“To file, or not to file? … THAT is A question.”
That is a question that thousands of debt-burdened debtors ask on an annual basis: “Should I file for Chapter 7 bankruptcy?”
Another question often asked is: “What are the alternatives to filing for bankruptcy?” And: “If any”?
This writer is of the belief that low cost, non-profit-based credit repair and counseling can be a viable alternative to taking the bankruptcy route – not exclusively, but as a first-choice alternative. What’s to lose by at least exploring the alternatives of “repairing one’s credit”, improving one’s credit score significantly, and using restored credit wisely and beneficially to support one’s “credit worthiness”?
If a consumer gives credit repair or “credit restoration” a try, the least he or she may lose is time. If credit repair doesn’t work for an individual after a reasonable length of time, the bankruptcy alternative still exists. “Nothing gained…” does not necessarily have to mean a “loss” all the way around.
Not long ago, being declared a “bankrupt” (yes, that was the term applied to those opting to file for and go through bankruptcy) was a social and economic stigma on the filer. People went to great lengths to hide the fact that they “went bankrupt” – even though, taking advantage of the bankruptcy laws is both legal and legitimate.
With the foregoing in mind, let’s take a brief look at both alternatives – bankruptcy and credit repair – to see if there are advantages and disadvantages with those options. We’ll start with the basics of Chapter 7 bankruptcy.
Chapter 7 Bankruptcy
Chapter 7 bankruptcy – commonly referred to as “liquidation bankruptcy – is the simplest and most common form of bankruptcy. In Chapter 7, if a debtor has assets that are not protected by an exemption, a Court-appointed bankruptcy Trustee may sell the assets and distribute the net proceeds to the debtor’s creditors according to priorities set forth in the United States Bankruptcy Code.
In exchange for accepting those terms, at the end of the bankruptcy case the debtor is granted a discharge by the bankruptcy court. In a discharge, most of the debtor’s liability for personal debt is wiped out or forgiven. Statistics show that in almost 99% of all individual Chapter 7 cases, the Trustee closes the case at discharge without having sold any of the debtor’s assets that might have been liquidated to pay debts.
Prior to 2005, obtaining a Chapter 7 discharge was quite a bit easier than since “reforms” were adopted in that year. Today, a debtor’s eligibility to file for Chapter 7 protection is governed, in large measure, by the means test. Some high earners may not be eligible to file for Chapter 7 bankruptcy if their debts are primarily consumer in nature. Those who are ineligible to file under Chapter 7 because they did not meet the standards of the means test, are eligible to file under Chapter 13 of the code.
A Chapter 13 filing is known as “reorganization” or “repayment” bankruptcy – a debtor must come up with a repayment plan that lasts over a 3 to 5-year period. Each eligible debt is included in a repayment schedule that is worked down monthly by regular payments. At the end of the plan’s period, remaining unpaid scheduled debts are forgiven in a discharge.
Briefly, Chapter 7 works as follows:
- Exempt property (an inexpensive automobile, household furnishings, equity in a primary residence, etc.) is retained by the debtor seeking a “fresh financial start”
- Non-exempt property is sold by the bankruptcy Trustee and the proceeds paid to creditors per formulae in the Bankruptcy Code
- At the end of the case, a discharge (release of personal liability) of all qualifying debt is granted
For some debtors, filing for Chapter 7 bankruptcy (or being re-directed to Chapter 13) does not make financial sense. For those with certain characteristics and status, filing for bankruptcy makes the most sense. The following are some of the factors that “make sense” as reasons for filing for Chapter 7 bankruptcy:
Debtor’s income meets discharge qualifications – If a debtor’s income is below their residency state’s household median income he or she is putatively eligible to file for Chapter 7. The determining factor re: qualifying is the aforementioned “means test” – a test that analyzes debtor income after allowing the subtraction of certain deductions. Income that is below the states median household income qualifies a debtor to file under Chapter 7
Debtor is “broke” after paying monthly household living expenses – Debtors who pass the means test may still not qualify to file under Chapter 7 if they have money left over (disposable income) at the end of the month. There is a presumption that debtors who have “disposable income” can pay creditors. In such a case, the Chapter 7 filing would be converted to a Chapter 13 filing or dismissed for failure to qualify
Debtor doesn’t own much property – In Chapter 7 bankruptcy, a debtor can keep (“exempt”) property that is needed to maintain a modest home and employment. Bankruptcy property exemptions are controlled by the laws of a debtor’s state of residence – debtors need to check their own state’s laws to determine which and how much of their property is exempt
Home mortgages and car payments – in most cases, home mortgage and automobile payments qualify for exemptions in Chapter 7. If a debtor is current on such debts, and can keep up with payments going forward, the bankruptcy automatic stay provisions will prevent the foreclosure on real property and the repossession of an automobile. The debtor remains personally liable for the debts and may face foreclosure or repossession in the event of a default
Some debt is non-dischargeable – income tax liabilities, court-ordered child and spousal support obligations, and most student loans are not dischargeable in bankruptcy. If a debtor’s obligations are mainly of this nature, Chapter 7 may not be the right course; rather, Chapter 13 bankruptcy may be a viable alternative.
On the other hand, if most debt is collection accounts, outstanding credit card balances, medical bills, personal loans, unsecured judgements, or overdue utility bills, it may make more sense for the debtor to undertake a Chapter 7 filing
“Self-Help Credit Repair” – a Viable Alternative
The effects of “credit damage” can be far reaching. As many a debtor has learned, it doesn’t take much to end up with bad credit. As one pundit noted, “You can ruin your credit score before you realize you even have one, or before you realize how vital it is – in this day and age – to have a good or excellent credit score”.
There exists an actual credit score scale that ranges on the low side from 300 to 850 on the high end. Consider a credit score of 600 – somewhere in the high-middle on the above-noted scale. If a consumer has a credit score of 600, things could be worse – but – credit scores of 630 and lower are “poor”. Someone with a score below 630 will likely be denied for credit cards and loans. Such a score also likely means higher interest rates on the credit one with such a “poor” score does manage to obtain.
Having a low credit score or a poor credit history (i.e. “bad credit”) can seriously impact a consumer negatively in the financial sense. A low credit score indicates to lenders – and to potential landlords and employers as well – that a person is a “high-risk borrower”, tenant, or employee. The result of a low credit score can mean the denial of credit, being turned down for rental housing, or a lost employment opportunity.
Some of the damaging side effects of having “bad credit” (and the following list is by no means all-inclusive or complete) are:
- Being subject to higher insurance premiums
- Being subject to higher interest rates on loans, credit cards, etc.
- Being subject to having loan and credit applications denied
- Difficulty finding or changing employment
- Challenges in starting a business
- Denial of application for rental housing
Some may wonder, “whose fault is bad credit?” – and the universal answer is probably the debtor with bad credit.
A consumer’s credit score reflects how he or she has handled their financial obligations. Credit scores are based upon information that’s been reported to the credit bureaus by companies associated with credit card issues and lenders.
Consumers who pay on time and never miss payments when due will have good credit. Those who are chronically late in making payments, or don’t pay some bills at all, are the ones who are carried on the books as “poor credit risks”. They are the same consumers with “poor” credit scores.
People with “poor” credit scores and reputations are more likely to take the bankruptcy route and not consider the alternative of attempting to improve their overall credit situation (i.e. work to improve a poor credit score, make an honest effort to “catch up and stay caught up”, not apply for new credit in any form, etc.).
There are many “credit repair” companies that promise to “restore credit” or “improve your credit score dramatically. Some are for-profits companies, and others are non-profit organizations. Consumers should know and consider the following: anyone can do all the same things a credit repair company can do by taking the DIY route to credit repair.
Those with bad credit AND a different mindset may want to undertake a “do-it-yourself” (“DIY”) approach to the task at hand. For those, the steps are fairly few and simple enough to almost assure success for all if diligently worked. Some of those steps are:
- Start with the Credit Report – First, obtain up-to-date and current copies of the consumer’s credit reports from the three credit reporting agencies, Experian, Transunion, and Equifax… by law, a copy of each report of the three agencies is available to every debtor on an annual basis (see annualcreditreport.com), once the reports are in hand, study them carefully for errors and inaccuracies
- Pay attention to “identity” errors – errors regarding debtor names, social security numbers, addresses, account numbers, etc. can have an adverse impact on credit scores, credit reputations, and credit worthiness
- Learn / know how to read a Credit Report – all credit reports contain personal identifying information, detailed history of all associated credit accounts, public records (bankruptcy, tax liens, judgments, etc.), and inquiries from companies that have “pulled” a consumer’s credit report
- Determine what needs to be repaired – the following is the type of information that needs to be repaired:
- Incorrect information, including accounts that do not belong to the consumer, payments that have been incorrectly reported as late, missing information, etc.
- Past due accounts that are late, “charged off”, or sent to “collections”
- Maxed out accounts that are over the credit limits
- Dispute credit report errors – always initiate a dispute and request for action with the appropriate credit reporting agency; all communications should be written and sent via certified mail, return receipt service (using certified mail gives the consumer a “proof of mailing” and keeps track of the response of the credit agency that typically have 30 – 45 days to respond to disputes and requests)
- Take care of “past-due” accounts – “payment history” is 35 percent of a credit score. A negative payment history record impacts a credit score more than any other factor. A credit report status of “current” or “paid” is a move toward improving one’s credit score. The only thing worse that a “poor payment history” is the “charge off”. A “charge off” occurs once an account is 180 days “past due”. “Charge offs” are the worst account status a debtor can have.
- Resolving Collection Accounts are a High Priority (while taking care of “past due” accounts at the same time)
- Limit, as much as possible, credit inquiries – “credit inquiries” are added to a credit report each time a company “pulls” a consumer’s credit report. Too many credit inquiries hurt a credit score and the ability to get approved for new credit
The foregoing, briefly, is a suggested manner to accomplish “DIY Credit Repair”. The listing of the foregoing steps and suggestions is not all inclusive or the only steps to take. The foregoing gives interested consumers a look at one alternative to filing for bankruptcy when “the end of the financial road” has been reached. Keep in mind – DIY repair costs little more than a consumer’s time and initiative.
Bankruptcy, on the other hand, can come at a much higher out-of-pocket cost and still, today, the potential “social cost” of stigma.
“To file, or not to file? – has the question been answered?” Answered “sufficiently”?
Picture Credit: Melinda Gimpel