I am often asked by clients how they could avoid bankruptcy, or if they had any other options. Obviously, the answer is different each time based on their unique circumstances. But, in this article I will go over some of the tips I give most frequently. Often a person is current on their mortgage and car payment but has a cash flow shortage, particularly when it comes to their revolving credit card and loan debt. In this case, they have no immediate problem like foreclosure or repossession, just a large amount of revolving debt that is eating away at their monthly budget. A bankruptcy may be able to help them by discharging their revolving debt thereby freeing up monthly cash flow. However, for whatever reason, they do not wish to file a bankruptcy, or they don’t qualify for bankruptcy. In this case, the person needs more income or lower expenses. Everyone will be in a different situation when it comes to this, but sometimes I advise a person to get a roommate. A roommate could pay $500 to $800 per month depending on the location and condition of the home. Sometimes a roommate is not possible, but where it is, normally a passive income of $800 a month will go a long way toward making a budget work. Other folks can raise their income by working a second job, taking more hours, or participating in the gig economy.
If increasing income is not practical, then another option would be to reduce expenses. This may be easy or hard depending on the person’s financial situation and mentality. Selling a home may be emotionally difficult, but one may be able to find another residence that is much cheaper, thus enabling them to save thousands of dollars in housing cost. Maybe selling a house will put tens of thousands of dollars in the person’s pocket, giving them an opportunity to pay off debt. If a person is struggling to pay bills, reducing housing costs by several hundred dollars per month could solve the financial problems. Maybe reducing expenses does not need to be as radical as selling a house, maybe the person just needs to take a hard look at his monthly budget. Do you really need a $900 a month car payment? Could you drive a cheaper car and put that $900 a month towards getting out of debt? Are there smaller expenses that could be cut? I've seen people save $1,000 a month by eliminating eating out. Groceries are expensive, but not nearly as expensive as some restaurants.
Another way to avoid bankruptcy is to pull money from a retirement plan to negotiate settlements with your creditors. This option is tricky and requires some serious consideration.
When one pulls money from a retirement plan, they are normally assessed taxes and penalties, not to mention the reduction in value of the retirement plan. However, if a person can pull out enough, they may be able to eliminate all of their debt for pennies on the dollar. Many creditors will take a 50% settlement. So, for example, if a person owes $30,000 in credit card debt, the creditors may take $15,000.00 as payment in full. So, you may have to pay thousands in penalties and taxes, but you saved $15,000.00 in the settlement. Unfortunately, the analysis does not stop there.
The IRS may consider the forgiven debt as income and charge taxes on the forgiven portion. In most cases, I do not recommend this option because the retirement plan is normally protected in bankruptcy. So, if your option is to reduce your retirement plan or file bankruptcy, unless there is a strong reason to not file bankruptcy, you should not withdraw funds from your retirement to pay debt. If you are considering withdrawing funds from a retirement plan to pay down debt you should consult with an attorney first.
Another way to avoid bankruptcy, in some circumstances, one could just ignore their debt and it may eventually go away. This won’t work for everyone, but if a person is Judgment Proof, then it may be the best option. If a person has no income, or his income is exempt from creditor collections, like social security, then the money cannot be seized or garnished by creditors. If you do not own a house or real estate, then, for the most part, there is not much a lien can attach to.
Even without wages or real estate, a creditor may be able to levy your bank and seize funds in your account. There are ways to avoid a bank levy. Creditors typically look for funds to seize in traditional, local, brick and mortar banks. If you keep money in a tiny, non-local bank, or an online bank, then a bank levy is less likely. If you do not see yourself having non-exempt income or real property in the next several years, then ignoring your debt may work.
The attorneys at John W. Lee, PC offer a free consultation to discuss bankruptcy options with our clients. However, if you are more interested in meeting with a lawyer to discuss avoiding bankruptcy, creditors, or asset protection, then, for a small fee, we offer a 'financial strategy session' where we help you come up with a plan to protect your assets and income.