Use of a spendthrift trust to protect assets which may be inherited during bankruptcy can be a good idea if a loved one is in poor health and able to make estate planning decisions. Parents and grandparents who have family members facing bankruptcy may want to consider spendthrift trusts as a means of structuring an inheritance to provide the greatest benefit to their successors, while also protecting the money from their family member’s creditors.

Section 541(c)(2) of the Bankruptcy Code provides that an “a restriction on the transfer of a beneficial interest of the debtor in a trust that is enforceable under applicable nonbankruptcy law is enforceable in a case under this title.” This provision preserves restrictions placed on the transfer of the debtor’s interest in a trust. Trusts which have transfer restrictions as part of the trust itself are often called “spendthrift trusts.”
This section (§541(c)(2)) of the bankruptcy code also means that a spendthrift trust does not become part of the bankruptcy estate when a beneficiary of such trust files for bankruptcy. When something is not part of the bankruptcy estate, it is not subject to liquidation by the bankruptcy trustee, and is therefore safe from the reach of creditors.

The issue then becomes what qualifies as a “Spendthrift Trust” under Colorado state law. A Spendthrift Trust is a trust that contains language which makes it non-transferrable by the beneficiary. In other words, the beneficiary has no control over the contents/assets of the trust, and is simply subject to getting whatever benefits the trust allows. The provisions of a spendthrift trust which prevent the beneficiary from exercising control of the trust assets are called anti-transfer or anti-alienation provisions.

One Colorado case put it this way:

To qualify as a spendthrift trust it is appropriate and necessary that the trust instrument contain articulated spendthrift provisions and the trust be administered in a correct and legally sufficient manner. If the provisions, administration and integrity of a spendthrift trust are disregarded, so too will its status as a special, protected asset of the debtor.

In re Alagna, 107 B.R. 301 (1989)

Additionally, Colorado law requires the following characteristics for a valid spendthrift trust: 1) the terms of the trust restrain the voluntary or involuntary transfer of the beneficiary’s interest, 2) the trust cannot name the creator of the trust as beneficiary, 3) the beneficiary does not have control over the corpus (body/assets/principal) of the trust. Brasser v. Hutchinson, 37 Colo. App. 528 (1976).

Therefore, a spendthrift trust that qualifies under Colorado law as outlined above is safe in bankruptcy. However, that protection applies to the corpus of the trust but not to distributions that may be made in the 180 following the filing of a bankruptcy case. Those distributions would be part of the estate, would not be exempt under Colorado law, and would therefore be subject to liquidation by the bankruptcy trustee.

Because of the strict requirements of a valid spendthrift trust under Colorado law, any pre-bankruptcy estate planning of this sort is best done with the advice of a qualified Trusts and Estates attorney.

(Press Release – Denver, CO) – Abraham Lincoln and Thomas Jefferson are noted for many things, but bankruptcy usually isn’t one of them. Yet both President Lincoln and President Jefferson were declared bankrupt in their lifetimes. According to historians, Thomas Jefferson is thought to have faced personal bankruptcy several times during his adult life. As more American’s are forced to file bankruptcy today because of our recession, President’s day can remind us that even America’s finest Presidents had financial problems.

Abraham Lincoln and bankruptcy

Abraham Lincoln is often considered the wisest American President. Lincoln guided the United States through a devastating Civil War by relying upon his incredible intelligence, leadership skills, and charisma. However, many years before Lincoln became one of history’s finest Presidents, Lincoln was a failed shop keeper. Lincoln opened a shop in 1832, became bankrupt in 1833, and spent the next 17 years paying off debts from his failed venture.

Thomas Jefferson’s Presidential accomplishments are incredible as well. After authoring the Declaration of Independence, Jefferson became the 3rd U.S. President and consummated the Louisiana Purchase, doubling the size of the United States. What many American’s don’t know, however, is that Jefferson spent most of his adult life in debt.

Historian Herbert Sloan writes “debt occupied an extremely important place in Jefferson’s life,” in his book Principal and Interest: Thomas Jefferson and the Problem of Debt. Sloan found that Jefferson’s personal debt load “was central to his experience from his thirties to his eighties, and this half-century of concern and worry about debt inevitably left its mark on Jefferson.”

During the time of both Jefferson and Lincoln, bankruptcy protection laws in the United States were significantly more onerous than today. While U.S. consumers living in 2010 can file personal bankruptcy to escape crippling debt, Jefferson and Lincoln had no such option. Instead, Lincoln toiled for nearly two decades to pay back creditors, while Jefferson died with more than $100,000 in debt – an incredible sum in the year 1826.

Local Colorado bankruptcy attorney Gailyn Wink says that “Many of the people I work with are amazed to learn that Presidents Lincoln and Jefferson dealt with personal bankruptcy.” Wink adds that “Lincoln and Jefferson weren’t alone. Former U.S. Presidents Ulysses Grant and William McKinley were bankrupt at one point.”

According to Gailyn Wink, bankruptcy has an negative reputation that it really doesn’t deserve. “If Abe Lincoln can deal with bankruptcy and go one to become of our nation’s greatest Presidents, today’s consumers should understand that sometimes bankruptcy is the best way out of a bad situation.” Gailyn’s business partner and husband Michael Wink, who is also a bankruptcy attorney, adds that “Around here, we have an expression. Bankruptcy isn’t a four letter word – debt is.”

If you are a Colorado consumer facing crippling debt, learn more about bankruptcy by contacting Wink & Wink, P.C.

Learn more about Wink & Wink, PC.

Owners of Sole Proprietorships can wipe out business debt while keeping business assets in bankruptcy

Sole proprietorships are not business entities but are essentially part of the business owner. While these businesses do not give their owners limited liability (i.e., if someone sues the business, they are suing the owner personally), they generally give their operators the most options in bankruptcy. This is because the business debts are generally wiped out along with personal debts when the operator files for personal bankruptcy. Additionally, under the Colorado Law (where I practice), the owner can claim up to $20,000 worth of business assets as exempt and keep them through the bankruptcy.

Owners of Business Entities are often NOT able to wipe out business debt and the assets of entity can be lost in bankruptcy

Most business entities, such as LLCs and corporations, offer their owners limited liability (i.e., those wanting to sue the business usually cannot sue the owner personally). However, lenders typically require the owners to sign personally as a condition of extending credit to the entity. For these debts, liability is not limited to the business, but extends to the owner. This situation is very common.
In general, the business owner can wipe out personal liability for the guaranteed business debt by filing personal bankruptcy. However, that debt remains on the business because business entities cannot get debts wiped out in Chapters 7 and 13. Business entities can pursue debt relief in Chapter 11, but that is generally too costly a process for the typical small business.

Additionally, assets of the business entity are NOT exempt under Colorado law. This means that the business owner may lose the assets of the business entity in bankruptcy, or pay to keep them. For these purposes, the value of corporate assets is their sale value minus corporate debt.

I know – it seems crazy that you can keep $20,000 worth of assets as a sole proprietor but not through a business entity. It has its reasoning in the fact the entity provides limited liability to the business owner. OK – you don’t have to like the reasoning, just know the distinction is real.

So, what should the owner of a business entity do if they are in need of debt relief?

Chapter 13 can wipe out personal debt while enabling the business owner to keep the business entity

If the business owner is struggling primarily with personal debt, Chapter 13 can enable the owner to wipe out personal debt while giving him or her time to pay the value of any assets held by the business entity. This is because Chapter 13 will put the business owner in a three to five year payment.

Chapter 7 can also wipe out personal debt, but assets of the business entity may be tougher to keep

Chapter 7 can enable the business owner to wipe out debt without a payment plan. However, the value of assets held by the business entity can be more problematic in Chapter 7 because the business owner will have to forfeit those business assets or pay for them without the benefit of a three to five year payment plan.

Business owners may have to close down business entities with significant debt or assets

If the business has significant debt, personal bankruptcy is likely not enough save the business because personal bankruptcy will not remove the debt from the business entity. Similarly, if the assets of the business entity are too much for the debtor to pay in Chapter 7 or Chapter 13 bankruptcy, the business owner will have to give up the entity either before or during bankruptcy.

Business owners should consult an attorney prior to shutting down a business entity in anticipation of filing personal bankruptcy. You may be able to go into business as a sole proprietor, but be careful about moving assets from the business entity into your own name. Transactions involving business assets will be highly scrutinized for fraud. If you have corporate debt, you cannot simply liquidate the business assets and pay yourself the proceeds or distribute the assets to yourself.

For business owners in financial distress, personal bankruptcy presents an opportunity to remove debt and gain a fresh start. However, personal cannot remove debt from a business entity and you may not be able to keep assets of the entity in bankruptcy. While these facts may be harsh, facing them may be the only way to get out of a bad financial situation.

Credit card bills are one of the most easily dischargeable types of debt in bankruptcy, usually. However, problems can arise when you use your credit cards close to the time you file for bankruptcy. Using credit cards after you have decided to file bankruptcy or have seriously considered filing for bankruptcy can have serious negative effects on your bankruptcy case.

Luxury Goods and Cash Advances

There is a specific section of the Bankruptcy Code that deals with purchases for luxury goods and cash advances in the 90 days before filing for bankruptcy. Section 523(a)(2)(C)(i) says that consumer debts for luxury goods owed to a single creditor and totaling over $550 incurred within 90 days of filing for bankruptcy are nondischargeable (meaning that bankruptcy does not get rid of them). Additionally, cash advances which all together total more than $825 taken within 70 days of the bankruptcy filing are nondischargeable under the same section of the Code.

It’s pretty cut and dried, if you made the charges for luxury items or took the cash advances, you are stuck with them. Bankruptcy cannot help unless you can wait to file to remove your case from the 90 or 70 day look-back period. But even then, there is another section of the Bankruptcy Code that can give you problems.

False Statements and Fraud

Section 523(a)(2)(A) holds that any debt for money, property or services obtained by false pretenses, a false representation, or actual fraud is not dischargeable in bankruptcy. This section is often used by credit card companies to object to their debts being discharged in bankruptcy. Their argument is basically that a person who uses credit when insolvent knows they cannot repay the debt and therefore commits fraud. The closer that credit card use gets to the date you file for bankruptcy, the stronger the credit card company’s argument becomes.

In fact, when dealing with such cases brought by creditors (these are called Adversary Proceedings and they are basically a trial with witnesses and exhibits, which means they cost you money) the Court will look at a list of factors when deciding whether the credit card use amounts to fraud.

The test under the law is called a “totality of the circumstances” test. That means the Court looks at evidence related to this list of factors and then makes a decision based on that evidence:

(1) the length of time between the charges made and the filing of the bankruptcy;

(2) whether the debtor consulted an attorney regarding bankruptcy prior to the
charges being made;

(3) the number of charges made;

(4) the amount of the charges;

(5) the financial condition of the debtor at the time the charges were made;

(6) whether the charges were above the credit limit of the account;

(7) whether the debtor made multiple charges on any given day;

(8) whether or not the debtor was employed;

(9) the debtor’s employment prospects;

(10) the debtor’s financial sophistication;

(11) whether there was a sudden change in the debtor’s buying habits; and

(12) whether the purchases were made for luxuries or necessities.

In practice, large amounts of credit card charges right before filing for bankruptcy are NOT GOOD. They have been held by bankruptcy courts to be fraudulent and therefore not dischargeable.

Therefore, if you are considering filing for bankruptcy it is time to stop using your credit cards. This is easier said than done for many people, but it is important. Once you file for bankruptcy, you will no longer have access to those credit cards. So, if you think bankruptcy is your best bet for wiping out debt and getting a new beginning then you need to be able to live without using credit for the time being.

For those who do have recent credit card usage that will likely cause problems in a bankruptcy, the usual solution is to wait, wait, wait. It is better to get some months away from the charges before filing. The longer you can wait, the better, especially if you can continue to make minimum payments to those creditors to show that you made the charges in good faith (it looks especially bad to make a bunch of charges and file bankruptcy without paying back a dime).

If that is not a good option for you, usually because you are facing a judgment against you and wage garnishment, then it is very important to meet with a bankruptcy attorney to discuss your likelihood of success against a claim of fraud from your credit card company.
The bottom line, however, is beware of using your credit cards if you are seriously considering bankruptcy. It’s not a true fresh start if your debt follows you through to the other side.

Legal Considerations – EQUITY and LEINS

From a legal perspective, you can only keep your car in bankruptcy to the extent your equity in it is exempt under State law. In Colorado, you are allowed $5,000 in vehicle equity, or $10,000 if you are 60 years old or older. The formula to determine equity is: current value of the vehicle LESS the amount you owe on it. If your equity in the vehicle is greater than the exemption limit in your state, you may still want to file. An attorney can probably help you plan to keep the value of the equity in your vehicle while also getting the benefits bankruptcy.

Additionally, if you owe on your car, bankruptcy generally does not remove the lien on your vehicle associated with this debt. This means that you will have to make car payments in order to keep the vehicle through bankruptcy.

However, if your car is currently worth less than you owe on it, bankruptcy may reduce the value of the lien on your car to its fair market value. This can effectively reduce what you owe on the vehicle to its fair market value.

Practical Considerations – AFFORDABILITY

From a practical perspective, you should seriously consider whether you can afford your current car when entering bankruptcy. This is because bankruptcy often represents an opportunity to walk away from a bad car deal with little or no liability. I know this is tough to think about, but you should NOT let your love of a fancy ride keep you from making smart financial decisions.

Of course, you still need a car. So, if you can’t afford your current car deal, you should pursue and consider the following options when preparing to file bankruptcy. These options are:

1)    HOOPTY: Buy a used vehicle with whatever money you can scrape together. Truthfully, this is probably your best financial option, but many don’t want to drive such an inexpensive car. Where I’m from, we used to call these HOOPTIES!!

2)    USED VEHICLE WITH A LOAN: If you have a job, you can probably get a loan even though you are filing bankruptcy. The loan may come after you file or after your discharge, in which case you will need to make payments on your old vehicle or utilize public transportation until you have the new loan. Regardless, you can expect to pay 18% to 21% interest. This is why a less expensive car with no loan is a better deal. Still, if you have a monthly payment you can afford with a high interest rate, you’re better off than you were before.

3)    NEGOTIATE YOUR CURRENT DEAL: Tell your current car lender you plan to file bankruptcy and ask them to reduce your monthly payment to something you can afford. In general, the car companies don’t like these deals, but it’s worth a try.

4)    RIGHTS IN BANKRUPTCY: As I mentioned above, if you owe more on your current car than it is worth, you may be able to effectively get the balance you owe on the vehicle down to its current market value. This may make the vehicle affordable to you.

a.    CHAPTER 7 REDEMPTION: In Chapter 7 bankruptcy, you can do this through your right of ‘redemption’, which enables you to buy the car from the lender for what it’s worth today rather than what you owe. Of course, you need a lump sum to do this, but there are lenders who will loan this money. Unfortunately, these lenders smell blood in the water and usually charge 21% to 24% interest. Because of this, this deal only makes sense if the car is worth substantially less than you owe.

b.    CHAPTER 13 CRAM DOWN: In Chapter 13 bankruptcy, you can reduce the amount of the lien on your car to the amount of its current value without having to take out a new loan IF you have owned the vehicle for at least 2.5 years. This is known as a ‘cram down’ and it can be VERY POWERFUL.

A good bankruptcy lawyer should be able to put you in touch with lenders and help you evaluate these options. First and foremost, the best deal is one that you can afford.

So, you generally keep a car in bankruptcy, but you can’t have too much equity in it and shouldn’t pay too much for it. If you think bankruptcy may make sense for you, I suggest you find out about it with a flexible mindset toward your car. For many, bankruptcy will wipe out tens of thousands of dollars worth of debt. Don’t let your love of that depreciating mode of transportation keep you from making smart financial decisions. Instead, know that bankruptcy will let you have a car of some sort and go for the fresh start!!

The lender’s right to repossess a vehicle comes from the lien that you agree to when you purchase the vehicle. If you fail to make all the payments you agreed to under the lending contract, they have the legal right to come and take the property subject to the lien (this comes up with property other than cars and trucks, but those are the most commonly repossessed). As with any area of the law, there are rules, and knowing the rules always makes things easier.

Timeline

In Colorado, the lender must wait until the debtor is in default for at least 10 days before the lender can send a “right to cure” the default. A “right to cure” simply informs you of your opportunity to make up the missed payments and stop the repossession process in its tracks. However, if you have already been in default during the prior 12 months and the lender has already sent one “right to cure” notice, then the notice does not have to be sent again. You have the right to get the notice just once per 12 month period.

After sending the “right to cure” the lender must wait for an additional 20 days for you to cure the default. If you have not cured the default by the end of the 20 days, the lender may repossess the vehicle. (Again, be careful if you have already received one “right to cure” in the past year. They get to skip these steps and go right to repossession if that is the case.)

Repo Men Are Not Above The Law

Although Colorado allows repossession without the prior permission of the court, the Repo Man is not above the law. The statute allowing repossession without court approval requires that the property be taken back “without breach of the peace.” This is what we like to call “legalese”, or lawyer-speak. It’s a term that gets defined by the courts over time. What it means for you is that anyone seeking to repossess your property cannot:

•    forcibly remove you from the vehicle;
•    stop you on the street or highway like a law enforcement arrest;
•    enter a closed garage or your home;
•    break into your house;
•    create a disturbance such as a fight or other altercation;
•    threaten any of the above actions; or
•    pretend to be a law enforcement officer while conducting the repossession.

Additionally, many new cars come equipped with a computer program embedded in the vehicle which allows the lender to disable the vehicle in the case of non-payment. This “breach of the peace” language means that the lender cannot disable your vehicle if immediate injury to any person or property is a reasonably foreseeable consequence of such action. Which means they cannot do it while you are driving or on the side of the highway.

Repo Men are also subject to the Fair Debt Collection Practices Act. I recently wrote another blog post about Debt Collection in Colorado. Anyone looking to repossess your property must follow those rules as well, which means they cannot:

•    Misrepresent their identity
•    Threaten you with legal action they cannot take or do not intend to take
•    Harass you .

What Happens After A Repossession

If your property is repossessed, you do have the right to redeem the property. That means that you can buy it back for every charge outstanding on the debt. This is highly unlikely for most, because if you have the money to “cure” all the outstanding payments and fees, you probably would have been paying the bill each month.  If you don’t have the cash, you can’t redeem the property.

If you do not redeem the property (meaning buy it back from the lender), then they have the right to sell it in any way that is “commercially reasonable” (more legalese!). You are supposed to receive notice of any sale, but failure to provide that notice isn’t enough to reverse the repossession, it’s just a no-no and there aren’t any real consequences.

After the sale, the lender will tally up the numbers. They are allowed to charge you for  “reasonable expenses of retaking, holding, preparing for disposition, processing, and disposing, and, to the extent provided for by agreement and not prohibited by law, reasonable attorney’s fees and reasonable legal expenses incurred by the secured party”. This means that they can tack on lots and lots of charges to what you already owe them under your contract.

If, by some miracle, they got enough for the vehicle at sale to cover all of what you owe them, you are entitled to a refund. However, what usually happens is that you still owe them money for the vehicle (which you no longer have), the cost of repossession, and a bunch of other fees. And they can sue you for that amount. It’s called a “deficiency judgment.”

Bankruptcy Can Help

If you are facing repossession or a deficiency judgment on a repossessed vehicle, bankruptcy does offer you protection. If you are behind on your payments, bankruptcy gives you the protection of the “automatic stay”, which prevents the lender from repossessing the vehicle for a time. It does not wipe out your obligation to pay under your contract, but it can provide some breathing room.

Some auto loans can be “crammed down” in a Chapter 13 bankruptcy to their fair market value, meaning you would only owe the lender what the car is worth today instead of your current balance. This option only applies to vehicles purchased more than two-and-a-half years before filing for bankruptcy, and requires a Chapter 13 repayment plan bankruptcy.

And if you find that you are simply unable to make the payments on your vehicle anymore, bankruptcy protects you from 100% of a deficiency judgment. You can surrender the vehicle during the bankruptcy without fear of any deficiency judgment or further debt. If you are already facing a deficiency judgment or have had a judgment enter against you, bankruptcy will wipe that out and allow you a fresh start.

Repossession can be a stressful ordeal. If you are facing repossession or a deficiency judgment, call a Colorado bankruptcy attorney who offers free consultations to explore your options and find out if bankruptcy can help you.

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The seven basic rules of debt settlement which I advise clients are as follows.

1.    You must financial hardship in order to qualify. Financial hardship such as job loss is required because your creditors are not going to give you a break unless they fear you cannot pay them back.

2.    You actually need to miss some payments. I know this sounds strange. How could your good faith efforts to make payments work against you? Well, your creditors have no reason to offer you a break on the debt you owe them as long as you continue to make payments. Sure, they may give you a lower interest rate if you give them a hard luck story, but you will not get significant reduction of principal balance on your debt until you miss some payments. Once you start to miss payments, you represent a greater risk to them and then you have negotiating leverage.

3.    You need to offer a lump sum of cash. This is required because a lump sum removes their risk. In general, they are not going to reduce your balance if they continue to have risk. Without a lump sum, they are better off keeping the full amount of the debt on their books and pursuing judgment against you or selling the debt to a collection company, who will pay a lump sum (cents on the dollar) for that debt.

4.    Most debt settles for 40% to 80% of what you owe. This means your lump sum will likely have to be this big. Of course, I suggest you start by offering 10% or 20%, but you may not get a deal done until you have 40% or more of what you owe in a lump sum.

5.    You can settle debts yourself. There are companies which specialize in this, but settling debt is no magic trick. One of the primary functions these companies perform is advise you to stop paying your credit card bills and pay them some monthly amount instead. This has the effect of worrying your creditors (#2 above) while building a lump sum to offer them (#3). You can do this yourself. If you can save a lump sum by not making monthly payments to your creditors or you already have a lump sum, all you have to do is start missing payments. At that point, your creditors will contact you. Now you can begin the negotiations!

6.    If you want to go with a debt settlement company, DO YOUR HOMEWORK. These companies often take your money to help you build up a lump sum. They are not a bank and this money is not FDIC insured. This is a recipe for you getting robbed. To avoid this, I suggest you choose a company from The Association of Settlement Companies (TASC). You may also want to choose a company with Better Business Bureau accreditation.

7.    Be aware of the costs of debt settlement. The costs of debt settlement are generally threefold. First, debt settlement hurts your credit score. The effect is not as much as bankruptcy, but is nonetheless significant. Second, if you use a debt settlement company, they will generally charge some percentage of what they settle. This is generally more expensive than a bankruptcy attorney. Finally, the amount of debt forgiven is reported to the IRS as taxable income!! Depending on your tax bracket, this means you will pay 35% or more of the amount forgiven by your creditor to the IRS. I know – this makes the savings of settlement a lot less exciting.

Now that you know the seven basic rules of debt settlement, you’re ready for the golden rule of debt settlement. Drum roll please…………………………

GOLDEN RULE: Understand bankruptcy as an alternative to debt settlement. Depending on your income and assets, you could do much, much better in bankruptcy than debt settlement. This is primarily because many debtors can wipe out debt in bankruptcy without paying their creditors anything and without losing any property. This is also because the attorney’s fees and court fees for bankruptcy are generally much less than what a debt settlement company would charge. And the removal of debt in bankruptcy is NOT taxable. Many debtors wipe out tens or even hundreds of thousands of debt in bankruptcy for less than less than $5,000 (in many cases, for less than $2,000). Debt settlement can’t touch this kind of result.

If you have more debt than you can pay and are considering debt settlement, you should know the seven rules of debt settlement. However, before you go down that path, you should know your rights in bankruptcy. Many attorneys, such as myself, will give you a free consultation. Your creditors know their alternatives (pursuing judgment or selling your debt to a third party collection company). You should know yours. This will help you know how much you should pay to settle your debt, and it may keep you from trying to settle at all.

The vast majority of people who file for bankruptcy already have terrible credit, that’s no surprise. By the time most people consider bankruptcy they have exhausted all other options, have fallen far behind on payments for their credit cards, home and auto loans and many are also under pressure from court judgments or wage garnishment actions. For this group of filers, bankruptcy actually provides a small credit boost. That’s right, your score usually goes up after bankruptcy if you are in the group of filers who have a low credit score before filing. This can be true even if you are making your monthly payments.

This is because the credit reporting bureaus re-classify bankruptcy filers in their own category, and as a group that category is actually less risky to lend to, because the law prohibits you from re-filing for bankruptcy for a period of 4-8 years. As a result, lenders are more willing to extend credit to those who have just filed for bankruptcy and gotten rid of their unsecured debt (such as credit card and medical bills).

The trick is in how to take advantage of the availability of credit after bankruptcy without getting yourself back into the same situation that got you there.

Use It or Lose It!:

You will come out of bankruptcy without unsecured credit, that’s a given. Access to large amounts of revolving credit with high interest rates is what gets many people who file for bankruptcy into trouble in the first place. It is therefore only natural to be wary of taking out more revolving debt (which is where the full balance does not have to be paid off every month, in lieu of minimum payments—the catch is that the finance charges and interest continue to rack up as long as the original debt remains unpaid).

However, credit scores are based on your track record with debt and how consistently and responsibly you pay that debt. This means that living entirely on cash is not an option for those who wish to rebuild their credit score in hopes of buying a home or car or other property. In order to qualify for decent interest rates on those items, you need a decent credit score. Which means you need to responsibly use credit.

Credit Card Options:

Many people will qualify for an unsecured credit card immediately following bankruptcy. (Again, this I because the banks see you as less of a risk because you can’t file for bankruptcy again for a while.) Many people get offers in the mail right away. For those who do not receive these offers, a secured credit card is a good idea. Secured credit cards have low purchase limits and are secured by cash that you give to the card issuer.

In either case, secured or unsecured, it is most important that you stay well under your credit limit and that you pay your bill in full, on time, every month. A good guideline is to put no more than 30% of the total credit limit on the card every month. It may seem like a ridiculously small amount, but this is how you rebuild your credit after bankruptcy, by staying well under your credit limit and by paying (preferably in full) every month before the due date.

Also, do your research before taking out a secured credit card, they are not all created equal. You want to look for three things: 1) No application fee or high annual fee—this is just money in the lender’s pocket, it doesn’t help your credit score; 2) Make sure the card lender regularly reports to all three credit bureaus–Equifax, Experian and TransUnion—without this reporting the card isn’t doing anything for your credit history; and 3) the card converts to an unsecured credit card within 18-24 months—this should be the reward for paying on time and using the card wisely.

Installment Credit:

The other type of credit key to rebuilding your score after bankruptcy is installment credit, such as student loans, auto loans or home mortgages. Many people come out of bankruptcy with at least one of these types of loans still in their life. So use it to your advantage!
Regular, on-time payments on installment loans can help rebuild your credit score quickly. So if you came out of bankruptcy with an auto loan, make sure to make prompt payment a priority. If you still have student loan debt, make it work for you by using it to build a good payment history. If possible, you can even pay a student loan off early by sending in extra each month.

18-24 Months – The Magic Numbers

So, how long will it be before you can get back into the real estate market, or buy a new car (hopefully just new to you—if bankruptcy doesn’t teach people that buying an expensive new car with a huge monthly payment is a mistake, I don’t know what will)? The magic number seems to be 18-24 months. Yep, that’s it. For some it could be shorter, but research has shown that most people who use the years following bankruptcy to engage in sound, responsible financial practices can expect to get loans rates as good as those who did not file within 18-24 months.

Stay On Top of Your Credit Report:

A bankruptcy stays on your credit report for 10 years, but based on the above information, the negative impact lasts for a much shorter period of time. One reason for this is sheer numbers. Bankruptcy filings are reaching all-time high levels, over 135,913 consumer bankruptcy filings in October 2009 alone. That means that having a bankruptcy on your record is becoming a common occurrence, and luckily the stigma associated with bankruptcy is lessening as a result.

Debts discharged in your bankruptcy case should be reported on your credit report as “discharged in bankruptcy” and reflect a balance of Zero.  However, don’t rely on that, make sure to keep tabs on your credit report and dispute any inaccurate information.

Overall, a bankruptcy filing is not the end of the world as far as your future ability to obtain credit. For many, your credit can improve immediately following bankruptcy. Regardless of the immediate impact for your situation, your credit history will steadily improve following a bankruptcy so long as you stay within your means and ability to repay.

I recently read a fascinating legal discussion paper out of the University of Arizona Law School that takes an in-depth look at the behavioral reasons which prevent strategic default. Strategic default exists when a homeowner walks away from an underwater mortgage he or she can afford to pay simply because paying it does not make financial sense (that is, they can make more money by renting and investing in something else). The article says people are reluctant to default on their mortgages despite the financial wisdom of doing so because: 1) the idea of foreclosure carries with it shame and guilt; 2) people feel exaggerated anxiety over foreclosure’s perceived consequences; and 3) the government and media contribute to people’s  shame, guilt and anxiety.

As a Colorado bankruptcy attorney, I often encounter people who feel this way. They are actually in a worse situation than the strategic defaulter discussed in the paper because most of the people I see can’t meet their financial obligations. Despite this, the feelings mentioned in the article are so strong that these people are still clinging to their home. They know they are in deep financial trouble. They know they are months behind on their loan payments. They know that even with a bankruptcy discharge of their unsecured debt (such as credit card and medical bills) they will likely be unable to stay current on their home mortgage. And despite these realities, they still cannot imagine giving up their home (and the unmanageable payments that often go along with it).

Their question is, “Can I keep my home in bankruptcy?” to which, I say “yes, if you keep up with your mortgage payment.” It’s that simple. But then it’s not.

You see, I can’t stop there. I feel compelled to point out the consequences of this decision, even though most people do not want to even consider walking away from their mortgage.

Why do I do this? Well, as someone with an MBA who has worked in investments, I know how their banker would evaluate this decision, and I want my clients to view their finances in a similar light. I don’t think borrowers should shoulder a disproportionate load of the housing meltdown because of feelings of shame and guilt when the Arizona paper above makes it clear that bankers and lenders not only do not feel these emotions, but seek to profit from people who do!

The financial analysis should compare the value of staying in the home versus the value of renting. The value of home ownership should include home value appreciation at some reasonable level (without regard for irrational hope of returning to where we were in 2006), principal reduction on your mortgage over time as you pay it, and the tax deductions you get for the interest portion of your mortgage payments. On the other hand, the value of renting should include the monthly savings from cheaper rent for a similar home (which seems to exist in almost every situation) as well as some appreciation which could be earned with those savings if you were to invest them while renting.

So, when should you consider giving up your home? When your home is worth less than your mortgage. In such a case, you are underwater and your monthly payment is recovering losses instead of adding to your financial benefit. Depending on how far underwater you are and the cost of renting, you may be better off financially by just walking away.

I find that people have a really hard time with this analysis because they just cannot believe their home is not a good investment. I suppose it took that kind of mentality to push our country to the point where 1/3rd of all mortgages are underwater today and 1/2 of all mortgages are projected to be underwater in 2011. But, make no mistake, these statistics and the fact you are underwater mean you should evaluate the financial sense of continuing to pay your mortgage.

I recently did some analysis for one of my clients in Colorado, where I practice, regarding whether they should keep paying their mortgage. In this case, the client owns a townhome worth $150,000 with a mortgage of $220,000. His monthly mortgage payment plus homeowners’ association dues is $1,675. He could rent a comparable townhome for $1,000 per month.

I looked 5 years out, comparing a scenario where he rented rent for 5 years with one where he pays his mortgage for 5 years. I assumed that both the home’s value and the cost of rent will increase by 3.5% per year during this time (the historical real estate appreciation rate). I also assumed the client could earn 3.5% per year by investing the money he saves from renting versus paying their mortgage. These assumptions reveal that this client could save approximately $37,000 in today’s dollars by renting versus owning a home.

In this case, the client recently lost his job, so he was likely going to default on the mortgage anyway. Because he may need the monthly savings from renting for living expenses, I also ran the analysis assuming that he will not invest those savings. He still comes out $35,000 ahead by renting and not investing the savings. This is because he can rent for cheaper than his mortgage and his mortgage payments will be recovering losses for the next 5 years.

This analysis doesn’t include another important factor in favor of renting. In Colorado, it takes 6 months for a bank to foreclose. During that time, you can legally live rent free. In the case of my client, this adds $10,000 to the savings of renting – more than enough to pay for a bankruptcy attorney and the cost of moving into the townhome up the street!

So, for those who wish to keep their home – YES, you can keep your home in bankruptcy in Colorado if you continue to pay for it and you have $60,000 or less in equity in your home. However, if you are underwater in your mortgage, you should consider walking away. You may find that you can reduce your monthly expenses without impacting your lifestyle.  If you just don’t feel right about this, ask yourself what your banker would do in your situation. It’s time to start looking out for your own bottom line!