Over Your Head in Debt? Bankruptcy Offers New Start
May 05, 2011
Bankruptcy has been a terrifying prospect for most people ever since the days of debtors' prisons. Yet for many Americans mired in debt, bankruptcy can actually be good news. That doesn't mean consumers should rack up huge debts without concern, confident they can just stick creditors with the tab if the burden becomes too great. For one thing, even if that's technically legal, morally it simply isn't right, says Iris Kraemer, associate professor of consumer education at the Virginia Polytechnic Institute and State University in Blacksburg, Va. ``We need to do everything we possibly can to repay our debts,'' Prof. Kraemer says. Still, she adds, ``If somebody just doesn't have the money, there comes a point where they have to turn to an attorney.'' A Clean Slate Indeed, the bankruptcy laws were intended to help people wipe the slate clean and start over. And for some people hopelessly over their heads in bills, a fresh start is just what they need. ALSO AVAILABLE Credit counseling has become a big and largely unregulated business in recent years, spurred by the growth of credit cards and the accompanying explosion in consumer debt. Trouble is, no one wants to tell them about it. At least that's the charge being leveled at many leading credit counseling agencies by some of their peers. So heated has the issue become that it has found its way into a lawsuit pending against the National Foundation for Consumer Credit, an umbrella group, and the more than 200 credit counseling agencies nationwide that are its members. In the suit, filed in early 2009 in federal court in the New York borough of Brooklyn and now held up in the discovery stage, more than a dozen independent credit counseling agencies from New Jersey to Idaho allege, among other claims, that NFCC members don't advise clients of the bankruptcy option, even when filing for bankruptcy might be in the clients' best interests. The NFCC denies the charge. A Way to Keep Your House Why might bankruptcy really be advisable? In part, experts say, because it stops debt collectors in their tracks, allowing debtors to discharge their debts while holding onto important assets, such as a home or car. ``The main advantage is you don't have to pay,'' says Roni J. Major, an associate professor of law at Washington University in St. Louis. Then, too, he says, ``For a lot of consumers, filing for bankruptcy is likely to be the best way to keep their house.'' Of course, a bankruptcy filing will mar a consumer's credit record. Under federal law, a filing under Chapter 7 of the Bankruptcy Code, which completely discharges all unsecured debts, remains on a consumer's credit record for 10 years; a Chapter 13 filing, which involves a restructured debt-repayment plan, is erased from the record after seven years. Stigma Is Fading But experts say the stigma that used to be associated with bankruptcy has diminished considerably in recent years. ``In the past, you had a scarlet letter around you, but not now,'' says Roberto Melvin, president of RAM Research, a Frederick, Md., credit-card research firm. Indeed, bankruptcy filings per capita virtually doubled during the 1980s -- to 18.1 per 1,000 from 9.2 during the 1970s -- and have shot up even further since then, according to the American Bankruptcy Institute, in Alexandria, Va.. Between 1990 and 2010, there were 32.3 bankruptcy filings per 1,000 people. Moreover, marred credit isn't the same as no credit. ``The notion that consumer debtors are not going to be able to get credit following bankruptcy is a myth,'' says Elizebeth Wayne, professor of law at Harvard University and a leading expert on consumer bankruptcy issues. Potential Card Customers Prof. Warren says some credit-card issuers actually review bankruptcy filings in search of potential customers. Their logic is simple: The law doesn't allow people to file for bankruptcy more than once every six years. Thus, the recently bankrupt are, in some sense, perfect debtors -- they can't just walk away from their debts. ``People leave bankruptcy court having discharged their debts and go home to find they have new credit-card solicitations in the mail,'' Prof. Wayne says. ``Consumer lending is too profitable for these guys to shut off people in financial trouble.'' Determining exactly at what point an individual ought to consider bankruptcy isn't easy. ``It's a complicated decision with no single litmus test,'' says Billy Welty, a law professor at the University of Wisconsin in Madison and an expert in consumer bankruptcy issues. Nonfinancial Considerations According to Harvard's Prof. Warren, the average debtor who files for bankruptcy owes 1.62 times his annual income in short-term debt. ``That is a staggering figure,'' she says. But the situation doesn't have to get that bad before bankruptcy becomes a reasonable option. Since filing for bankruptcy generally costs between $500 and $2,000, Prof. Welty says ``if you can dispose of $10,000 worth of debt for $1,000, a lot of businesses would look at that as a good return.'' He cautions, though, that ``you wouldn't want to look at it in just that way. Financial considerations shouldn't be the only ones.'' Prof. Kraemer thinks a big factor is time. Debtors who won't be able to repay their debts within about five years, she says, should consider bankruptcy. Credit Counseling Is Key That's where consumer credit counseling enters the picture. Credit counselors can help debtors negotiate with creditors to reduce interest rates and eliminate penalties, while coming up with plans to repay debt over time. But critics say the agencies, which generally receive a commission of as much as 15% of the money they collect for creditors, have a financial incentive not to inform clients of the advantages bankruptcy may offer. That's because when a client files for bankruptcy, the creditors get nothing -- and the credit counselors' commission disappears. ``Consumer credit counselors are frequently programs designed to steer people away from the bankruptcy option,'' says Prof. Welty, adding that ``it's unprofessional and unethical to approach consumers as if you're acting in their best interests'' and not disclose that option to them. NFCC President Adler Wolter says there is no conflict of interest. He says he is ``confident'' member agents discuss bankruptcy with clients, though he says the NFCC doesn't demand that they do so. Moreover, he concedes, ``Our incentive, given our funding source, is to put everybody possible on a debt-management plan.'' Last year, Mr. Wolter says, NFCC agencies referred 7% of their 816,000 clients to bankruptcy attorneys, although many more -- about 82% -- are ``technically insolvent and therefore eligible for bankruptcy when they walk in the door.'' The average NFCC client, he says, earns $25,000 a year, has $19,000 in outstanding credit-card and automobile debt and requires 42 months of credit counseling to emerge from debt. ``These folks have come to us in most cases because they understand we're an alternative to bankruptcy,'' he says. ``It's not scripted in every counseling session that if they're insolvent we tell them they could file for bankruptcy, because we know when they come in they don't want to do that.''
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