Research says over 90 percent of all Bankruptcies are filed because of medical bills, a divorce or job loss. In my experience is that accurate?
Credit card debt is the leading reason our clients have filed for bankruptcy relief. Saving their home comes in a close second and in third place, the reasons are split between divorce, student loans and taxes.
Credit card debt forces many into bankruptcy because of the outrageous fees and interest these companies are allowed to charge. Once a person is behind or over the limit, late and over the limit fees and interest added to the principal credit card debt make the amount ‘unpayable’ in a person’s lifetime. Until Congress wakes up and lowers the percentage of the interest rate the credit card companies are allowed to charge, credit card debt will more than likely continue to be the leading cause of bankruptcy.
I can’t count the number of times I consulted with a client who is just able to survive on their income. Along comes a hiccup in their budget; an additional expense that causes them to borrow money. If the expense is small the family can borrow from their flexible expenses, such as food, clothes, and entertainment. If the expense is large the sacrifice to food, clothes and entertainment become a hardship, often forcing decisions to delay much needed medical treatment, saving for retirement, or saving for their children’s college expenses. Utility companies offer reduced rates to low-income families, Churches and other charities offer food pantries, and Thrift Stores prices for clothing are much lower than department stores, but these budget savers are often not enough to help.
Starting in 2008 people from all walks of life needed the bankruptcy laws to help them save their homes. The American Dream of owning a home was shattered by the mortgage industry crisis.
People in the six figure income bracket could not afford the bad mortgage loans they entered. The lenders sent loan modification offers. People accepted and paid the modified amount yet found foreclosure notices posted on their property.
Other homeowners had their wages reduced and could not afford the bad mortgage loans they entered. The lenders sent loan modification offers. People accepted and paid the modified amount yet found foreclosure notices posted on their property.
It was a crazy time for the homeowners and the consumer attorneys. To top it all off the banks were allowed to ‘lose’ documents, charge for all kinds of made up things like ‘drive by’ appraisals and apply the money they received from homeowners to ‘suspense accounts’ instead of the principal mortgage.
Clients with a home and investment property in California often needed a Chapter 11 to save their property because the dollar amount of their mortgage debt made them ineligible to file a Chapter 13. These Debtors were ‘Debtors in Possession’, and had several tasks to complete, such as opening new bank accounts, calling their insurance companies, adding the US Trustee as additionally insured and filing monthly reports with the US Trustee’s Office. The loans on their investment properties were ‘crammed-down’ (reduced to the fair market value) which created a new loan with a new interest rate a few points above prime and 20 to 30 years to pay off. Chapter 11 does not allow a ‘cram-down’ on home mortgages; the lenders knew this and their attorneys created all kinds of road blocks to modification. Chapter 11 also requires the creditor's vote to accept the plan and without one class of creditors voting yes, no plan. Chapter 11 can be very stressful, expensive, and long; it can also save property.
A Chapter 13 helps when there is only a home to save or low-value properties. In 2008, Debtors were required to pay the regular monthly mortgage once the bankruptcy was filed. If the debtor couldn’t afford the mortgage before bankruptcy, they couldn’t afford to pay that amount after they filed bankruptcy while they pay the amount necessary to cure the default amount (the amount included all the extra costs the lenders/servicers created, and the courts generally allowed). Now, about eight years later, the Chapter 13 Trustees allow the debtor to pay the hoped for modified amount after they file bankruptcy and give the debtor about 6 – 9 months to work out the modification with the lender. If modification is not possible then the debtor can convert or dismiss the case, or modify the plan payment.
A few years ago, when the Big 5 Banks were forgiving and modifying some second mortgages, I filed a Chapter 13 bankruptcy for a couple struggling to pay their mortgage and keep his business running after the wife was injured at work and no longer brought a paycheck home. It was a stroke of luck that they received the forgiveness of their second mortgage and the lender filed a Rescission of Mortgage with the County Recorder before we filed their bankruptcy. They are almost through their five-year plan and looking forward to a fresh start.
The State of California shelters homeowners from a deficiency judgment when the lender forecloses, unless the loan paid off bills without improving the home. I have represented clients who were bamboozled into thinking it was better to tax a tax deduction for mortgage interest than pay credit card interest. They were bamboozled because they turned an unsecured dischargeable debt into a secured debt that could and did in many cases cause the loss of their home. Bankruptcy gave them a fresh start whereas if they had allowed a foreclosure outside of bankruptcy they would have incurred a tax liability, the lender would have sent a 1099-MISC for the amount of the mortgage debt they were ‘forgiven’ in the foreclosure.
Divorce is devastating to the parents and the children. The family assets are diminished to nothing in the division fight, so that the only one making out in a divorce is the attorneys. Huge attorney fees awarded in the Family Law Court are not discharged in bankruptcy if the Family Law Court includes them as part of a child support order.
If the property division was finalized within a year of filing a Chapter 7 Petition, the Bankruptcy Trustee can undo the property division, if the property division looks unfair. Many times a property division looks unfair if one of the spouses was financially responsible and the other wasn’t. What a surprise to the non filing financially responsible spouse when the Chapter 7 Trustee demands turnover of the house or savings.
Credit card debts listed in the Family Law Property Division can also become a problem later. Many clients do not understand that the Marital Settlement Agreement dividing property and debts is an Order from a court of ‘limited jurisdiction’. This means that, even though the Family Law Court assigned certain debts to certain spouses, if the assigned spouse fails to pay a debt, the creditor can still come after the other spouse to collect. The only remedy in Family Law Court is to bring the non paying ex-spouse back in front of the Family Law Judge and ask the Court for an Order Compelling the non paying ex-spouse to pay, but it does not stop the creditors from collecting the debt from both ex-spouses.
Bankruptcy does stop the debt collectors but with the change in the laws the unsecured credit card debts listed in the Marital Settlement Agreement may or may not be dischargeable and depending on the age of the tax debt and actions the spouses took with the taxing entities the joint tax debt may or may not be dischargeable. Sometimes it is better to file bankruptcy then file for divorce or file for divorce and wait at least a year after the property division.
Student loans are driving many to seek bankruptcy relief. It is criminal how the costs of colleges and universities have increased so that a graduate is saddled with such a heavy debt load they are unable to start a family and buy a home. Our society supported State Colleges and Universities to provide an affordable education for the next generation, thereby improving our nation. Unfortunately the ‘financial experts’ figured out how to securitize student loans and many schools, to meet the eligibility requirements for federal loans, increased tuition so students had to take out private loans. It seems the schools purpose changed from educating the next generation to sacrificing the students to support the school. Other students failed to earn a diploma and the jobs they are eligible for don’t pay enough for them to pay their student loans and support themselves and their dependents with a minimal life standard.
My own experience with student loans was that the monthly payment was more than my income. Fortunately, now, Federal Student Loans offer repayment options based on income; but not so for Private Student Loans, yet. Chapter 13 may offer repayment options.
Student loans have a special status in bankruptcy and the test to discharge the debt is a hard test to pass. The test is whether the payment of the student loans creates an undue hardship and prevents the Debtor from maintaining a minimal standard of living. A Bankruptcy can stop a wage garnishment, and even if the Debtor can’t pass the test for complete forgiveness of their student loan debt, if they can afford to pay their attorney, the Debtor has an opportunity to reach a negotiate a settlement agreement on the amount of the monthly payment, negotiate partial forgiveness, and have the amount of the student loan left after completing a payment arrangement relate back to and be discharged in their bankruptcy discharge, thereby avoiding any tax consequences of 1099 for forgiven debt.
Tax debt is another devastating event that drives clients to bankruptcy. Like credit card debt the interest and penalties can make a person a ‘debt slave’. If a family experiences an expense hiccup and doesn’t or can’t pay the ‘hiccup expense’ and they don’t have the money to pay income taxes because they increased their deductions they often adjust the withholding on their paycheck so they have more take home on their wages and hope to be able to pay their taxes in April. When April comes the money may or may not be there, what then? Penalties and interest accrue on the tax debt. The old adage ‘nothing in life is certain except death and taxes’ is true.
Congress created some statutes that allow discharge of income taxes if they are old enough and the Debtor filed tax returns. In the case of unsecured income tax debt that is not dischargeable a Chapter 13 is a great remedy. Inside of bankruptcy, penalties and interest cease, whereas outside of bankruptcy, penalties and interest continue to accrue. I have helped many clients who pay on an installment plan and the balance increases, even though they faithfully paid each month. Even if some of their taxes are dischargeable and some not, the Chapter 13 plan is a payment arrangement with a light at the end of the tunnel.
I have helped clients who suffered the double whammy of losing investment property to foreclosure and gaining tax liability because the lender sent 1099 on the deficiency amount. Clients who borrowed from their 401K to pay their mortgage then lost their home to foreclosure anyway and gained tax debt because they weren’t able to pay the taxes on the 401K withdrawals. Clients who couldn’t pay their taxes and the IRS filed liens. Chapter 13 allows the debtor to strip tax liens when house values are down and freeze the amount of the tax debt for payoff.
The IRS can be very aggressive collectors. In Bankruptcy they have the burden of proof, in Tax Court the taxpayer has the burden of proof. Bankruptcy can be a better place to deal with taxes. Tax Debt is especially painful when the spouses filed joint returns, divorce, and the spouse the debt is assigned to in family law court fails to pay and the IRS garnishes wages or levies bank accounts of the other spouse. Bankruptcy can be the best remedy.