The recession of 2008-2009 has especially affected retirees whose fixed income investments no longer provide enough money to live. For many retirees, credit card balances have increased the past several years and they can’t even afford the minimum payments. Others make mortgage payments on homes that are now worth less than the total mortgage debt. Selling and downsizing is no longer viable. As an option to help retirees out of their financial troubles, bankruptcy is often met with ambivalence. Moreover, and not surprisingly, to hardworking, industrious men and women, bankruptcy represents both a financial and a personal failure.
Complicating the issue, many retirees hide debt problems from their adult children, or they make ill-advised decisions, such as liquidating retirement plans, long before they meet with their legal or financial advisors.
But before you dismiss the idea of bankruptcy, let’s learn a little more about it.
What is bankruptcy?
Bankruptcy is a financial and legal process by which an individual or married couple seeks relief from creditor action in federal court. It offers powerful protection from creditors, but it should always be considered as a last resort.
The automatic “stay”.
Except in some cases of a second or third filing, the minute your bankruptcy petition is filed and a case number assigned, you are protected by an “automatic stay”, which puts an immediate halt to foreclosure, repossession, garnishment, levy, phone calls, letters – and just about any action by a creditor to collect a debt. Even the IRS and state departments of revenue are subject to the automatic stay.
To get the benefit of this powerful bankruptcy stay, you must formally file a case. Many lawyers electronically file cases from their offices and in emergency situations can get a case number and automatic stay within a matter of minutes.
Chapter 7 vs. Chapter 13
The most common forms of bankruptcy are Chapter 7 and Chapter 13. Most individuals will look to Chapter 7 or Chapter 13, which are the “consumer” types of bankruptcy. By contrast, a business would reorganize under Chapter 11, which is a “business” type of bankruptcy.
Chapter 7 bankruptcy functions as a “liquidation”, allowing you to walk away and cancel your unsecured debt in exchange for turning over your non-exempt assets to a bankruptcy trustee.
Debt is “unsecured” when there is no property or collateral that the creditor can go after if you do not pay. Typical unsecured debts include credit cards, medical bills, personal loans from friends or family members and signature loans. By contrast, “secured” debt includes obligations such as home mortgage loans, vehicle installment loans, furniture or jewelry purchase agreements or personal loans from finance companies that are secured by household goods.
“Exempt property” is sheltered from creditors per state or federal law. For example, in most states your clothes, household goods, and retirement plans are “exempt” and can never be seized by a bankruptcy trustee or by creditors. You can also declare as exempt a certain amount of equity in your home, your vehicles and other property. The specific exemption rules that apply to you depend on where you file. An experienced lawyer can advise you which exemption rules apply to you and what property and assets you can protect.
In most Chapter 7 cases, debtors do not have to give up much, and often they do not give up anything.
Chapter 7 works best if you own very little property, real or personal. Clients are known to have walked away from $50,000, $75,000, even $100,000 in unsecured debt.
Chapter 13 bankruptcy works as a court-supervised payment plan. Here you pay back your missed mortgage payments, vehicle payments, and credit cards over a 3-5 year payment plan. Often, unsecured debt is paid at less than 100 cents on the dollar, some 1 or 2 cents on the dollar.
A typical Chapter 13 plan might look like this: you send a check each month in the amount of $450 to your Chapter 13 trustee. the trustee then disburses funds to creditors per the terms of your plan. This $450 includes an allocation of $275 per month Ford Motor Credit to cover your car note, an allocation of $100 per month to the IRS to pay past due taxes, an allocation of $12 to Citibank, Discover and Chase to cover credit card debt, and $39 to the Chapter 13 trustee as an administrative fee. As long as you remain current with the trustee, all creditors are bound by the terms of your plan.
Chapter 13 works best if you are trying to stop a foreclosure or repossession, or if you have significant equity in your home. Often Chapter 13 reduces your monthly “outflow”, and it can reduce your total debt load as well. For example, before bankruptcy you may be paying $375 to Ford Motor Credit for your car note, $500 to the IRS for back taxes, $85 to Citibank as a minimum payment, $50 to Discover as a minimum payment and $75 to Chase as a minimum payment. Pre-bankruptcy your out of pocket expenses total $1,085. In a Chapter 13, that monthly out of pocket cost may be reduced to $450 per month. If your plan provides for a 10 cents on the dollar payment to unsecured creditors, your total payment to credit card lenders could be $3,500 instead of $35,000 and all accruing interest stops. This is just an example, but frequently I am able to reduce my clients’ total debt by tens of thousands of dollars and I can push a plan through that reduces the monthly expenses by $300 to $700.
Waiting to ask for help. Frequently, emotionally distraught retirees have borne the burden alone, without telling their adult children of a deteriorating financial situation. By the time retirees meet with an attorney, they (and their family) are often physically and mentally drained and perhaps even ill from the stress.
Waiting to address a financial problem can be just as unwise as waiting to address a medical problem. Even if poor money management or misuse of credit cards caused the financial problem, it likely won’t get better.
While every family is different, adult children are often more concerned with the physical and mental health of their parents than with their poor money decisions. But if you see a financial crisis brewing, do turn to your immediate family for guidance and support.
Not understanding implications. Making financial decisions without thinking through the consequences is common. Sometimes the obvious financial move is not the best choice, especially if you end up considering a bankruptcy.
In most jurisdictions, for example, 401 (k) plans and pensions are totally exempt from creditors. Too often, retirees liquidate their retirement plans to pay credit card lenders only to see the outstanding balance of credit cards increase again because of high interest rates. If your credit card interest rate is raised to 15%, 20% or higher, it does not take long for a $20,000 balance to turn into $30,000 or $40,000.
Usually retirees can keep their entire 401 (k) and still eliminate the credit card debt. Thus, I would advise anyone who is thinking about raiding his 401 (k) to get money to pay credit cards or any other debts to speak to a bankruptcy lawyer first.
Transferring assets or shifting debt. Transferring assets or moving balances from one credit card to another usually backfires. If you transfer title or give a valuable asset away for less than market value, you may lose eligibility for bankruptcy because the courts consider such transfers “fraudulent”. As far as the bankruptcy law is concerned, if you give property away, creditors will end up with less than they would have received and therefore your eligibility for a bankruptcy discharge may be at risk. A “discharge” is a formal order from the bankruptcy judge stating that your debts have been legally canceled.
Similarly, if you transfer a large credit card balance to a card with a lower interest rate, you may have to wait many months or agree to pay the “new” creditor back. The bankruptcy laws give extra protection to newly incurred debt and newly transferred debt is considered new debt.
Even if your intention was reasonable, your actions may cause problems should you file for bankruptcy. Best to avoid such problems than to take time solving them.
Handling a loss of home value. When the real estate market was good, financially struggling seniors could always sell their home to raise money, or at least break even and thereafter downsize. Now, you may find yourself with negative equity in your home and seemingly no way out.
Bankruptcy allows you to walk away from your mortgage, usually with no penalty or deficiency claim. This means that your mortgage lender is not likely to sue you for the difference between the loan balance and a quick sale. So, instead of using all your savings to stay in a house you cannot afford, a bankruptcy (Chapter 7, in particular) permits you to turn over the keys when you are under water with your mortgage and move on – all without penalty or cost.
Bankruptcy may not always work for you
Even if you think bankruptcy might not work for you, talk to an experienced lawyer to make sure.
When bankruptcy doesn’t work, often it is because retirees have too much equity in their home.
Every state has “exemption” rules that allow a bankruptcy debtor to shelter equity in real estate and other property. If your state’s exemption limits are very low, your high equity may make bankruptcy relief too costly.
For example, the real estate exemption in Georgia is $10,000 per person ($20,000 for a husband/wife filing). If someone has a paid-off house worth $150,000, he or she can shelter $10,000, leaving $140,000 “non-exempt”.
If this client then files Chapter 7, the trustee will seize his asset (home), sell it, and use the proceeds to pay unsecured creditors at 100 cents on the dollar.
In this situation, the senior and his or her family would be better off considering non-bankruptcy alternatives, such as selling the home or obtaining a reverse mortgage. In this case, a family trust might be a better alternative to bankruptcy, especially if that trust was set up long before the senior got into financial trouble. In general, actions taken by a senior to protect his property – such as transferring title to an adult child or to a trust are much less likely to generate a challenge in bankruptcy if those actions are done a year or more prior to the bankruptcy filing.
Bankruptcy may not work if you want to keep most or all of your assets but you do not have sufficient disposable income to file a Chapter 13. Bankruptcy may not work if you have recently given your adult child a quitclaim deed transferring your home to that child. And bankruptcy may not work if you have religious or moral beliefs that make you uncomfortable with the idea of not paying back your debts.
How much should you expect to spend?
If you do decide to file, you can expect to pay $1,500 – $2,500 for a Chapter 7. Chapter 13 cases will be more costly because Chapter 13 cases last as long as five years. Typically, the total cost for a Chapter 13 will be $3,500 to $5,000, with $500 – $1,500 due up front with the remaining attorney’s fee paid as part of the Chapter 13 plan.
Ultimately, before you enter into a fee agreement with a lawyer you should be comfortable that your lawyer understands the law and is prepared to answer your questions and address your concerns.
Bankruptcy is not a “one size fits all” solution and the more you can educate yourself about the process the more likely you will end up with a positive result.
Jonathan Ginsberg, Esq.
Ginsberg Law Offices