20 Mar Choosing between debt consolidation and bankruptcy

 Q. Can you direct me reputable source for consultation for debt consolidation vs. bankruptcy? My wife and I are in our early 60’s and are struggling with debt due to job layoffs over the past 10 years. I am currently working at a position earning 1/4 of my earlier income and struggling with the debt we have incurred.

A. We’re sorry to hear you’ve come into hard times, but there are options.

You’ve experienced a drastic reduction in cash flow, so it’s not surprising that you’re having difficulties, said Beverly Harzog, author of “The Debt Escape Plan.”

She says you should start by taking a hard look at your budget after you’ve adjusted your income for the lower amount. If you don’t have enough — or barely enough — cash flow to meet your monthly expenses, then it’s a good idea to speak with a reputable credit counselor, she said.

Harzog recommends you start with the National Foundation for Credit Counseling (NFCC) to find an accredited credit counseling agency.

“Many credit counseling agencies will offer you a free telephone consult,” she said. “An NFCC-certified credit counselor can discuss debt consolidation options so you can decide if this might be the best option for you and your wife. Depending on your circumstances, the agency could also suggest a debt management plan (DMP), which might include lowering your interest rate so you’ll be paying less interest and paying off the principal amount more quickly.”

Harzog said people often confuse DMPs and debt consolidation. Here’s the difference: With a DMP, you’re not opening a new line of credit. The counselor works with your lenders to make it easier for you to pay back the loans you already have. This might include lowering your rates or accepting lower minimum payments. With a debt consolidation, you’re opening a new line of credit, whether it’s transferring the debt to a balance transfer card, getting a home equity line (HELOC) of credit or consolidating the debt into a personal loan.

“You can set up a debt consolidation loan on your own, but the options, such as a HELOC, can be tricky, so it’s best to get advice from a credit counselor,” Harzog said. “You can also contact your local bank, a credit union, or even an online lender, but it’s still a good idea to touch base with an accredited credit counselor first so you get a full overview of the best options in regards to your specific situation.”

She said if you still have excellent credit, you have another option. You might be able to consolidate your credit card balances on a balance transfer credit card. A balance transfer card allows you to pay down your debt while paying zero interest for a period of time, usually 12 to 18 months.

If some of your debt is on credit cards, you can also try to negotiate with your lender on your own. Call the credit card company and ask to speak with the hardship department, Harzog said. Major credit card companies have this, but it isn’t advertised.

“Before you call, make a list of the points you want to cover. You want to come across like you’re confident you can pay the balance off if you can get a temporary break, such as a lower APR or a decreased minimum payment,” she said. “These programs only last for about a year, so this may or may not be enough help depending on your exact situation. A credit counselor can help you decide if this is a strategy you should pursue.”

There are several things to consider to know if debt consolidation or a debt management plan is a better option than a bankruptcy.

Taxes is one consideration, said Ilissa Churgin Hook, a bankruptcy attorney with Hook & Fatovich in Wayne.

You need to know if receive a discharge of debt in a bankruptcy proceeding, you do not have any tax liability for the portion of the debt that was discharged, she said. To the contrary, under some debt consolidation plans, a portion of the debt owed is forgiven. In that case, creditors can issue a 1099 Form for the forgiven debt.

“If you owe a creditor $20,000 and it accepts a settlement payment of $10,000, the $10,000 that was forgiven counts as income to you for tax purposes,” Hook said. “If the $20,000, or some portion thereof, is discharged in a bankruptcy proceeding, no portion of the $20,000 is considered income to you.”

Another factor to consider is whether you really have the ability to repay your old debts.

If your current income is substantially less than your prior income, you may not have any excess income in your budget to dedicate to paying down your debts unless you substantially reduce your monthly expenses, Hook said. If that is the case, a bankruptcy filing, in which you can possibly discharge certain debts, may be your best option.

She said because you’re in your 60s and are earning substantially less money than in the past, your analysis should also include an examination of your retirement planning. Ask yourself how much money should you be putting away each month/quarter to ensure a secure retirement.

If you choose bankruptcy, Hook said most individuals seek relief either under Chapter 7 or Chapter 13 of the United States Bankruptcy Code.

Generally, in a Chapter 7 case, a debtor seeks a discharge from his/her debts in exchange for exposing his/her assets to an examination by a third party Trustee, who acts as a fiduciary for creditors, she said. One of the Trustee’s obligations is to look for assets that have equity (after taking into account the costs of sale, any liens against the asset, and any relevant bankruptcy exemptions) and can be liquidated to pay creditors.

“Assuming that you qualify for a Chapter 7 bankruptcy — depending on your income and expenses — you would have the opportunity to achieve a Chapter 7 discharge of certain types of debt, which would give you a `fresh start’ and would prevent these creditors from taking any (further) collection action against you,” Hook said.

A Chapter 13 filing is an option available to an individual or a married couple with regular income seeking to reorganize his/their debts and retain assets. A Chapter 13 case normally lasts three to five years and involves a payment plan, which allows a debtor to repay his/her debts over time, Hook said. The length of the Chapter 13 Plan depends on your income and ability to make monthly payments.

“Notably, additional interest on unsecured debts, i.e. credit cards and medical bills, does not accrue during the life of the Chapter 13 Plan,” Hook said. “In a Chapter 13 Plan, you would have to pay unsecured creditors the greater of (i) your excess monthly income, or (ii) what the creditors would have received in a Chapter 7 liquidation.”

Finally, Hook said, there is no tax implication if you pay back only a small portion of your unsecured debt via a Chapter 13 Plan.

If you do file for bankruptcy, learn more about rebuilding your credit here.

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This post first appeared in March 2015.