Having accumulated debt is an emotionally and financially draining situation. Sometimes you may owe lenders more debt than you can afford to repay. What would you do when you find yourself in this situation? Would you rather walk away from the debt or file for bankruptcy? Each option can be suitable or unsuitable based on the specific situation, as we shall see in this blog.
Walking Away From Debt
When you owe lenders more money than you can afford to repay, doing nothing and walking away may seem like the only option. But walking away can cause even more significant problems in the short or long term.
Walking away from debt is also called "defaulting on debt payments." It means violating the cardholder agreement or promissory note with the creditor by failing to make timely payments. Each creditor has independent rules regarding the number of missed payments a person can accumulate before they are considered to have defaulted. In some instances, the number of missed payments could be as low as one, while in others, it could be as high as ten.
When you miss a payment, what happens before you are considered to have defaulted will depend on the kind of debt, the lender, and your specific agreement with that lender. However, generally, here is what to expect:
- You can anticipate a call, email, or letter from your lender within thirty days to remind you that you are late on the payment. Additionally, the creditor may report your missed payment to a credit bureau.
- If you do not answer the thirty-day message or pay the missed debt, you can anticipate receiving more aggressive messages requesting payment. Your creditor may apply a penalty, and you may be assessed late fees. Additionally, the creditor will virtually certainly report your missed payment to credit bureaus. Most importantly, your credit standing will drop.
- If ninety days pass without paying your debt, your lender will likely consider you to have defaulted. In this case, your credit standing will fall further, making it challenging to be eligible for another credit card or loan. The creditor may sue you seeking wage garnishment or even place a lien on your home to collect part of the profit when you sell the house. Or, the creditor may sell the debt to a debt collection agency, which then tries to collect the amount you owe. Or, if it is a secured debt, the lender may start repossessing the collateral.
These are only general guidelines. What happens in detail depends significantly on what kind of debt you owe.
Filing for Bankruptcy
Declaring bankruptcy is a legal process initiated when an individual or business cannot repay outstanding obligations or debts. It involves listing assets and debts and potentially finding means to repay the debts or obligations. A bankruptcy court judge decides whether any of a person's debts are dischargeable and if they can use their assets to repay the remaining debt balance. The judge also decides what possessions the person can retain and what assets the creditor can seize.
Bankruptcy offers a fresh start for individuals who can no longer afford to pay their debts. Therefore, declaring bankruptcy may be an ideal alternative to defaulting if you wish to solve your debt problems and start on a clean slate. How the bankruptcy process works is based on the chapter of bankruptcy a person declares.
If you declare bankruptcy under Chapter 7, the court judge will decide what assets should be sold to pay off your lenders. However, this must be founded in law and the law is revolved around exemptions. Any outstanding debt will then be forgiven except for child support, student loans, alimony, and taxes. Consequently, declaring bankruptcy under Chapter 7 could discharge most of your unsecured debt, so you are no longer responsible for paying it. Chapter 7 bankruptcy remains on a person's credit report for ten years.
If you declare Chapter 13 bankruptcy, you may retain all of your possessions while discharging some (maybe all) of the debts. The nondischargeable debt will be placed on a repayment plan of at least three and a maximum of five years. Bankruptcy under Chapter 13 focuses on debt reorganization. You must maintain strict spending to ensure you have paid most of your debt within your repayment plan.
Declaring bankruptcy under either chapter will likely lead to a significant drop in your credit standing initially. Your credit cards may be closed the moment you declare bankruptcy. Securing another credit card or loan can also be challenging in the initial stages after the bankruptcy period has ended. As time passes, bankruptcy will impact your credit score less, but only if you are disciplined with your credit. And in the long term, the bankruptcy can help your score since you have now resolved the debt obligations.
Walking Away From Debt vs. Declaring Bankruptcy: Which Option Is Better?
From the above discussion, the following questions can help you decide whether to declare bankruptcy or just default on payments.
Do You Have Any Assets That Lenders Can Seize?
Most lenders must file and win a money judgment in court before taking your assets. However, if you do not have any possessions that a judgment lender can seize, you are judgment-proof and may not need to declare bankruptcy. You are generally judgment-proof when:
- You do not have any home equity.
- You do not own any property you cannot protect from lenders using the state exemption law.
- You do not work, or your job is very low-paying.
- You have an income source exempt from lenders, like unemployment and social security benefits.
Note that being judgment-proof can be temporary. For example, you may be unemployed now but will be employed soon. If you are relatively certain your financial condition will not improve significantly and debt collection pressure does not trouble you, there may be no reason to declare bankruptcy.
Will Declaring Bankruptcy Erase All or Most of Your Debts?
Not all debts are dischargeable when you declare bankruptcy. If you are still required to repay your most burdensome debts after declaring bankruptcy, then filing will probably not be ideal. On the contrary, if declaring bankruptcy wipes out enough debt that you will have enough finances to pay your non-dischargeable debt, doing so may still help.
Are there Available Alternatives to Bankruptcy?
Before you declare bankruptcy or default on your debts, consider other methods of addressing debt. You can walk away from debt when you have a suitable bankruptcy alternative (other ways to solve your debt problem without declaring bankruptcy). Bankruptcy alternatives include the following:
Debt Consolidation Loans
If you have difficulty repaying your debt but have yet to miss any payments and your credit standing is fairly good, you can choose debt consolidation instead of defaulting or declaring bankruptcy.
Debt consolidation entails applying for a loan for the amount you owe on your existing debts and then using the funds to repay your outstanding debts. Then you will repay the new loan over time. Generally, debt consolidation loan terms last up to seven years, and the loans have low fixed interest rates. Since the interest rates for these loans are generally lower than those of credit cards, the loans are an affordable means to pay off higher-interest credit card debts.
Debt consolidation may lead to a drop in your credit standing at first due to the credit inquiry required when securing the loan. But with time, this method of addressing debt might raise your credit standing if you are consistent with timely loan repayments.
Debt Settlement
Debt settlement is also called "debt adjustment" or "debt relief." It involves negotiating with lenders to settle your debt for less than what you owe while promising to pay the value settled for in full. You could negotiate independently or hire a debt settlement company to do it for you. This option works for some people, but it has various risks. Your credit standing will drop, and most importantly, creditors may refuse to settle, leaving you with the same debt as when you began, causing more financial damage than good.
Debt settlement might seem like a convenient way to sort out your debts, but it has a few downsides. Finding a reliable debt settlement company may be challenging, and negotiations may take longer. Additionally, debt settlement companies charge hefty fees, generally between 15% and 25% of the debt they settle. For example, if you wish to settle a $50,000 debt, your charges will depend on that value, not the eventual negotiated repayment value.
Debt settlement can also harm your credit standing. For example, most debt settlement companies require that you cease making payments using your credit cards during negotiations, as creditors may not negotiate with individuals who can still pay their monthly bills. Failure to pay your bills will damage your credit standing.
Credit Counseling
Credit counseling involves seeking assistance from a licensed nonprofit debit or credit counseling agency. These agencies can review your debts, income, and other expenses and assist you in devising a budget and plan to pay off your debts and boost your financial image. Based on the seriousness of your case, coaching and advice from an expert financial counselor might be all you need to manage your debts and avoid filing for bankruptcy or defaulting.
If your situation requires more than just planning, a credit counselor may help you avoid bankruptcy by working out a plan with your lenders that reduces your payments and will solve your debt issues within a few years through a debt management plan.
Hardship Options for Student Loans
Bankruptcy does not forgive student loan debts. But there are ways you can manage your payments. If you have a federal student loan, you can pursue forbearance or deferment for a maximum of three years. The interest could still accrue during this period based on the kind of student loan you secured and the relief you opted for. Neither forbearance nor deferment will affect your credit standing. However, both will reflect on your credit report.
The second way to manage your payments as a federal borrower is to change to an income-guided payment plan with a loan forgiveness option. Doing this would extend your payment timeline. However, since the payment plan is based on your actual monthly income, your monthly payment could be as low as zero dollars. The advantage of this option is that a credit check is not required to start an income-guided payment plan, and your credit standing will not be affected.
If you secure a private student loan, you might still qualify for forbearance or deferment. This will depend on the creditor. If you have financial problems, contact your creditor and ask what options you have. A deferment program through a private lender may affect your score.
Negotiating on Medical Debt
If you owe medical debts, you may significantly lower your monthly payments. Contact the billing department, explain your financial circumstances, and negotiate a reduced monthly payment. Most healthcare centers offer discounts and relief plans for financial hardships.
Negotiating a reduced monthly payment with your medical provider for your debt does not affect your score if you repay the entire medical debt you owe and do so on time. If your monthly payment is low and easy to manage, there is a low chance you will miss payments. This may indirectly and positively affect your score.
Find an Experienced Bankruptcy Attorney Near Me
The simplest way to know your best option between walking away from debt and declaring bankruptcy is to consult a bankruptcy lawyer. A bankruptcy lawyer will assist you in weighing and balancing your needs and determining whether you would benefit more from filing bankruptcy rather than defaulting or pursuing bankruptcy alternatives.
At Sacramento Bankruptcy Lawyer, we help clients overburdened by debt find relief by finding the most suitable way to address the debt issue. If bankruptcy is the ideal option, we will determine what type suits their needs and help them through the entire process.
If walking away from debt is in their best interest, we will advise them not to do anything about it. And if neither option is suitable, we will discuss other alternatives, like debt consolidation and credit counseling. Call us at 916-800-7690 for a consultation if you need help solving your debt problem.
