… and how can you avoid them altogether?

Personal Bankruptcy in America is a major issue and a concern for many.  Recent numbers show that close to 14% of homes are past due on their mortgage, with almost 2% of those homes currently in some level of foreclosure. How do you know when your debt is so toxic and overwhelming that bankruptcy is the right answer?   What alternatives do you have for avoiding foreclosure?

Capitalism without bankruptcy is like Christianity without hell.
- Frank Borman

If we don’t change, millions of American families are just one medical emergency, or one layoff, away from financial disaster and bankruptcy.
- Jim Cooper

Personal Bankruptcy

The number of personal bankruptcies peaked in 2005, when over 2 Million families filed for bankruptcy.  The law changed after that to require debt counseling prior to declaring bankruptcy, but the number is climbing once again, now back nearly to 2001-2004 levels.  There are two main types of personal bankruptcy, Chapter 7 and Chapter 13.

Chapter 7 bankruptcy is the most common choice, at 65% of bankruptcies.  In Chapter 7 bankruptcy, most debts are discharged (except some debts like student loans, spousal/child support) but much of the debtor’s property is forfeited to a trustee, who then sells the property to pay down the debts.  In Chapter 13 bankruptcy, less common at 35% of personal bankruptcies, the debtor keeps all of their property, but they are required to make payments over 3-5 years to a trustee in order to pay down a portion of their debt.  You can file for Chapter 7 every 8 years, and there is no set limit on frequency for Chapter 13 Bankruptcy.

California and Florida have the most Bankruptcies by sheer numbers, but Nevada beats both by a high margin in per-capita bankruptcies.  Entire city and state governments are considering bankruptcy as a solution to the mounting debt.

Foreclosure

If you stop paying on your mortgage, the bank will eventually kick you out of the house and take possession of it.  You will forfeit any equity that you have built up, and this foreclosure will show up on your credit report and public record for at least 7 years.  The number of people who are seriously delinquent on their mortgages has climbed drastically over the last few years.  Many factors play into this steadily climbing rate, but the main culprits are the recession and pre-recession loan practices, which often leave families with payments that they could not afford even if their incomes were at a normal or stable level.

What can you do?

The first thing to think about is prevention.  Many bankruptcies and foreclosures are the result of some lack of foresight.  What can you do to make sure that, barring a catastrophic financial event, you will be able to avoid foreclosure and/or bankruptcy?

1) Get educated

Consumer education on credit, home ownership and financial responsibility is the #1 way to avoid dealing with a bankruptcy or foreclosure in the future.  If you don’t know where to start, we recommend checking out http://www.mymoney.gov/, where you can find basic worksheets, calculators and advice.  Don’t assume that you are making the best financial decisions just because you are following the examples of others; as Dave Ramsey likes to say… “Normal is BROKE, I want to be WEIRD”.  Don’t take anyone’s word for it, find out what your options are, what you can actually afford, and plan for your long-term goals.

2) Get Insured

Health Insurance, Life Insurance, Auto Insurance – make sure that you have the right coverage and the right plans.  Your insurance should cover you for major events that you cannot afford; like replacing your or someone else’s car, paying for surgery or losing a parent or spouse.  These policies are not investments, they are costs; avoid policies with investments built into them, like whole-life or universal life insurance.  Proper insurance coverage can help you altogether avoid bankruptcy or foreclosure due to a major medical event or another large out-of-pocket expense that will “never happen to you”.

3) Start Saving

Without this component, the other two are almost worthless.  If you are spending every penny that you bring in, you need to change something.  Career, spending habits, or housing situation – whatever it is, it is going to leave you in a position with no room for anything to go wrong.  Ideally; you will be in a position where you can live off of 75% of your Net Income, putting at least 10% in savings and throwing 15% into paying off debt.  This is a big step to take, and a budget will be helpful to accomplish this goal.

What if it’s too late?

If you have a recent bankruptcy, or you are currently behind on your Mortgage payment, there is hope.  First of all, Bankruptcy or Foreclosure is not a death sentence for your credit.  You will not qualify for very good rates, and you will definitely need to make changes to work around the negative impact of Bankruptcy or Foreclosure, but with diligence and planning, you can bounce back.  With Chapter 13 bankruptcy, you can be considered for a Home Loan after only 12 months of good payment to the trustee, and their permission.  With Chapter 7, you can typically be considered for a new Mortgage after 2 years, or less if you can prove that the bankruptcy was medically-related.

For some Americans, Foreclosure seems to be the only option; they are miles upside down on their mortgage and/or they cannot afford the payments.  Many Americans are in this same position – and banks are having a difficult time keeping up.  At this point, the average time it takes a bank to foreclose on a property is 14 months of delinquent payments.

What are my options?

For Bankruptcy, you are now required to complete debt counseling before you file; this is really the worst of both worlds because this debt counseling will usually trash your credit further by making underpayments on all of your already delinquent accounts (these payments are usually not reported to the credit bureau because the company you are paying is not getting the total payment due to them).  One better option?  Negotiation.  In many cases, companies are willing to work with you to avoid the paperwork and lower payoff of a bankruptcy situation or a collections agency.  If you are faced with an aggressive or abusive lender, you may try to contact the company through a different department to find someone who is willing to negotiate your debt.  If push comes to shove though, remember that in bankruptcy you are not allowed to discharge certain debts like taxes, student loans and support payments; prioritize those debts so that you are not left with large bills after a Bankruptcy.

In Foreclosure, there are new government mandated programs where banks are incentivized and in some cases required to restructure your loan, or forgive it altogether.  Many banks are resistant to this process though, so it helps to have an expert on your side to guide you through the process.  Many lawyers have made a LOT of money by being that expert, but there are many non-profit organizations that have entire departments dedicated to helping people navigate the Loan Modification, Restructuring or Loan Forgiveness options available.  Many of these non-profits are also able to help you clean up your credit after a foreclosure or a bankruptcy.

Whether you are just starting to feel the recession, looking at Bankruptcy or Foreclosure as an option, or trying to recover from one or both; there are options and alternatives for you to consider so that you can make the best of a bad situation. Get educated about your options, get insured so that you don’t lose everything overnight and start saving for a rainy day, even if it’s already pouring.

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- Mortgage Pro Blog; Geoffrey Boyd; PrimeLending, Clackamas OR