With all the COVID-19 related unemployment, evictions and credit card collections you would think that bankruptcies would have increased, right? In fact, just six months ago I thought with all of the new cases I would be flying my newly purchased corporate spaceship to Mars and back. But alas, the expected rise in cases has not transpired. How could that be? Consumer debt was high and jobs were being wiped out. Well, there are two major factors that have contributed to a decline in consumer bankruptcy cases.
The first reason for the decline is that interest rates have remained incredibly low. If you track historical bankruptcy filing rates they tend to rise and fall in concert with interest rates. So if inflation goes up and the Fed decides to raise interest rates you can expect that cases will also rise. But there’s something more insidious happening that has caused a reduction in bankruptcy cases. Consumers are cracking open their retirement accounts and using the money to pay off unsecured debts.
At first glance you might think that’s an honorable or decent thing. Or you might surmise that it’s a good idea because later on if they have lower debt they can borrow more in an emergency. But the problem with this is twofold. First, as you may have seen, the stock market continues to rise. Opening the retirement piggy bank to take money out now deprives you of experiencing any gains in the stock market. Second, you’re basically allowing the banks to use your retirement money. I want you to think very carefully about that sentence. Say it again to yourself. You are giving away your retirement money. This is money that you have earned tax free for many years, possibly decades. This is money that you need to rely on in your old age. It’s money that will cushion the blow from higher consumer costs. It could keep you in your house. It could make sure that you’re eating or paying for hospital bills. Or it could mean the difference between you being a millionaire and a pauper.
Why would anyone do such a thing? Well, the first answer is that it’s probably a lot easier to take the money out right now. Certain legislation has allowed people to borrow or even take out more money from their retirement accounts if they had a hardship related to COVID-19. The second answer is that people tend to be more worried about their credit cards than they are about their mortgages, or their future. I can’t count how many clients are more interested in paying down credit cards than staying current on their mortgage even though they don’t live in their credit card. That may be because credit card companies are very aggressive when it comes to collections actions. If you miss a payment or two they start calling right away and after three months they may hire a collection attorney and take you to court. So folks legitimately get worried about being yelled at or losing access to ‘emergency funds’.
But in almost all situations it’s a terrible idea is to use your 401(k) or your 403B or any of your retirement accounts to pay off an unsecured debt. It’s ridiculous. And here’s why. In chapter 7 and chapter 13 bankruptcy your retirement plan is, in almost all cases, completely exempt. That means that creditors can’t take that money or count it against you when it comes to paying them back.
You could file a bankruptcy and potentially pay zero back to your creditors and keep 100% of the money in your retirement account. Your future self will be so happy if you do that. But if you spend that money to pay off Capital One or any other Wall Street firm, your future self will be terribly upset, and possibly broke, homeless and hungry. So before you borrow from your future, contact your local bankruptcy attorney. While bankruptcy may seem like an emotional decision, it’s a financial one. And often times when you’ve lost income, it’s the best financial decision you can make not just now, but for your future.
While it's a difficult decision to make, after going through your budget and realizing you can't pay off your debts before the year 3000, you decide to file bankruptcy. But what does it take to plan for a bankruptcy? Is there even such a thing? While there isn't a lot you need to do before filing, except speak to an attorney, there are some things you absolutely want to avoid to make your bankruptcy case as smooth as possible.
1. GIVING AWAY ANY PROPERTY
One of the biggest mistakes I see before people file bankruptcy is that sometimes they decide to sign the title over to their home or car to a friend or relative 'to protect it from creditors'. Not only won't this protect your property from creditors, but it could put those items at greater risk. In bankruptcy you have the ability to protect some personal property and real estate with state or federal exemptions to a certain extent, and if you cannot protect all of it in a Chapter 7, you can typically in a Chapter 13 case. Even if you don't file a bankruptcy, giving away your property to a family member or friend when you owe your creditors money can be completely set aside by those creditors. Instead, before you act rashly, contact an attorney to go over what you need to do with your big ticket items to ensure they are protected. If you want to see what could go wrong when transferring your property to someone else, check out Tiger King on Netflix.
2. SELLING PROPERTY
As a corollary to the first mistake, this isn't the time to start raising cash. This can present two problems: first, the sale might be closely scrutinized to determine if it was at fair market value. That could mean the trustee in your case contacts the buyer and sets the sale aside. Second, assuming you sell the property and it was exempt, converting it to cash may not protect it at all. Exemptions are different for each type of property. For example, you may be able to exempt thousands of dollars for your personal residence, but much less once it is sold, depending on the circumstance. So do yourself a huge favor – talk to an attorney first before you make any major moves.
3. BORROWING MONEY
If you're filing bankruptcy, now is not the time to borrow money. Why? It looks bad if you borrow on the eve of filing, especially if it's unsecured debt like a line of credit or a credit card. If you borrow money and then file bankruptcy right away, creditors may object to your discharge unless you exclude them from the filing. Moreover, what are you borrowing money for exactly, and where will that money go once it is borrowed? If it's going to buy food, that may not be as big of a problem as going to Disney World, but before you borrow a penny, talk to an attorney. As a corollary to this, don't co-sign on any debts, whether it's for your friend or family member. Not only could you put their co-signed collateral in jeopardy, it may make you chose between your relationship and getting a fresh start from your debt.
4. PAYING FAMILY, FRIENDS OR ASSOCIATES BACK
Borrowing before filing is one thing, but paying back your relative or your buddy who loaned you more then $600 could be a problem. Paying back an 'insider' as they are called, more than $600 in the prior year before filing means that the payment can be clawed back by the trustee and distributed to your creditors. Worse? You may feel morally compelled to pay them once your case is over, and then you'll wind up paying twice. Instead, let your friend or family member know you cannot pay this debt, or any debts and you are filing bankruptcy. Do you believe you must pay them back, no matter the consequences and you don't want the trustee to take this money from then? You can do that, but you're going to need to wait another year to file bankruptcy.
5. GOING ON VACATION
It's certainly not illegal to go on vacation before filing your bankruptcy case, but understand that your bank accounts may be subject to careful examination, and if they see you dropped $1500 to go to Europe a few weeks before filing, they might have reason to believe your case was not filed in good faith. Also, did you have to borrow money to go on that vacation? See number 3 above.
In summary, these are the top 5 things you don't want to do before filing bankruptcy. There are more than these above, but in general, if anything you're trying to do involves more than $600, stop, wait, and seek legal advice. Big moves arouse suspicion. Lay low, and you'll stay under the radar. For more information about proper bankruptcy planning, feel free to contact me.
Jesse Sweeney is an American Board Certified consumer bankruptcy expert licensed in Colorado and Michigan, both Federal and State courts. A graduate of Michigan State University, Jesse has been practicing bankruptcy law for over 20 years and has helped consumers save millions of dollars.