Most people, by the time they start thinking about bankruptcy, have exhausted other options. Many times people find themselves in a situation where they may or may not be able to dig themselves out of a financial hole, depending on future contingencies, most typically income, but sometimes due to other factors such as a contested lawsuit, where the result will either preclude or compel the need for a bankruptcy. So I put together a list of things to consider, if the possibility of filing bankruptcy might be on the horizon.
- Consult with a bankruptcy attorney. And I would recommend paying for a consultation. While many attorneys offer a free consultation, you get what you pay for, and the attorney best knows the value of their time. Advice from a free consultation is worth what you paid for it. The reason attorneys give free consultations, is because they want you to come back and hire them, not because they give away their time to provide free advice on how to avoid using their services. An attorney who is paid for a consultation is more likely to objectively advise on non-bankruptcy options of debt relief versus bankruptcy options. The two main things the attorney will help with, is first, to ensure you qualify from a budget standpoint, in which case there may be long-term things to do to beat the means test. And more importantly, to ensure that your assets are exempt, and (when appropriate, which is infrequent), to discuss a pre-bankruptcy plan to liquidate and spend/re-invest non-exempt assets, for which there are right ways and wrong ways.
- Can you consolidate debt and/or reduce interest rates? Then go for it. The key when you do this, from a personal discipline standpoint, is to close off the access to credit that you just paid off so you are not tempted to dip back into it. And I’d avoid home equity loans and 401k loans (for reason explained in my next blog post, things NOT to do if you are considering bankruptcy).
- Take a look at your budget and see if there are things you can do to increase revenue, or reduce expenses. Can you pick up an extra shift? Are you eating out too much? Maybe it’s time to give up cigarettes – back when I was a smoker, I never bought a carton, because I never foresaw myself smoking ten more packs of cigarettes, plus I liked the ritual of going to the convenience store. When I ask smokers how much they spend on cigarettes a month, we sometimes realize quitting would free up a good chunk of disposable income. Plus they are unhealthy and stinky. Cutting out eating out, cable TV, or joining a meal swap group, are other ways to reduce expenses.
- Consult with a nonprofit credit counseling agency. This isn’t to say that this is always the best alternative to bankruptcy, because it’s going to damage your credit about the same as a bankruptcy, but it can be for high income debtors would need to pay a hundred percent of their debt in a chapter 13 anyway, and/or debtors with a nominal yet overwhelming amount of debt. The best part is that if you really do belong in bankruptcy, they will honestly tell you so.
- If you are looking at debt settlement, deal with that big creditors first. This is the opposite of what Dave Ramsey teaches, which is to pay the small ones off first, because he believes that that will give you a sense of confidence and will help you focus on the bigger issues. The reason I focus on the bigger creditors first, is because if you are looking at debt settlement as an alternative to bankruptcy, and are unsuccessful, then you can file on everything, whereas if you paid off the smaller ones first, that will happen money wasted. Moreover, the smaller creditors (i.e. under $1,000) are less likely to actually pursue the debt, so sometimes those will eventually just go away if you ignore them long enough.
- Keep your priorities straight, which brings three things to mind: housing, transportation, retirement. Keep the roof over your head first and foremost. This might seem obvious, but sometimes the biggest expense is the hardest one to cover, and I have seen many people who were proud of the fact they are current on their credit cards, but have gotten behind on their mortgage, rent, or the car that they need to get to work. In certain circumstances the house is simply unaffordable, additional options can be discussed at the consultation with the attorney, such as loan modification, chapter 13 curing of arrears (in which case if a chapter 13 is inevitable, the advice is sometimes to intentionally get behind), or surrendering, possibly with an intervening chapter 7 to buy more time in the house.
Ironically, I have advised people to buy a car before they are considering bankruptcy, for a few reasons. First, they are often driving an old beater that is not commensurate with their incomd and because they are humble and working their way out of debt. Second, the old beater will eventually need to be replaced, and a person is going to have an easier time qualifying to get a new car before their credit goes south than afterward. And third, having that additional expense is reasonable and can help higher income bankrupt debtors demonstrate that they cannot afford to pay their creditors.
And while wealth accumulation may be the last thing from your mind while you are trying to reduce debt, everybody should be contributing to retirement, at least 10% of income if not more. I have seen too many people who stopped contributing to retirement (or stopped tithing to church) so they can pay off their creditors. The law permits you to tithe and to make reasonable retirement contributions, and particularly in the case of higher income debtors, a history of regular retirement contributions will be deemed a reasonable expense and may help on the means test (although there appears to be a growing trend outside of Minnesota to the contrary).
In conclusion, I should stress that any suggestions that are given here, particularly numbers five and six, can vary greatly based on individual circumstances, so I would re-stress the first suggestion above, which is to consult with a bankruptcy attorney, to ensure your plan is tailored to your circumstances.