I received my discharge in bankruptcy, now what?

Here is a classic video from Saturday Night Live (NBC) (posted by danwho.net) that succinctly answers the question I’ve posed in the title of this post. Caution, if you are still feeling a little sensitive about your financial state, you may feel offended – but it certainly is not offered for that purpose. Also, while the video clip offers sage advise, it over simplifies many peoples’ dilemma. They did not get to the place of needing bankruptcy because of being irresponsible. Most people I talk to, the debt crept up little by little over time for reasonable things but then some unexpected event occurred that made the debt uncontrollable. Regardless, this clip is a funny reminder that bankruptcy does NOT cure financial problems; it only gives a fresh start that allows you to make the necessary lifestyle changes. This is extra important after a bankruptcy because, after filing a Chapter 7, you cannot file a Chapter 13 for four years and you cannot file another Chapter 7 for eight years. With no other relief in the immediate future, you either follow the advise from the clip or sink.

Helping Families Save Their Homes in Bankruptcy Act of 2009

H.R. 200, the Helping Families Save Their Homes in Bankruptcy Act of 2009, offers hope for distressed homeowners and is currently pending a vote by the House of Representatives. One of the most useful provisions of this bill, found in Section 4, would allow for judicial modification of loans mortgaged (secured) against ones principal place of residence. In fact, this bankruptcy tool could prove powerful enough to allow many to avoid filing Chapter 13 in order to save their home.

Currently, banks and other lendors have little incentive to renegotiate their loans with homeowners because they know that such secured home loans are not modifiable within bankruptcy. That is to say, if you are like most distressed homeowners your income is too high for a Chapter 7, your home is your largest debt, and your are thinking about a Chapter 13 primarily to save your home. Once in the Chapter 13 you are bound to the same terms on your home loan as got you into trouble before bankruptcy. So, negotiating with a lendor secured on your home pre-bankruptcy is much like David walking up to Goliath but without his sling and stones – all David can do is ask “pretty please” while Goliath just rolls over top of him. Sure, there have been some lendors who have offered short term accommodations for homeowners in trouble, but these accommodations have done little more than buy a few months reprieve against the inevitable foreclosure.

H.R. 200, on the other hand, puts that sling and stones back into David’s hands. If it becomes law, then lendors will be forced to calculate what terms they will end up with if the homeowner goes into bankruptcy and thus, it will make them more prone to negotiate terms to allow the homeowner to avoid bankruptcy. H.R. 200 would allow a home loan to be modified in substantial ways: 1) adjustable rate interest can be frozen during the repayment plan, 2) adjustable interest rates can be converted to a fixed rate, 3) the length of the loan can be extended by a number of years, and most importantly 4) allow for the secured part of the loan to be repaid while loan amounts over the value of the home are stripped down (treated as unsecured debts). One other substantial benefit to this legislation is Section 5 which limits fees and charges that can accumulate on the loan during bankruptcy.

I refer to the fourth item from Section 4 as “most important” because it directly impacts situations where the principal balance on loans secured by the house is greater than the value of the house itself. In days long past, one rarely saw this kind of “upside down” debt because lendors would not extend credit beyond the value of the home and home values generally rose each year. More recently, lendors loaned beyond the value of the homes and many home values have subsided. Without H.R. 200, a person entering Chapter 13 with a home valued at $100k but debt secured on that home of $125k would have to repay $125k. With H.R. 200 as law, he or she would only have to repay $100k and the remaining $25k would be treated as unsecured debt and potentially discharged at the end of the Chapter 13 plan.

Since lendors would know these various modifications would occur if the homeowner filed Chapter 13, you can imagine they would be inclined to cut a deal that preserved more of their interest but still made life feasible for the homeowner. One could argue that if the overhaul of the Bankruptcy Code in 2005 had not taken away that ability to “strip down” secured home loans, we might not be facing such a huge foreclosure crisis today. Home loan banks and other lendors are opposing this legislation and so it is crucial that you let your Senators and Representatives know where you stand on this bill.

Looking out for extended family can cost them in your bankruptcy

When faced with bankruptcy, people hate to turn away from family that have helped them. The natural and common thing to do is try and repay those family members instead of other debts or to protect family assets by giving them away. This very human reaction may be understandable, but under the law it is not forgivable. Such transfers can create real problems for yourself and for the family you were trying to help.

The bankruptcy code provides for a trustee over a Chapter 7 estate to go after assets transferred prior to the filing of a Chapter 7. These transfers can take the form of favorable repayment of one (or some) debts over others or in the form of a gift. A favorable repayment may constitute a “preference” and a gift may qualify as a “fraudulent conveyance (or transfer)”. When the person receiving the preferential payment or the gift is a family member, the bankruptcy code is especially tough. The trustee can go after preferences made up to a year prior to the filing of the bankruptcy if made to an “insider”. Family members are insiders by definition. Trustees can go after fraudulent transfers (gifts) to insiders made two years prior to filing under the bankruptcy code. However, one cannot rely on that two year period because the bankruptcy code also has a “strong arm” provision that allows trustees to use state law to go after preferences and fraudulent transfers. In Kentucky preferences are treated the same, but the reach back period for fraudulent conveyances to insiders is five (5) years prior to the filing date.

Two situations recently came to me that point out the need for caution. In the first situation, a person borrowed from a close relative to put into a business. They intended to pay this relative back in a lump sum from a retirement account, but then it began looking like a Chapter 7 might be imminent. This would have created a double impact: first, exempt funds that would have ridden through the bankruptcy would have been converted to non-exempt funds and second, the trustee would have pulled that large lump sum payment back into the estate from the relative. From those reclaimed funds, the trustee would pay himself a percentage and the rest would have gone to unsecured creditors. This is a good example of a preferential payment within a year of bankruptcy to an insider. The retirement would be gone and the relative would remain largely unpaid (they would be treated the same as any other unsecured creditor and recieve cents on the dollar).

The second situation involved a person who had racked up considerable unsecured debt and had their personal residence secured to the hilt, but they owned several acres in another state free and clear of any lien. It was important to this person to retain the out of state land because it contained a family cemetary. They wanted to give the land to someone else to keep it in the family. Unfortunately, this would have been a fraudulent conveyance and the land would be taken and sold by the trustee with proceeds going to unsecured creditors. The cemetary itself would likely be protected and the family could still access it, but ownership of it and all the surrounding acreage would leave the family. With a five (5) year reach back in Kentucky anyone would be hard pressed to plan for hard financial times well enough to preserve such an asset, but this example highlights the importance of sitting down with a bankruptcy practitioner who will help devise a comprehensive plan. In this scenario and with other factors beyond the limits of this posting (such as the age and health of the debtor), delaying bankruptcy by using this land as collateral to obtain enough funds to live on would be a wise alternative.

Tips for Tough Times #2

In my last post I discussed a general strategy for going further into debt in the event of a crisis such as lost employment or major illness. I want to clarify that the intent is not to figure out how to “trick” the system; rather, the intent is to be shrewd in surviving tough times. While some folks will misuse the suggestions, my hope is that honest folks, who want and plan to repay their debt if possible once they get back on their feet, will use the information to plan for worst case contingencies.

Given that preface, another temptation to avoid during tough times is raiding retirement accounts to make ends meet. Much like the strategy of maximizing your homestead exemption, leaving retirement accounts intact maximizes your assets across a bankruptcy. In a Chapter 7, retirement funds, such as a 401k, are exempt and so you emerge after the discharge with your retirement whole. Taking funds out (unless you meet qualifying events such as age, etc.) not only converts exempt funds into non-exempt, but you will also likely incur a ten percent (10%) federal tax penalty for early withdrawal. So, if you have unsecured credit available to you during a crisis, it is best to use that resource to pay for necessities than dipping into your retirement.

Tips for Tough Times #1

It is human nature: we often wait until the last possible moment (or later) to seek help we need. This goes for medical issues, retirement planning, home repair, etc. It is doubly true for legal matters. This is unfortunate because lawyers can be so much more effective (and less expensive) acting preventively rather than reacting to a crisis. Consulting an attorney practicing in bankruptcy law can benefit one whether filing is imminent or a distant possibility.

One example of the benefit of a proactive use of an attorney is evident during tough financial times. Many people are experiencing layoffs in our present economy. During these times, it is tempting to dip into retirement savings despite tax penalties or deplete one’s home of any remaining equity. While these offer lower initial costs of obtaining financing compared to higher interest credit cards, they may be incredibly costly in the long run.

An individual in Kentucky can claim up to $20,200.00 in a homestead exemption and a married couple can claim $40,400.00 in a Chapter 7 bankruptcy. So, if you have much more than that exempt amount in equity in your home, it is smart to obtain a loan secured on your property to make ends meet while searching for work. However, if possible, you do not want to borrow past that exemption threshold. For example, if you are married and your home is worth $150,000.00 and you owe $80,000.00 on it, you could borrow up to $30,000.00 more secured on the residence to live on, but it might be better to use higher interest credit cards beyond that. By doing so, you have your house sufficiently mortgaged to make it nearly certain that you can reaffirm on those loans in a Chapter 7 and thus keep your house. Also, you have maximized the amount of equity you can exempt and have at your disposal after the Chapter 7 is filed. The unsecured credit would then be discharged.

To make sure this is kept in perspective though, you must be able to afford the payments on the loans secured by your house subsequent to a Chapter 7 filing for this to work. You also do not want to run up debts on luxury or fluff items – this strategy is for the necessities of food, clothing, shelter, and medical care. Of course, this is a strategy for temporary events beyond your control, such as being laid off or suffering a major injury, where you expect things to turn around in a matter of several months. Because of all these complexities, the general suggestions I am offering need to be applied to your specific situation. The facts in your situation may call for a very different strategy so it is worthwhile to invest in preventive legal counsel.