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When Should You Consider Bankruptcy & How to File

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Updated – November 14, 2018

If you’re drowning in debt and having trouble keeping up with your payments while still handling your living expenses, you may have at least begun to consider filing for bankruptcy.

Filing for bankruptcy is meant to give people in serious financial distress some relief and a chance to start over. By the time most people get to that point, they’ve probably tried many other methods for managing their debt.

Bankruptcy certainly has its benefits, potentially allowing you to wipe the slate clean and start anew.

But there are a lot of things to consider before making a decision, from the negative consequences of filing to whether bankruptcy would even provide relief for your specific situation.

“For most folks that come in, this is the last option,” said John Colwell, a San Diego, Calif.-based bankruptcy attorney and President of National Association of Consumer Bankruptcy. “I know I’m like the dentist. People really don’t want to be sitting in front of me.”

This is a big decision that requires a significant amount of due diligence before moving forward. While it’s important not to take bankruptcy lightly, it may be the best way for people to get back on their feet.

So how do you know if bankruptcy is the right way to relieve your debt? In this post, we’ll go over some of the key points to help you get started.

The basics of filing for bankruptcy

Bankruptcy is a legal procedure to discharge debt built up by someone who either will not be able to repay those debts or does not have the means to repay debts owed currently. There are two notable forms of bankruptcy: Chapter 7 and Chapter 13.

In a Chapter 7 bankruptcy, a debtor’s nonexempt assets are sold and the proceeds are used to pay debts. An individual must pass a means test before they can file a Chapter 7 bankruptcy to ensure that the court would not be abusing the bankruptcy law by granting one. We will talk more about the means test below!

A Chapter 13 bankruptcy is a “wage earner plan.” To qualify, an individual must have a steady income. This allows them to pay back all or part of their debts by developing a repayment plan. The plans last between three and five years.

In most cases, bankruptcy does not protect you from any future debts incurred. It also will have an effect on your credit score and remains on your credit report for 10 years with Chapter 7 and seven years with Chapter 13. In a Chapter 7 bankruptcy, you may lose assets such as your house or your car depending on how much equity, if you’re able to exempt your equity and if you’re current on your payments.

Are You Eligible?

As stated above, there are two types of bankruptcy for individuals: Chapter 7 and Chapter 13.

There are some significant differences between the two programs, but here’s a high-level summary:

  • Chapter 7 allows you to completely discharge your debts, with some exceptions (such as student loans, certain tax obligations, and child support). But you may be obligated to sell some of your property to settle some of your debt obligations.
  • Chapter 13 allows you to create a payment plan to repay some or all of your debts over a 3-5 year period. So your debts are not discharged, but you will also not be obligated to sell any property in order to make your payments.

Either one could be more or less beneficial depending on the specifics of your situation. But the very first question is whether you qualify for either one, and each has its own set of criteria.

Chapter 7 bankruptcy has what’s called the “means test”, which is meant to ensure that only people who truly can’t afford their debt payments are allowed to file. There are two different wants to pass it, and therefore qualify for Chapter 7 bankruptcy:

  1. If your monthly income is less than the median monthly income in your state for your family size, you pass. You can find current median income numbers by family size here.
  2. If you don’t pass #1, you’ll have to go through a complex calculation to see whether your disposable income after subtracting out certain expenses is enough to satisfy your debt obligations. At this stage it would probably be best to talk to a professional who could help you navigate the process.

Eligibility for Chapter 13 bankruptcy is a little more straightforward. Here’s how it works:

  1. As opposed to Chapter 7, you need to prove that your disposable income is high enough to afford a reasonable repayment plan.
  2. Your secured debt (mortgage, auto loan) can’t exceed $1,149,525, and your unsecured debt (credit cards, medical bills, etc.) can’t exceed $383,175.
  3. You must have filed both federal and state income taxes each of the last four years.

There are some other requirements for each, but those are the major ones. Assuming you qualify for at least one of them, there are a few other things to consider.

What Kinds of Assets and Liabilities Do You Have?

Depending on the specifics of your financial situation, one type of bankruptcy may be preferable to the other. Or it may be that neither would actually be particularly helpful.

As an example, neither type of bankruptcy would likely help you all that much if your primary debts are student loans. They wouldn’t be discharged in Chapter 7 bankruptcy. And while your required payments might be reduced over the 3-5 year repayment period in Chapter 13 bankruptcy, once that was over you would have to continue paying them back as usual.

The type of assets you own and their value also matters, particularly if you’re going through Chapter 7 bankruptcy. During that process, your bankruptcy trustee is allowed to sell your property in order to settle your debts, but certain property is protected.

For example, your house and car are protected up to certain limits. Employer retirement accounts like 401(k)s and 403(b)s are fully protected, while IRAs are protected up to about $1 million. But other accounts, such as checking, savings, and regular investment accounts may not have the same protections.

The rules here vary by state, and having a strong understanding of which assets you might be able to keep and which you might end up losing will help you make your decision.

When to file bankruptcy

According to Colwell, filing for bankruptcy needs to be “worth your while,” meaning it should give you relief from your debts to ensure you don’t find yourself in a similar situation in the near future. That means that if you have major expenses that you are about to incur, you should wait to file until after you have incurred them so they can be included in the bankruptcy settlement. This is especially important when it comes to filing bankruptcy due to medical bills.

However, with a Chapter 13 bankruptcy, you can seek court approval to include new debt that you’ve incurred post-filing into your payment plan.

In general, though, there are aspects of your financial situation that signal when it’s time to consider bankruptcy. If you can’t pay your bills (and you don’t see that changing anytime soon) and your debt continues to pile up, bankruptcy is probably worth considering.

Here are other red flags to look out for:

  1. Debt collectors are calling. If you’re behind on your bills to the point that you’re hearing from debt collectors, it may be time to consider bankruptcy. This is especially true if you’re being sued by debt collectors.
  2. You’re in danger of losing your home. If you’re at risk for losing your house to foreclosure, filing bankruptcy can help you get caught up on your payments and keep your home. With Chapter 13, you’re given the chance to keep your home by creating a plan to repay your outstanding debt.
  3. You’re using loans to pay your bills. Using short-term high-interest loans such as payday loans can get you in trouble. With these loans, people borrow against their next paycheck. “People get caught in the trap and it starts rolling over from paycheck to paycheck to paycheck,” said Colwell. Title loans are another form of small loan where a vehicle is used as collateral; these loans can be problematic for someone already in financial distress.
  4. You’re liquidating your retirement assets. Retirement money is exempt in a bankruptcy, meaning trustees can’t use it to repay lenders. So in most cases, it doesn’t make sense to burn through your retirement money to pay debts. “I hate that with a passion,” Colwell said. “It’s your retirement money, what are you doing?!”

How to file for bankruptcy

Most initial consultations with lawyers are free of charge. At these meetings, you’ll walk a bankruptcy attorney through your financial situation and your reasons for wanting to pursue bankruptcy.

There are also ways for individuals to file for bankruptcy on their own, known as filing pro se. Court employees and bankruptcy judges can’t give out legal advice to people in their courts, so if you go that route, you will be on your own. To file yourself, you should be familiar with the United States Bankruptcy Code, the Federal Rules of Bankruptcy Procedure and the local rules of the court.

Unless you have a strong understanding of legal issues and have the time to handle the paperwork, it’s probably best to use a lawyer — that’s because making a mistake can impact your rights, according to the U.S. Courts. You’ll also need the capacity to fill out a lot of paperwork, Colwell also noted.

If you use an attorney, they should be able to provide services including:

  • Advising you on whether to file a bankruptcy petition and under which chapter to file.
  • Telling you whether your debts can be discharged.
  • Advising you on whether or not you will be able to keep your home, car, or other property after you file.
  • Advising you of the tax consequences of filing.
  • Advising you on whether you should continue to pay creditors.
  • Helping you complete and file forms.

How to file Chapter 7 bankruptcy

A Chapter 7 bankruptcy involves the sale of all of your nonexempt assets to pay back your creditors. This is the most common kind of personal bankruptcy, accounting for more than 60 percent of all non-business bankruptcies in 2017. The process usually takes about four to five months.

Filing for Chapter 7 will wipe out your allowable debt (such as as credit card, medical and personal loan debt), but the bankruptcy will remain on your credit report for up to 10 years.

The first step is to take a mandatory credit counseling course from a government-approved organization, within 180 days of your filing date. Upon completion, you can decide if you still feel it appropriate to move forward with a bankruptcy, and move on to the next step.

At this point, you, or your attorney, would file your petition and other additional forms with the court. Along with your filing petition, the forms include a list of your creditors, a summary of your assets and liabilities, lists of property (both exempt and non-exempt) and any documentation needed for your “means test.” There are also companies that will send you a packet of all relevant documents, for a small fee.

At this point, you will be subject to the “means test.” If the debtor’s current monthly income is more than the state median, the means test is applied. Abuse is determined if the debtor’s monthly income over five years is either more than $12,850, or more than 25% of the debtor’s nonpriority unsecured debt of at least $7,700.

A trustee is then appointed to review the paperwork and take nonexempt property; you will also have to submit your most recent tax return to the trustee.

The next step in the process is a meeting of creditors, known as a “341 meeting.” At the meeting, you will answer questions about your finances and bankruptcy forms under oath. Creditors are allowed to attend the proceedings if they choose.

It is now decided if you are eligible to file for Chapter 7. At this stage, secured debts are determined: they can be repossessed by the creditor, you can redeem it by paying back what it’s worth or you can reaffirm the debt, which removes that debt from the bankruptcy filing and allows you to pay it back when the bankruptcy is over.

You will have another course to attend that will include information on developing a budget, using credit and managing money — afterward, your debt will be discharged.

Cost: A Chapter 7 bankruptcy needs to be paid for upfront by the debtor. It is generally a flat rate and may be contingent on the complexity of your debt structure as well as the market in which the attorney is operating.

How to file Chapter 13 bankruptcy

A Chapter 13 bankruptcy will last between three and five years, from start to finish. These processes are long and complex, so it’s strongly recommended that you use a lawyer. If you have a steady income, Chapter 13 bankruptcy allows you to keep property, like a house or car, that you might otherwise lose in Chapter 7. Chapter 13 develops a three-to-five year repayment plan for your debts.

The first step is to take a credit counseling course. Afterward, you or your attorney will prepare and file a bankruptcy petition and paperwork that includes a list of your creditors, a summary of your assets and liabilities and your Chapter 13 repayment plan; you will also need to provide your most recent tax returns.

The court will later appoint a trustee to administer your case and a stay on collections will take effect — this means that certain creditors won’t be able to proceed with lawsuits against you, call you for repayment or garnish your wages. You’ll begin making payments for a month after you file the paperwork. In addition, like Chapter 7, Chapter 13 also requires a 341 meeting.

You or your lawyer must attend a confirmation hearing where objections to your plan either by the trustee or the creditors will be addressed and eventually your plan for repayment will get confirmed.

Your creditors will also file proof of claim so that they can get repaid; it is at this point that you can object to the claim if you feel it is unfair.

The repayment period begins when you start to comply with your plan’s requirements and payments; this is the longest portion of the bankruptcy. If required by your plan, you may also have to submit documents to the court like income and expense statements.

Exactly as in Chapter 7, you’ll have another course to attend that goes over budgeting, using credit and managing money. Afterward, your debts may be discharged and your case closed.

Cost: There are two ways an attorney can charge you for handling your Chapter 13. It may be a “no look” fee, a flat fee set up by the district in your state, or they can bill you hourly. Your payment to your attorney can be worked into your Chapter 13 repayment plan.

Conclusion

Filing for bankruptcy is a big decision, and in the end you’re the only one who will know what’s right for you.

Bankruptcy can be not only a long process, but also a very emotional one for those seeking to discharge debts.

Do your research, evaluate all of your options, and then make the decision that most helps you reach your personal goals.

Looking into your options sooner rather than later may help you shore up your financial future and lose less in the long term.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

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A Procrastinator’s Guide to Managing Your Finances

Editorial Note: The editorial content on this page is not provided or commissioned by any financial institution. Any opinions, analyses, reviews, statements or recommendations expressed in this article are those of the author’s alone, and may not have been reviewed, approved or otherwise endorsed by any of these entities prior to publication.

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Many of us fall victim to procrastination from time to time. And when it comes to managing your finances, avoiding or delaying tasks can get expensive very quickly.

“Our lives are busy, and sometimes we don’t want to deal with it,” says Gerri Detweiler, education director at the business credit management website Nav and author of “Debt Collection Answers: How to Use Debt Collection Laws to Protect Your Rights.

In fact, Detweiler remembers the price she paid the year she pushed off renewing her business filings with the state.

“I didn’t get it done right away and paid enormously for it,” she said.

No matter the reason behind your procrastination, it can lead to a financial mess unless you move it to the forefront of your to-do list. Know that it is possible to transform into a doer – even if you’re a habitual procrastinator – by adopting the small changes below to achieve big results down the line.

1. Automate as much as possible

If you’re prone to procrastination, keeping on top of payments can feel overwhelming, especially if you have multiple lenders you need to pay every month. Consider automating your payments so you can avoid late fees and charges. Detweiler advises setting up text or email alerts so you know when payments are due and if there are any changes to the minimum payment amount. You can set up automatic payments with either the lender or through your bank’s bill pay tool; all you have to do is just make sure you have enough money in your account to cover what you owe.

2. Consolidate debt so you have fewer bills to keep track of

The average person has 3.06 bank cards and 2.5 retail cards, according to Experian’s 2018 State of Credit Report. Detweiler advises keeping two credit cards active at any given time: one with a lower interest rate to use for bigger purchases where you can revolve a balance, and a second credit card that is used for everything else, including earning rewards, that you pay off in full at the end of month. Then, put the rest of your cards in a drawer once they’re paid off and use them only occasionally to keep the accounts from being closed by the issuer.

If you have multiple high-interest credit card balances, you may be able to qualify for a balance transfer card offering 0% interest for a specific period of time. While most balance transfer deals charge a 3% balance transfer fee, which is added to the amount you transfer, it may make financial sense to move multiple balances to one card with one payment. Then, devise a repayment plan to knock down that balance as much as possible during the no-interest period as your payments will all be directed toward the principal until the 0% offer has expired.

Another option is to consolidate multiple card balances or other debts with a debt consolidation loan. Depending on how good your credit score is, you may be able to find a lender offering an interest rate lower than what you’re paying on your credit cards. The beauty of a debt consolidation loan is that you can use it to pay off your debts and then have one fixed payment over a specific period of time, generally two to five years. Of course, this will only help if you have the discipline to refrain from adding new debts or purchases to your now-cleared credit cards.

If you’re really struggling and over your head with your finances, consider talking to a credit counselor that can put you on a debt management plan.

3. Turn to technology to help change behavior

If you’re a procrastinator, relying on your willpower can be challenging. Thankfully, technology can help with that. Consider turning to apps or websites to help change any unhealthy behaviors and transform any bad habits.

For instance, you could download a robo-saving app, such as Digit, or enroll in a savings program like Bank of America’s Keep the Change, that help make saving as painless and out-of-mind as possible. Remember that small financial goals (like saving $5 per day versus $150 per month) will seem more achievable and can help lead to big improvements.

Other apps or websites aggregate information about multiple accounts, so you can see what’s due and what’s outstanding on a weekly or monthly basis, can also come in handy. Detweiler suggests Mint, Credit Karma, or the EveryDollar budget app. She also suggests setting reminders so you can remember to log in regularly. When you see the progress you’ve made in a chart or graph, it acts like a reward that is sent to your brain, which is key to long-lasting behavior changes, as journalist Charles Duhigg noted in his book “The Power of Habit.”

Whether your procrastination is the result of being really bad at time management or overly demanding standards that result in unhealthy levels of perfectionism, it helps to be aware of what’s causing any counterproductive, irrational behavior so you can determine how to do better.

For instance, if you’re really bad at estimating how long it’ll take you to finish a task, then make a habit of starting earlier than you normally would. Or, if your overly demanding standards stop you from getting started, then remind yourself before you start the task that “done” is better than perfect and think back to times that procrastination has proven harmful to you.

Changing behaviors, like managing your time better or reducing any anxiety you feel when tackling big tasks (like paying multiple lenders every month), can be challenging, but not impossible. Breaking things down into small, simpler tasks and using technology to help you as much as possible can set you on a fresh path to break unhealthy habits and lead to big improvements on your finances.

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Got Tax Debt? Here’s What to Do

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Some people are fearful of the IRS. But if you are someone who owes tax debt to the IRS, you need more than a little bit of healthy fear to get you through — you need a plan. Here’s what you can do to pay off tax debt.

7 steps to pay off tax debt

Make an initial payment.

If you can’t pay your tax bill, one strategy — according to the IRS — is to make an initial payment based on how much you can afford, then work to determine a plan for paying down the rest of your debt.

Determine how much you can pay.

When faced with what seems like a staggering tax bill, don’t panic. The important thing is that you don’t ignore the IRS. One of your first steps should be to determine how much of your tax bill you can afford to pay. And keep in mind that whatever you don’t pay will be subject to accruing interest and penalty fees.

Choose a payment option.

Once you have settled on how much of a payment you can make, you have to make that payment. These are the main options for payments: using the electronic federal tax payment system, which is free, but is most suitable for businesses or large payments and requires enrollment; electronic funds withdrawal (which can be done during e-filing) straight from your bank account or from the IRS mobile app, same-day wiring (which may carry bank fees), a check or money order, or cash at a retail partner.

Ask for an installment agreement.

If you know you can’t make your payment in full, you can apply online for a payment plan through the IRS. Your eligibility for a payment option will depend on your individual tax situation.

To apply for an installment agreement, you have to fill out an application online that will include information such as your Social Security number, your most recent tax return filing date and your basic personal information. There are three options for a payment plan: a full payment, a short-term payment plan that will require paying in less than 120 days and a long-term installment agreement to pay over more than 120 days. In general, you are eligible to apply online for the installment agreement if you owe $50,000 or less in combined tax, penalties and interest fees and you have filed all your tax returns. The Federal Trade Commission also notes that the IRS usually can’t deny an installment agreement if you owe less than $10,000.

Ask for an offer in compromise.

Contrary to what you may think, the IRS is willing to work with you if you have tax debt and can’t pay what you owe. According to the IRS, it will consider what it calls an offer in compromise if you can’t pay your bills — and if doing so will cause a financial hardship to you.

An offer in compromise is something that can be considered after you have exhausted other options. It is based on several factors that the IRS will assess, including:

  • Your ability to pay
  • Your current income
  • Your total debt and expense obligation
  • Your assets and equity

If you can put together a reasonable offer in compromise, the IRS notes that it is generally able to accept the offer if it represents the most it can expect to collect within a “reasonable amount of time.”

There are some qualifications that you have to meet to be considered for an offer in compromise, which is detailed on the IRS website. When you submit your offer, you will have to choose one of two payment options to show the IRS your offer is serious: a lump sum or a periodic payment. The lump-sum offer consists of you including 20% of the total offer amount. If the IRS takes your offer, it will keep that 20% payment and you will pay the rest in up to five payments. If you go the periodic payment route, you’ll still submit an initial payment with your offer application, but you’ll make monthly installments while you wait to hear back from the IRS. If it does accept your application, you’ll pay monthly until your offer is paid off.

In some cases, if you meet certain low-income qualifications, your application fee, initial payment and monthly installments will be waived while your offer is considered. While the IRS considers your offer, you are required to make any associated payments with your offer, and any other collection activities will be suspended. If you don’t hear back from the IRS within two years of your offer, it is considered accepted.

Ask for “Currently Not Collectible” status.

Depending on your financial state, the IRS may determine that your account is not collectible at the moment and temporarily pause collection until your status changes. To be eligible for the status, you may have to complete a Collection Information Statement and submit proof of your finances, such as your monthly income and assets. Even if the IRS determines that you are in a not-collectible status, your debt will still be susceptible to penalties and interests until the full amount is paid. To request a delay in the collection process, you have to call the IRS.

Work with a professional.

Although it might seem counterproductive, it may be helpful to hire a tax professional who can help you sort through your options and make a plan. The IRS recommends that if you choose to work with a tax professional, you make sure you vet their credentials. There are certain rules pertaining to debt collection, and you always have the right to work directly with the IRS instead of a debt collector.

What you should know about tax debt

Tax debt can occur in large or small amounts. Essentially, as soon as you fail to pay what you owe the IRS, you have tax debt. Here’s what you should know about tax debt.

IRS collection practices. The official collection practice for tax debt begins after you have received your tax bill from the IRS and failed to make your payment in full. After you receive your first tax bill, the IRS will send you one more bill before enacting collection actions. But, in the meantime, the amount you owe will continue to accrue interest and possible penalties.

Once the IRS has sent your final tax bill, it will move to collection actions, which can range from using any future tax refunds to seizing your property and assets or showing up at your home or business.

Statute of limitations. In general, the statute of limitations on a tax liability for the IRS is 10 years. After the statute of limitations expires, the government no longer has the right to pursue collecting that liability.

Always file your taxes. One of the best ways to be proactive against tax debt is to make sure that you always file your taxes by the IRS deadline and work to make any type of payment that you can. Delaying, either with filing or with debt, never pays off. It’s always best to work with a tax professional to file your return to make sure that you reduce your chance of an error.

Don’t ignore notices from the IRS. As tempting as it may be to think that ignoring notices from the IRS will make them forget about any debt you owe, it doesn’t exactly work that way. In fact, the longer the IRS doesn’t hear from you or is unable to reach you, the more it may increase its efforts. For instance, the IRS could turn to seizing property, your bank account and your possessions, or issuing you a summons.

The bottom line

If you find yourself in a situation where you have tax debt, you have options. You can work directly with the IRS and submit details of your financial status to come up with some sort of payment plan or even temporary deferment depending on your specific situation.

The most important thing you can do is communicate with the IRS and take steps to show it you are serious about making some form of payment.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

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