The Seven Biggest Mistakes People Make Prior to Filing Bankruptcy and How to Avoid Them.
MISTAKE NO. 1
USING FUNDS FROM A TAX EXEMPT RETIREMENT PLAN TO PAY DEBTS.
As stated above, it is human nature to want to avoid filing for bankruptcy. Many people have done everything in their power to avoid meeting with a bankruptcy attorney. Those actions include draining their 401-K account or IRA to payoff credit cards. This is especially disturbing when we meet with people who are close to retirement age. Under bankruptcy law, subject to certain limits, an individual’s 401-K account is exempt (protected) from creditors. Therefore, for example, if you owe $50,000 in credit card debt, but have $100,000 in a 401-K that conforms with IRS regulations, those funds are exempt and can’t be touched by the credit card companies. Therefore, it is strongly recommended that you consultwith a bankruptcy attorney before jeopardizing your retirement funds.
MISTAKE NO. 2
TAKING ON A SECOND MORTGAGE TO PAY OFF CREDIT CARD DEBTS.
In Florida, one of the best bankruptcy exemptions that is unique to our State is the homestead exemption. The homestead exemption protects your home and any equity that you have in it from attachment or levy by creditors. This means that if your home is paid off and, for example, you have $50,000 in credit card debt, the credit card companies cannot touch your home. The only creditors that can touch your home is the mortgage company if you fail to make your payments, a contractor who performed work on your home and who has not been paid, an HOA, or the county for failure to pay property taxes. We often see clients who have equity or a paid off home, take out a second mortgage to pay off credit cards. Their reason for taking out the second mortgage is to reduce the interest rate, have a lower payment, and spread it out over a longer period of time. However, the second mortgage is usually only a temporary band-aid covering a much more serious issue and, ultimately, they fall behind on their first and second mortgage payments and again are looking at a possible loss of their house. The tragedy is that they have taken unsecured debts (credit cards) that cannot be enforced against their house and converted them into a debt that can be enforced against their homestead, namely the second mortgage. Therefore, unless borrowing by use of a second mortgage will absolutely prevent the filing of bankruptcyAND is a payment you can afford to pay each month, a second mortgage can be a major mistake that could have been avoided had someone first consulted with a bankruptcy attorney.
MISTAKE NO. 3
BORROWING MONEY FROM FRIENDS OR FAMILY TO PAY OFF CREDIT CARD DEBTS.
Again, we know that bankruptcy is the option of last resort for the majority of our clients. They attempt to do everything in their power to avoid filing for bankruptcy. As a result, they may turn to family and friends to borrow money to pay off their credit card debts thinking that as soon as the economy turns or they get a second part-time job, they will be able to pay their friends and loved ones back. More often than not, it is just a band-aid on a much larger problem and now, not only has the individual suffered a loss, but they are going to cause a financial loss to friends or family members that may cause further embarrassment and possibly the ending of a long term relationship. When we sit down with clients, we advise them that one of the questions the Trustee will ask is: “have you paid any friends or relatives back any money in the last twelve months". Many times they will say “yes". They may have paid back $1,000, $5,000, $10,000 dollars or more. The problem is that, although we have no doubt that the funds were borrowed and paid back, under the bankruptcy law, any transfer to a friend or relative within a year of filing can be considered a preferential payment to an “insider" and the trustee could go after that friend or relative for the money. Basically, if a friend loans you $2,000 and you pay them back within a year of filing, that loan is an unsecured loan just like a credit card is an unsecured loan. You cannot give one unsecured creditor who is an insider a preference over an unsecured creditor such as a credit card. Therefore, by borrowing funds from a friend or relative, despite your best intentions to pay them back prior to filing bankruptcy, you can expose them to liability from the Trustee.
MISTAKE NO. 4
PAYING OFF OF A CAR FROM EXEMPT ASSETS.
This can be a HUGE mistake! Often people are looking for ways to decrease their monthly expenses to have more money to pay off credit cards. One way they try is to eliminate a car payment. However, the way the car payment is eliminated is by using exempt assets such as a 401-K or taking on a second mortgage as discussed above. Again, these are exempt assets that creditors cannot touch. With regard to a motor vehicle, under Florida law, you are entitled to only a $1,000.00 exemption for a vehicle. Therefore, for example, lets say you have 2008 Honda Accord that has a value of $11,000 and a loan balance of $10,000. If you were to file bankruptcy and claim the $1,000 exemption and subtract the $10,000 loan balance, that vehicle is now a fully exempt asset that you are able to keep. However, if prior to filing bankruptcy, you took money out of a 401-K to pay off the car loan, you now have an $11,000 asset, of which you get to exempt only $1,000 leaving a $10,000 asset available for your creditors. If you wish to keep the vehicle, you will have to pay $10,000 to the Trustee and probably be forced into a Chapter 13. Proper planning would have saved you $20,000, that is, the $10,000 you took out of your 401-K and the $10,000 you had to pay to the Trustee in your bankruptcy. Consultation with knowledgeable professionals in all aspect of life is always in your best interest.
MISTAKE NO. 5
FAILURE TO ADVISE ELDERLY PARENTS OF YOUR FINANCIAL SITUATON.
Most children hope to make their parents proud. To let a parent know that you are facing financial difficulty or may have failed in a business venture is embarrassing and not a conversation that one wishes to have with their mother or father. However, if your parents have some assets that you anticipate receiving after their passing, it is imperative that you advise them of your precarious financial situation so that they have the opportunity to change their estate planning documents accordingly. There is nothing worse than to meet with a client to find out their lone surviving parent died a week before and that they anticipate inheriting a large sum of money. The inheritance, even if not yet received, is part of their assets and would be subject to their creditors. By having an honest conversation with your parents, they can change their estate planning documents to provide that should they pass away that the funds go to another relative or even your children. It is a shame to see assets that were hard earned over a lifetime be subject to creditors that were not even related to debts of your deceased loved one. Accordingly, as difficult as it may be, it is best to be honest with your parents if you anticipate a possible inheritance.
MISTAKE NO. 6
INCURRING TAX LIABILITIES RELATED TO A SHORT SALE PRIOR TO FILING FOR BANKRUPTCY.
A common practice that occurs in today’s depressed real estate market is the “short sale" of a property. A short sale is when you sell a house for less than what you owe on the mortgage. However, the difference between what you owe and what the bank actually receives is considered “debt forgiveness" and is treated as taxable income for you if it is not your primary residence. For example, if you owe $100,000 on your mortgage and sell the property for $75,000 with $25,000 being forgiven, that $25,000 is treated as income and you will be taxed on that amount. If you are in a 15% tax bracket, that amounts to a tax bill of $3,750. If you subsequently file bankruptcy, the tax liability is generally NOT dischargeable. In the alternative, if you do not do a short sale and file for bankruptcy, the mortgage debt is forgiven AND there is no tax bill.
MISTAKE NO. 7
INDIVIDUALS TRYING TO REPRESENT THEMSELVES IN BANKRUPTCY.
The bankruptcy court is set up with forms and procedures that allow someone to represent themself when filing bankruptcy. However, there is an old adage that states: “He who represents himself has a fool for a client". Bankruptcy is a unique area of the law in which many attorneys do not practice. You must also remember that neither the trustee nor the bankruptcy judge can give you any legal advice.
The changes to the U.S. Bankruptcy Code in 2005 make the practice of bankruptcy law even more complicated. Issues constantly arise regarding the interpretation of the new Code such as how does the Means Test work? What are allowable deductions from my income under the Means Test? Why is social security income deducted from the Means Test but not deducted from my monthly disposable income? While there are hundreds of thousands of pages of information available on the internet regarding bankruptcy, the same can be said for removing an appendix. However, while one certainly would not perform an appendectomy on oneself or another person, many people try, without success, to represent themselves in Bankruptcy Court. The worst case scenario is to spend the time, money and effort to file a bankruptcy petition and only have the case dismissed or pay thousands of extra dollars to the trustee due to your lack of knowledge regarding the Bankruptcy Code. Since most bankruptcy attorneys give a free consultation, it is foolish not to take advantage of at least meeting with a bankruptcy attorney prior to making a decision as to how to best protect your assets from creditors.
We are here to assist you in getting relief from the stress of mean spirited, harassing creditors and get you on the road to a fresh start. Please call us for aFREE CONFIDENTIAL,ONE HOUR,BANKRUPTCY CONSULTATIONin our offices in Port Charlotte 941-206-3700.