Tuesday, August 7, 2012

When Debt Collectors Sue--is Bankruptcy The Right Choice?

With approximately ten trillion dollars of consumer debt in the U.S. and rampant unemployment, debt collection lawsuits are exploding everywhere. What should you do if your debt collector stops bugging you with phone calls and decides to sue you? People being sued for debt often panic and look for the quickest, easiest and least scary-looking way out, and bankruptcy often looks like the answer because people have heard that it stops lawsuits against you and "wipes out" your debt. However, bankruptcy is often not a solution in the real-world sense. And there are better ways to handle old credit card debt.

Let's consider debt. Debt is divided into two types: "secured," and "unsecured." Secured debt means that the debt has specific assets backing itif you miss payments, you can have your house foreclosed or your car repossessed and sold to pay off the loan. These things "secure" the debt and can be sold if you stop making payments. Unsecured debt is debt that isn't attached to any specific assets. Broadly speaking, houses, cars, and certain appliances tend to be financed with secured debt; credit cards and most consumer items tend to be unsecured.

Just because a debt is "unsecured" does not mean that you can't be sued for the debt. On the contrary, it means you must be sued in person before the debt collector can collect any money from you. Debt collectors often don't mention this fact to people they are harassing because they want you to believe you could lose house and home at any time. Remember this: on an unsecured debt, the debt collector can only collect if it can get a judgment against you. And then it can collect money by garnishing wages or attaching accounts if it can find them. But finding them can be difficult for various reasons.

Lenders on secured debts are in a much better position in various ways than those who are not secured. One of those advantages is that it's far easier to foreclose on a house than it is to get a judgment against a person. Another advantage comes in bankruptcy, where they have special protections which basically provide that if you want to keep your house you're going to have to pay the mortgage, on-time, every time. Why?

In the law, the item securing a debt (the "security") is really regarded as belonging to the creditor who lent the money. Specifically, consider a mortgage on a house. The house "secures" the debt, and if you stop making payments the bank can take the house and sell it to pay the debt. In the bankruptcy law, it is considered unjust to allow someone not paying for property to keep it from the rightful owner. So the lender asks for the bankruptcy "stay" to be "lifted" so that foreclosure can take place. Although this can sometimes be delayed, the courts usually "relieve" the lenders and allow them to foreclose on secured debt. Of course there are times when the brief delay caused by bankruptcy seems helpful to the consumer, but it is expensive, and in my observation it rarely helps the debtor at all.

With unsecured debt in bankruptcy, on the other hand, the debts are simply added up and paid according to how much money the bankrupt person has. Usually very, very little. And only at the end of the bankruptcy procedure. So bankruptcy could offer some help with unsecured debt but before you go that route, though, you should know that you probably have a better choice.
What all that means practically is that if you have a large secured debt (mortgage) that you cannot pay, bankruptcy offers you very little protection. If you have a large unsecured debt, bankruptcy will protect you, but it is slow, time-consuming and expensive compared to defending yourself against the debt collector. And if you try to defend yourself and fail, you can still go into bankruptcy.

Some examples may make it clearer.

Consider the Smiths. The Smiths have a house and make payments of .500 per month. Mr. Smith loses his job and they fall behind in their payments. If the family seeks bankruptcy as their house payments add up, the lender will obtain "relief from the stay" and foreclose on the house. The Smiths are out of luck, and bankruptcy usually does not help long-term, though it will likely allow them to stay in their house an extra month or two by delaying the foreclosure.

Now consider the Joneses. If the Joneses have credit card debt of ,000 and Mrs. Jones loses her job so they can't make payments, they could seek bankruptcy help. It would probably cost them at least a thousand dollars to file, require them to disclose most or all of their finances over the past year or two or more and fill out a vast amount of paperwork. At the end of the proceeding, at least a year later, their debts would be wiped out. But so, of course, would their credit reports. The bankruptcy filing will remain a mark against them for the following seven years.

The Jones could, however, simply defend themselves against the lawsuits brought by the debt collectors. For reasons I've made clear elsewhere their chances of winning the suit would be excellent. And if the Jones do it right, they can simply get the debt eliminated. This does not usually mean completely cleaning their credit reports, but it can often mean canceling the debt and removal of the recent credit report damage inflicted by the debt collector. And it usually will happen in less than six months from the date the debt collector brings suit. (Although remember that previously recorded negative information will probably survive for seven years--from the time it was posted, so the credit damage is reduced in size and duration, but there's still damage.)

The Jones can do it all themselves for almost no money at all and probably less time and effort, all told, than a bankruptcy would require. If they happen to lose, they could still go into bankruptcy and seek its protections.

Better results, less cost, little risk. That's why it's often better to defend yourself against credit card debt than to seek bankruptcy protection.

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