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Ask Dr. Don
By
Don
Taylor,
Ph.D.,
CFA
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Bankrate.com |
Bankruptcy not a matter of
convenience
Dear Dr. Don,
I bought a home about one year ago when I was doing
fine financially. I am self-employed and my income has since dwindled
down to nothing, coinciding with the downturn of the economy. I have
managed to incur about $30,000 in credit card debt (most of which
I had at the time I bought my house). I was fortunate to have bought
my house at a good price and now, after putting a great deal of work
into it, have about $40,000 of equity in it.
I will probably be selling the property within a year
or so and have inquired about taking out a home equity loan to pay
off my debt. Since I will not be in my home for a very long time,
I would not be making much of a profit on it if I do take out the
home equity loan. Consequently, I have considered filing for bankruptcy
to have my debt waived.
If I did file for bankruptcy, which type should I
file for? Would my home and other personal possessions be free from
creditors? Would my bankruptcy be reported to my mortgage company?
If so, what effect would it have on my mortgage?
Nancy Naught
Dear Nancy,
There's a difference between a personal bankruptcy and a business
bankruptcy. In my reply I'm assuming that you're considering a personal
bankruptcy. Individuals typically file for either a Chapter 7 (Liquidation)
or a Chapter 13 (Individual Debt Adjustment) bankruptcy. The U.S.
Courts electronic pamphlet, "Bankruptcy
Basics," does a good job of explaining the different types
of bankruptcy filings.
With a Chapter 7 bankruptcy, a bankruptcy estate is
formed from your nonexempt assets and the proceeds of the estate
are used to pay your creditors. Any eligible remaining debts are
discharged. Your ability to hold on to your home through a Chapter
7 filing depends in large part on what part of the equity in your
home is exempt from the bankruptcy estate. Some states, like Florida,
have fairly liberal homestead exemptions while others do not. This
site provides a listing of bankruptcy exemptions by state.
The mortgage lender's lien on your property will survive
the bankruptcy process, so the loan remains secured by the property.
Eligible debts aren't waived; they're discharged. A bankruptcy filing
stays on your credit report for seven to 10 years; seven years for
a Chapter 13 filing and 10 years for a Chapter 7 filing.
By your own accounting, you've got about the same
level of credit card debt that you had when you bought your house
a year ago, so you haven't been using your credit cards much for
living expenses as your self-employment income fell. You also haven't
said anything about late payments or creditors breathing down your
neck, so your credit history could be in fairly good shape.
Tapping your home's equity to pay off your credit
cards takes unsecured loans and secures them with the equity in
your home. It's not a great move because it reduces your financial
flexibility, including your options if you decide to file for bankruptcy.
What it comes down to is your ability to meet
your living expenses while making your debt payments. If you have
no real prospect of doing that, either from your self-employment
income, salary or wages, then bankruptcy is something to consider.
Taking that step as a matter of convenience will turn out to be
pretty inconvenient, however, because you'll spend the next decade
trying to rebuild your credit and managing your finances around
your poor credit.
-- Posted: Jan. 9, 2004
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