Prioritizing Payments: Managing Your Debt Before Considering Bankruptcy

Get out of debt

Household consumer debt stands at over $11.4 trillion according to the most recent Federal Reserve report—that’s almost $37,000 for each person in the United States. Many people find themselves even deeper. Having $100,000 in debt is easier to fathom when you consider how quickly it can all rack up: $125,000 from law school, $26,971 from  uninsured medical procedures, $14,517 on your credit cards. It’s no wonder that so many Americans find themselves buried beneath their financial obligations. If you find yourself in this situation, remember: not all debts are created equal.

Type of Debt

Consequences for Failure to Pay

Auto Loans

  • Higher interest rates, late fees, and damaged credit with missed payments
  • Repossession of vehicle or other collateral in default
    • Still liable for remaining balance on the loan;
    • Towing and storage fees

Mortgages

  • Late payments damage your credit rating and lead to late fees
  • Three months missed can start the foreclosure process

Credit Card Debt

  • $15-$35 late fee
  • Damage to credit rating
  • Two consecutive missed payments can lead to a “default interest rate” increasing your APR to up to 31%,

Medical Bills

  • Missed payments will show up on your credit score
  • Lawsuits can lead to a lien on your house and garnishing of wages

Student Loans

  • A missed payment decreases your credit score
  • Increased interest rate
  • Default can lead to forfeited your tax refunds, garnished wages, and extra collection fees

Utilities

  • Late payment fee
  • Consecutive missed payments can lead to disconnected service.
  • Possible reconnection fee

Child Support

  • Garnished wages
  • Suspension of driver’s license
  • Withheld passport
  • Denial of tax refunds
  • Possible jail time

Examples listed are some of the most common forms of debt and their consequences; the list is by no means exhaustive. Actual penalties and fees may vary depending on state law and individual circumstances. Consult with your creditor, local regulations, or an accredited bankruptcy lawyer before making important financial decisions.

NerdWallet’s Recommendations

First of all, if you really can’t make a payment, don’t just ignore it. Be proactive and seek negotiated terms or repayment schedules. There is a host of government-approved credit counseling agencies that can help set you back on the right track.

Handling large amounts of debt becomes even more difficult without a roof over your head or running water. Prioritize debts that will affect these essential needs: rent, home mortgages, utilities, possibly auto loans (if you are dependent on your car for work), etc.

If you owe child support, make sure you continue to pay it. The consequences of failing to meet your obligations are dire and include the possibility of jail time.

From there, it makes the most sense to pay off loans with high rates of interest, which typically means credit cards. Penalty rates can reach beyond 30% APR, meaning you’ll never pay off your principal if you’re only paying the minimum payment.  While paying down smaller debts can give you a psychological boost, in the long run you’ll save more money by paying down as much of the high interest loans as possible.

Student loans, especially those from the government, carry heavy penalties and should be approached with medium priority. With a federal loan you are considered in default after 270 days compared to 120 for private loans.

What about bankruptcy?

Bankruptcy is a legal status for people unable to pay debts owed to their creditors, but should be taken only as a last resort. If you are facing lawsuits, garnished wages, foreclosure, or you owe more than you own, and you’ve exhausted alternative debt management measures (like debt counseling and negotiating directly with creditors), then bankruptcy may worth pursuing.

There are two options for individuals seeking bankruptcy: Chapter 7 and Chapter 13.

Chapter 7 involves selling off all of your nonexempt assets and distributing the proceeds to creditors. Chapter 13 is meant for individuals with regular incomes.  It allows you to keep your home or other assets in exchange for an adjusted repayment schedule that generally lasts three to five years depending on how much you earn.

Bankruptcy is attractive because you can discharge a majority of your debt, protect your property and income, and halt any actions being taken by your creditors.

The process should not be taken lightly, however. Bankruptcy isn’t cheap, nor does it mean a completely blank slate. Filing fees cost over $200, and it’s best to be represented by a lawyer in court. It does not discharge you of child support, alimony obligations, or student loans. Additionally, filing for bankruptcy will remain a dark mark on your credit report for 10 years, and having filed once, you will be barred from doing so for another eight years.

Other Expert Opinions

Anthony Mangianello, author of “The Debt-Free Millionaire” and creator of DebtFreeAcademy.com, had this advice for indebted individuals:

“If at any time non-payment for any one of your debts results in a judgment, that can change the game, and move that debt up the priority list. In all cases, use your best judgment to ‘keep the wolves at bay’ while you struggle through this difficult time. Each situation can be as unique as a fingerprint. The biggest mistake people in this category make is assuming that ‘things will just get better.’ When it comes to breaking free from the shackles of debt, assume the worst is never over and maintain a sense of urgency until you regain control of your financial situation—and own your income again.”

Steven Lever, bankruptcy attorney and founder of LeverLaw, had this advice:

“Normally one would probably pay off the highest interest bearing obligations first.  However, if a bankruptcy is contemplated or needed, only non-dischargeable debt should be paid prepetition, if it is a Chapter 7 case.  Nothing should be prepaid typically if it is a reorganization, such as a Chapter 13.  One also needs to be careful about preferring one creditor over another, because trustees in bankruptcy can claw that back by suing the preferred creditor.”

Kimberly Pelkey Sdeo, bankruptcy attorney at MasselliWarren, had this insight into the sources of heavy debt loads:

“When I have someone come to me with $100,000 or more of debt, it is almost always due to a failed business endeavor.  These debtors continue to pour money and resources into struggling businesses trying to keep them afloat.  The most common mistake is not knowing when to wind down and wrap up their business operations.  It may start small with the debtor pouring more cash into the business and then incurring more bank loans or credit card debt until it compounds and spirals without any improvement or growth to the business to absorb the greater debt loads, which leaves the business owners in a precarious position.  Often times, lenders require personal guarantees before extending a business loan, leaving the owner ultimately on the hook if the business fails.”

Daniel Gershburg, a New York City-based bankruptcy attorney, has this advice:

“Generally, if you know that there is no way to pay back this debt, even if it were cut in half, then bankruptcy can help you TREMENDOUSLY.  It all depends on your assets as well.  Do you have a home that’s underwater that you wouldn’t mind walking away from?  Well, the bankruptcy may be right for you.  Did you’re aunt leave you a house worth $600,000 and no mortgage when she died?  Well, then bankruptcy may not be right for you.  I know I sound like a commercial, but go see a reputable lawyer if you’re considering bankruptcy.  Go see two.  They have free consultations and you’ll know your options.”

 

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