Will bankruptcy erase defaulted debt?

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Dear Bankruptcy Adviser,
Should I file for bankruptcy? In mid-2008, I stopped paying my car loan, mortgage and credit cards for “personal reasons.” My credit score is currently around 500. Is filing bankruptcy my best option to get myself back on track? The house was foreclosed and the car repossessed. My credit card debt should be around $20,000, but it is only coming up on my report as $8,000. An $11,000 card has no balance for some reason. I talked to the company, and they said it was settled. I don’t know if that is a blessing or if it will sneak up on me later. I want good credit as quickly as possible, and I have little money. Do you have any thoughts on how to help my situation?
— Chris

Dear Chris,
Let’s hope this debt does disappear. I doubt it, but a healthy dose of optimism never hurts. Let’s also hope you can avoid bankruptcy altogether. Good credit should always be your goal. While bankruptcy can be one way to start over and build a new, good credit history, the decision to file should not be hastily made.

You stated you may have only $8,000 in debt, and I’m assuming you may be able to manage that amount. However, figuring out how $11,000 disappeared will be essential information necessary for your final decision.

Let’s look at all the issues you are facing.

  • Foreclosure: You lost the house in foreclosure, and that is a very big negative credit mark. You now need to know whether you are liable on any remaining foreclosed mortgage balance. This deficiency balance is the loan balance remaining after sale of the property. If you are liable for the post-foreclosure mortgage deficiency, that could make your bankruptcy decision very easy.
  • Car repossession: The lender repossessed your car, and it may have notified you of a pending sale then sold the car at auction. Sometimes, the car sells for the amount owed. If that’s the case, it would mean there was no deficiency balance remaining, and that would be a reason not to file bankruptcy. However, you may need to reassess if there is a balance owed.
  • Credit card debt: You stopped paying all debts more than three years ago. The statute of limitations may be ending soon. This is the time period lenders have to sue you to collect a debt. You need to review the statute of limitations in your particular state. The range is from as little as three years and as long as 10 years (10 years only in Rhode Island). Most states generally have a four- to five-year statute of limitations period. The period can be up to 15 years for some types of debt.

The statute period starts on the date you last used the card or made a payment. After the statute period runs out, you have only a moral obligation to pay the debt. I would never advise someone to pay based on that reason alone. But you must be careful because making a payment, even a small one, restarts the statute of limitations.

I am concerned about the $11,000 phantom debt. Debt generally does not disappear. You say $11,000 in debt disappeared from your credit report. And when you called the company, you were told the amount was “settled.” I doubt the debt is gone.

The original creditor likely charged off the debt as “uncollectible.” That means they do not want to try and collect on this debt anymore. It also means the debt is alive, but a collection agency has not bought it yet. Usually, charged-off debt is purchased in the secondary debt market for pennies on the dollar. These agencies know when the statute of limitations will expire and will file a lawsuit against you within days of that date.

The filing of the lawsuit stops the statute period from running and an entirely new, and much longer, collection period starts. A judgment is good for 10 years and can be renewed before the end of the 10-year period for an additional 10 years. The right to renew the judgment can continue for many decades, and the judgment debt balance will continue to grow at 10 percent interest.

You can make your final decision once you determine the status of the $11,000. It is hoped you can manage to pay on the $8,000 balance to avoid bankruptcy if the other debt is truly gone.

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