do so, banks are still not warm and fuzzy about helping you.They say they are helping people. I want to know WHO they are helping???? If the new BK law with a cram down clause (allowing the judge to order your lender a modification based on current value) passes the senate, many people will have do this in order to get relief.

  4. Brenda Says:

    I am $45,000 in debt. I considered bankruptcy. One credit card company is currently garnishing my wages at %25. Is is better for my credit to declare bankruptcy or to allow my credit cards to go into default and have my wages garnished for the next 4 years?

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