Drowning in Debt? (for the US)

If you find yourself struggling with debt or even filing for bankruptcy after your divorce, here are some strategies for dealing with your post-divorce credit problems in the US.

By Jeffrey Cottrill
Updated: April 06, 2015
debt and divorce

A long marriage usually creates a firm financial stronghold and system for a couple. When the couple gets divorced, the system suddenly gets shattered: assets and debts must be split; a spouse who may have largely depended on the income of the other may be up a creek without a paddle -- and, unfortunately, you may end up with a lot of excess debt. Sometimes, if the divorce is very bitter, the legal and other professional fees can add up to impossible levels; other times, you end up unexpectedly saddled with your ex's debts. Just having a decent place to live can make it worse if you go on your own or with your children -- especially in areas where housing is extremely expensive.

If divorce has left your finances in ruins, you need to find a way to get back on your feet. There may be several options open to you, depending on your unique situation and credit history. One is filing for bankruptcy; another is finding a way to pay off your debts -- at least to a point where creditors temporarily won't harass you. This may, of course, be impossible -- and unfair to you, depending on the situation (you may not have expected or meant to get in so much debt through your divorce in the first place).

If your income is relatively high, or if you feel that the debts are primarily your responsibility and can realistically pay them over the long run, you may be wisest to do so. You could also consider selling off some of your assets to pay your creditors, which will keep your credit rating in good standing.

Another solution is to have a credit counselor work out an easier payback plan for you. "There are plenty of budget and credit counseling/consolidation services in which the individual makes adjusted payments," says Charles H. Scupp, who practices matrimonial and bankruptcy law in Garden City, NY. "Credit reduction services claim they can make settlements with your creditors, but the problem is that your credit report will say that you didn't pay in full. The only way to completely reestablish your credit rating is to pay your debts in full. But with these services, if you can make your payments frequently and work with creditors, they can lower or knock off your interest."

Consumer Credit Counseling Services (CCCS) or Debt Consolidation companies generally offer to help you by reducing all your debts to one affordable monthly payment. These companies contact your creditors on your behalf, and they try to renegotiate the remaining balance, the interest rate, or both.

You'll make small, monthly payments directly to a CCCS, but your creditors usually absorb the lion's share of the fees. Some CCCS companies will take the entire first payment as a fee for their services; these fees won't lower your debt, however, so be sure to find out how each and every payment you make will be applied to your debt.

As with any company you're considering hiring, you should ask the CCCS for references, and check with the Better Business Bureau and Chamber of Commerce before signing on the dotted line.

You also need to know that credit counseling could have a negative impact on your credit report, since your creditors might report that the original balance was renegotiated. But that shouldn't stop you from considering the process: it can be a lifeline when you're drowning in debt.

You could try to negotiate deals with your creditors yourself to get your payments down to a manageable level, but this may be very difficult. It may be easier to restructure your mortgage or car payments in order to make your full debt load easier to handle.

But this solution is only viable if you actually have the ability to pay. "By the time people come to me, they've dealt with consolidating firms or consulting groups," says Ellen K. Bromsen, a bankruptcy attorney in Englewood Cliffs, NJ. "I only see people after those places have turned them down because they don't make enough money. I don't see any success stories coming from there." In many cases, you may be just as well to go with a Chapter 13. "Ask yourself: is there enough money coming in to be able to pay as with a Chapter 13? I've seen few Chapter 13s completed; very few people make that much more than they spend to put into these kinds of plans to pay creditors."

Bankruptcy

The good news is that going bankrupt (like divorce itself) doesn't carry as much of a social stigma as it once did. It's also usually not as disastrous or terrible as you may believe. Although the word "bankruptcy" might stir up thoughts of poverty, failure, confiscation, or just plain guilt, the fact is that bankruptcy is more common today than ever before. "According to the National Coalition for Consumer Credit Rights, someone files for bankruptcy once every nine seconds," note James and John Caher (a lawyer and journalist) in their book Debt Free! (Henry Holt & Co., 1996)

It's not the end of your life or career, not even financially. Desperate to get blood from a stone, some creditors will tell you that bankruptcy is financial suicide, but remember that these are just cheap scare tactics designed to make you give in. Whether your debt problems resulted from a financially chaotic divorce, bad business decisions, a scam, or just personal carelessness, you should look upon bankruptcy as a chance to start anew. If it goes through without any hassle, you'll end up with a clean slate and your debt worries over.

That doesn't mean that you'll escape scot-free. You may have to give up a lot in return for a simpler lifestyle; you will have to pay for a bankruptcy attorney to represent you; and you won't be able to use credit for several years. In fact, bankruptcy may not be the most viable solution for your own situation. Although it will eliminate most of your debts and give you a fresh start, it is still an enormously important decision to make and a relatively traumatic process to undergo. This article is designed to give you an overview to help you consider whether bankruptcy is the solution for you.

How does it work?

In the United States, there are two basic types of bankruptcy for consumers (ie. non-business): Chapters 7 and 13.

Chapter 7 is the simpler and more common form of consumer bankruptcy. All of your debts that are considered dischargeable are eliminated. (Debts that are generally not considered dischargeable include income taxes, student loans, alimony, and child support.) There's a possibility that you may have to hand some assets to a trustee to sell, after which he or she will distribute the funds to your creditors. Fortunately, there are relatively few cases today in which people lose their cars, homes, or other personal belongings merely because of bankruptcy.

"The only way in which bankruptcy differs from state to state is in terms of exemption law," explains Bromsen. "This concerns the property that you're allowed to keep off the top." Although there are federal exemption laws, individual states may opt out of it in favor of their own laws. In New Jersey, debtors have a choice between abiding by the federal or state exemptions. "But the federal law is always used because it's far more favorable," adds Bromsen. "For example, New Jersey has virtually no homestead exemption, whereas $18,000 is the federal homestead exemption. The federal motor vehicle exemption is $2,775 for individuals or $5,550 for a jointly-held automobile."

Unfortunately, New York State does not offer the option of using the federal exemption laws. "New York has a low ceiling of exemption," admits Scupp. "There's an equity of less than $10,000 on homes. Some states, like Texas and Florida, have 100% homestead exemption, so there you could keep your house and wipe out all your debt." The motor vehicle exemption in New York is $2,400. So Chapter 7 won't ever exempt you completely from automobile or mortgage payments; you remain responsible for them if you plan to hold on to your house or car.

With a Chapter 13, you pay all of your secured debts (and a portion of your unsecured ones) under a repayment plan approved by the court. Usually, such a plan consists of monthly payments of your net disposable income -- the difference between your income and living expenses -- which is distributed to your creditors. "Chapter 13 is the equivalent of reorganizing a business -- like Chapter 11, only it's for the individual," continues Scupp. "The vast majority of Chapter 13 debtors have homes and enough financial resources that they can handle the entire amount of their mortgages."

So you generally file for Chapter 13 if you have assets to protect. "The vast majority of Chapter 7 bankruptcies involve consumer debts and dischargeable loans," says Scupp. "Chapter 13 saves your property; Chapter 7 basically wipes out your debt. Although some people file Chapter 7 with homes, a large majority of their debts involve consumer creditors. Chapter 13 can save your home and your car."

The pros and cons

Once you've successfully filed for Chapter 7, you're immediately protected from the harassment, threats, and possible lawsuits of creditors -- and once your bankruptcy is discharged, your unsecured debts are gone. Similarly, if you comply with the Chapter 13 plan you agreed to, your creditors cannot hound you. "One advantage is that you stop getting phone calls from creditors," says Bromsen, "and you stop feeling like you're drowning. Almost all of the people I've worked with have taken a long period of harassing telephone calls both at work and home. When people file Chapter 7, a weight's been lifted. Almost immediately, you get rid of that upsetting, emotionally draining debt. You can really live again."

"The upside of Chapter 7 is that you can wipe out a substantial amount of debt that you couldn't otherwise pay back," adds Scupp. "Most people manage to turn around their financial situation within a two- or three-year period. Chapter 13 can enhance your credit rating a little bit more, since you are paying off some of your debt; many creditors don't give credit to those who just filed a Chapter 7."

However, bankruptcy does have serious consequences to consider. A recent Chapter 7 on your record will make it very difficult or impossible to obtain credit for a while. "The Credit Reporting Agency keeps your bankruptcy on file for 10 years," Scupp says. And Bromsen adds, "Getting credit after your discharge will be difficult, but many companies offer services for those who have been in bankruptcy. There's a higher interest rate because of it." Plus, after you declare Chapter 7, you're not permitted to file for Chapter 7 again within the next six years.

Bankruptcy isn't a loophole that gives you the freedom to take advantage of creditors: it's a financial lifeline that helps you start with a clean slate when you desperately need it. Bankruptcy may be the only way out when your debts result from mounting medical bills, household repairs, or divorce-related fees. But it's not a license to go on wild shopping sprees that you'll never be able to pay for.

Ironically, creditors may start harassing you again after your discharge in a completely different way: by trying to get you hooked again. "After you file for bankruptcy, credit companies know that you can't file again for another six years. So they automatically send you new applications," says Bromsen. However, if you do want credit again, you may see this as an advantage. "A car dealership may give you new credit," Scupp points out. "As long as your debts have just been discharged, they know you can't file for Chapter 7 again."

Despite the relief that bankruptcy provides, it's not a decision to be taken lightly. And as we'll see later, it's definitely not a way of getting out of your spousal or child support obligations. Bankruptcy should be considered a last resort after you've examined all other possible options.

Can your ex-spouse's bankruptcy affect you?

Yes. A problem that occasionally occurs when a divorced person files for bankruptcy is that his or her ex-spouse gets stuck with some or all of the debts. Suppose that your ex-spouse owes $50,000 on credit cards, and your divorce agreement states that both of you share the debt. If your ex files for Chapter 7, you'll be saddled with the entire $50,000. The law tends to see people as being responsible for their spouses' debts, so it's important to get who owes what straightened out before and/or in your divorce agreement.

Be aware, too, that if your ex-spouse files for Chapter 7, you're only protected if the debt is in his or her name and not in yours. For example, if your divorce agreement specifically states that your spouse will be solely responsible for your credit card debt, but the cards are in your name, then creditors will come after you after he or she files.

"Many matrimonial attorneys have little experience in bankruptcy," says Scupp. "Concealment or transfers of assets can complicate things in certain cases. Sometimes in a divorce, a so-called breadwinner will go into bankruptcy court and try to wipe out certain obligations. One situation that can become a potential problem for divorce attorneys is when there's an equitable distribution award to either side. Under New York law, equitable distribution is dischargeable, so one party may try to wipe what they owe out through bankruptcy. Every divorce lawyer should be made aware of this potential problem."

However, you can't use bankruptcy as an excuse to get out of support payments. "Alimony and child support are exempt from discharge by federal statute," Bromsen points out, "and state law can't change that." Although Chapter 7 cannot eliminate support obligations, it can make them easier to adhere to simply by eliminating other debts. Some attorneys might even recommend Chapter 7 as a way to meet your support payments -- simply because it lightens the whole load. "If you can't afford to live because of a substantial amount of money owed, then the credit-card debt has to go."

So don't worry about losing your ex-spouse's support payments because he or she filed for bankruptcy. Instead, be concerned with any loose ends of joint debt that weren't cleared up before the divorce.

Just like starting over...

Contrary to the traditional image of bankruptcy as a shameful, destitute state, it has become a way of getting back on your feet after financial disaster. Few people who file for Chapter 7 or 13 really are irresponsible deadbeats; many just made poor judgments or had a run of bad luck. In the long run, bankruptcy could be a positive decision. However, make sure to consider it thoroughly before you choose to file. Weigh the pros with the cons; analyze your current situation and whether other alternatives would be more effective; think about everything you have to gain and lose; and if you choose to file, make sure you never, ever have to do so again.

For more information on bankruptcy laws, procedures, and the exemptions and rules in your state, speak to a local bankruptcy attorney.

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September 24, 2012
Categories:  Financial Issues

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