Filing bankruptcy is a difficult decision. Understandably, most people take a while to decide whether or not to file.
If you think you might need bankruptcy relief but you are still unsure about filing, there are some pitfalls you should avoid. Certain transactions can make your bankruptcy less effective at best, and can make you ineligible for bankruptcy relief at worst.
Avoiding these mistakes will help keep your options open if you later decide to file bankruptcy.
This is a two-part post. Part 1 below discusses mistakes people make when postponing their decision and / or trying to avoid bankruptcy. Part 2 discusses mistakes people make when preparing to file bankruptcy.
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Debt Settlement Scams
Many people call our office after they have worked with a “debt settlement company.”
While some debt settlement companies do a good job, others do not. People who are scammed don’t know there is a problem until debt lawsuits are filed against them. (Note: in some states, it is illegal for debt settlement companies to collect advance fees.)
Once debt lawsuits are filed against them, consumers have already spent more money than they would have if they had filed bankruptcy in the first place.
And, a bankruptcy (1) is a relatively “sure thing” for most bankruptcy filers and (2) wipes out most debts.
By contrast, debt lawsuits have expensive filing and attorneys fees. And, they can be unpredictable.
In other words, you might spend a lot of money fighting them, and still owe the debt once all is said and done.
Taking a Line of Credit or Second Mortgage to Pay Unsecured Debt
It is generally a bad idea to take out a second mortgage or line of credit secured by your residence to pay off unsecured debt.
Many people do this because they mistakenly believe they would be forced to sell their house if they filed bankruptcy.
In many states, however, equity in real estate can be protected up to a certain amount when you file bankruptcy.
If your equity can be protected and you can keep your mortgage payments current, you should be able to keep your house when you file bankruptcy.
Emptying Retirement Accounts to Pay Unsecured Debt
Many people use the money in their retirement accounts to try to pay off unsecured debts in an effort to avoid bankruptcy. They often do this because they mistakenly believe the trustee would seize their retirement accounts if they filed bankruptcy.
But, retirement accounts are generally exempted and protected in bankruptcy; this means you get to keep the funds in the retirement account if you file.
Credit Card Charges, Balance Transfers, and Cash Advances in the 90 Days Before Filing Bankruptcy
Many people are forced to use credit cards and cash advances for living expenses while they are trying to decide whether to file bankruptcy. Unfortunately, this can cause problems with your filing.
Cash advances within 70 days of filing are often ineligible for bankruptcy discharge.
Certain credit card charges made within 90 days of filing are usually ineligible for bankruptcy discharge.
Some other patterns of credit card use might cause a particular creditor to object to your bankruptcy discharge and / or appear at your meeting of creditors.
If you have any credit card activity in the 90 days before you file bankruptcy, be sure to tell your bankruptcy attorney about it.
Once you have decided to file bankruptcy, you must by law stop using your credit cards.
If you continue using the cards after deciding to file, this is considered credit card and / or bankruptcy fraud.
Using your Credit Card to Pay Bankruptcy Fees: Not an Option
Many people plan to use their credit cards to pay their bankruptcy filing and attorney’s fees if and when the time comes. Unfortunately, this is not permitted by the bankruptcy code.
In other words, don’t postpone the bankruptcy filing decision until your finances are in such bad shape that there is no way to pay the necessary fees for filing.
Paying Unsecured Debts While Not Paying Secured Debts
On the other hand, many people continue making minimum credit card payments every month when they are trying to decide whether or not to file bankruptcy. (Where do they get the money? Often from retirement accounts. Please see above for more information.)
Although you should not take on “new” debt just before filing bankruptcy, potential filers should keep in mind the sooner they file, the sooner they can stop making payments on “old” unsecured debts.
Many people spend several hundred dollars a month on credit card payments, and they never make a dent in the amount they owe. And, the average bankruptcy filer takes several months to decide whether or not to file.
Worse yet, many people continue paying unsecured debts while letting their mortgage or car loan go into default. But, most people want to keep their homes and cars when they file bankruptcy.
To make a Chapter 7 bankruptcy work when you want to keep your house and / or car, you usually need to be current on house and car payments when you file.
Financing a Car Purchase at a Credit Union Where You Also Have a Credit Card
This isn’t strictly a bankruptcy issue– it’s a “bad decision” issue that comes up sometimes in bankruptcy.
Here’s a brief explanation:
Many credit union car loans have a “cross collateralization” clause in their loan agreements.
Basically, these clauses say that your car is considered security for the car loan– but also for any other debts you owe to the credit union.
Suddenly that unsecured credit card you have with your credit union has become secured debt.
Bankruptcy filers often need to decide whether or not to “reaffirm” a car loan in bankruptcy. This decision can be complicated when there is cross-collateralization.
Basically, the bankruptcy filer has to decide whether to reaffirm the car loan debt PLUS the credit card debt. This is because the car loan and the credit card are both secured by the car.
Even if you can’t imagine ever filing bankruptcy, cross-collateralization is bad news. Just avoid it.
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While no one should rush into a bankruptcy decision, it is important to maximize the benefits of filing. Carefully timing your filing will help you keep your options open and ensure you get a truly fresh start.