Despite the “recovery” that government officials and anyone involved in the real estate market like to talk about, unemployment and underemployment are persistently high and the housing market is in full on crash mode. This is not to mention wage decreases, which many employers are handing out like candy. This is leading many people to liquidate or borrow against some or all of their retirement account.
If you are feeling this pinch and considering taking money out of your 401K, IRA or whatever form of ERISA qualified (tax deferred) retirement account you may have, my advice is to stop and consider alternatives prior to touching this money. I don’t mean to say that you should never take money from your retirement account, but you should strive to avoid doing it and view it only as a last resort.

RETIREMENT ACCOUNTS ARE EXEMPT IN MOST STATES

In Colorado where I practice as a consumer bankruptcy attorney, any amount you have in a retirement account is exempt. This means your creditors cannot get it if they sue you. It also means you can keep this asset if you decide to file bankruptcy. By taking money out of your retirement account, not only are you taking from your own future, you are essentially opening the door for your creditors to get something they otherwise have no right to get.

If I had a nickel for every time a client tells me they liquidated a retirement account before coming to see me, well – I probably wouldn’t be rich or anything because a nickel isn’t worth what it used to be with inflation and all – but I’d have a piggybank full of nickels!!

That heavy pig wouldn’t make me nearly as happy as I would be if people stopped liquidating retirement accounts to pay debt.

Of course, the exemption laws vary from state to state, and some states limit the exemption to a certain amount in a retirement account. However, these limits are generally quite high. For example, the federal exemptions (which apply in some states and situations) limit IRAs and Roth IRAs to $1,095,000, and have no limits on other tax exempt retirement accounts such as 401K accounts.

WHAT TO DO BEFORE TAPPING YOUR RETIREMENT ACCOUNT

If you are struggling to keep up for whatever reason and considering getting money from your retirement account, I strongly suggest you consider the following options as alternatives to tapping your retirement account.

Stop paying unsecured debt

Credit card bills and medical bills simply rank lowest on the totem poll of who to pay when you are struggling. If you can free up enough money to cover your necessities by simply not making these monthly payments, you absolutely should NOT touch your retirement account! Period. End of Story.

You may have to file bankruptcy to get rid of those debts, but that is a much, much better option than mortgaging your untouchable, and well deserved, future.

Stop paying secured debts and letting these assets go

For many, stopping your monthly credit card payments is not enough to position you to cover the necessities of life. If this is you, you have some tougher decisions to make.

HOMES

I suggest you start by looking at your home. In particular, you should look at how much the house is worth (I suggest you look at the low end of the estimate provided by Zillow) versus how much you owe on it. One of my previous blog articles covers this topic.

Many homes are worth less than the amount owed on them, or underwater. And with the real estate market in a free fall (a recent Bloomberg article reports that home sales fell 27% in July 2010, YIKES!), existing underwater homes are sinking into the abyss while many more are falling below the surface. This means it’s a bad time to own a home.

If the federal government can’t prop up the real estate market with all of its stimulus, what good is your 401K??

If your home is underwater, I suggest you consider letting it go before you go pulling money from your retirement account. This may be the best investment decision of your life, especially when you factor in how long you can stay in the home rent-free while the foreclosure process runs its course. In Colorado, homeowners can often stay in the home for 9 to 12 months or more once they stop making payment.

Again, this decision may ultimately require you to file bankruptcy because your home lender may be able to sue you for the difference between what your home is sold in foreclosure versus what you owe (topic of another previous blog post). But if the alternative is throwing your future into real estate losses, this as a small price to pay to help insure your future.

CARS

Another asset to consider when working to make ends meet is your vehicle. If I had a nickel for every client coming to me with a high car payment (which I consider be over $450 per month) while considering bankruptcy, my piggybank would be bursting at the seams (even if I wouldn’t be rich!).

Of course, finding a more affordable vehicle may be difficult. If you have bad credit, you may not be able to get into another vehicle. And auto repossession can happen quite quickly when you stop making payments.

But, if you’re going to tap into a retirement account to make a high car payment, a better use of the retirement account funds may be a different car. While a vehicle worth $3,000 or $4,000 may not be as cool as your current ride, it is probably a smarter use of your retirement account funds than throwing them into a bottomless pit – which is what a high car payment is when you can’t afford all of your obligations.

WHEN IT MAKES SENSE TO LIQUIDATE A RETIREMENT ACCOUNT

If these alternatives are not available to you, you are in a situation where you can justify an early withdrawal or a loan against your 401K. Everyone’s gotta eat!

But lots and lots of people are making early withdrawals from their retirement accounts who have better financial options. This is because early withdrawals from your retirement account take from your future while also unlocking your money for your creditors. Because of this, early withdrawals from your retirement account or loans against it should be viewed as a last resort only to be visited after stop paying on unsecured debt, let your home go if it is underwater (and live there rent-free until they foreclose on it), and find something cheaper to drive. Such moves will likely require you to file bankruptcy, but will position you to protect your retirement account while also reducing your current expenses. Now that’s what I call a fresh start!

Active service members can take steps to reduce loan obligations, prevent court judgments, and avoid eviction and foreclosure.

A powerful federal law helps active service persons handle their legal affairs and reduce financial obligations while on active duty. Below we discuss the following benefits provided by this law:

* reduced interest rates on existing debts
* special treatment for tenants regarding lease cancellations and evictions, and
* protection from court actions and repossessions.

For employment issues facing servicemembers, see Taking Military Leave.

The Servicemembers’ Civil Relief Act

The Servicemembers’ Civil Relief Act, or SCRA (50 U.S.C. App. § 501 and following), applies to all active duty members of the armed forces, including the activated National Guard, the commissioned corps of the National Oceanic and Atmospheric Administration (NOAA), and the commissioned corps of the Public Health Service.

The SCRA aims to allow military members to serve without suffering financial or legal repercussions at home. In particular, Congress recognized that military pay for many activated reservists would likely be lower than their normal income, making it hard to pay debts.

Reduced Interest Rates on Existing Debts

Under the SCRA, many active duty personnel are entitled to a 6% interest rate cap on debts or financial obligations of any kind (except federally guaranteed student loans).

Conditions to Get the Interest Rate Reduction. To get the reduced rate, you must meet these conditions:

* You took out the loan before you began active duty. For example, a reservist who buys a car in June and goes on active duty the following October is entitled to the reduction. A sailor who secures a car loan while on active duty and then is transferred out of the country does not qualify for the reduction.
* Your military service materially affects your ability to pay the loan at the pre-service interest rate. This usually boils down to showing that you make significantly less money now than before you went on active duty.

How to Get the Rate Reduction. Write a letter to the lender asking that the interest rate on the loan be changed as of the date your active duty began. Include copies of your orders and paychecks, and evidence that you are now making less money than you did prior to active duty.

What Must the Lender Do? The lender must reduce the interest rate on the loan to 6% or less if you’ve provided the correct information. The lender can contest the reduction in court – which it might do if it believes your income reduction doesn’t materially affect your ability to pay the interest on the loan. Until the court rules, however, the interest rate must remain reduced. Once you resume inactive status, the loan will revert to its original rate.

Special Treatment for Tenants

Many active duty members may also be able to terminate lease obligations and avoid eviction.

Cancellation of Residential or Commercial Leases

Tenants who enter active military service after signing a lease or rental agreement have a right to get out of their rental obligations. This is true for both residential and commercial (business) leases. You must mail written notice of your intent to terminate your tenancy, along with a copy of your orders, to the landlord or manager.

* Month-to-month rental agreements. Once the notice is mailed or delivered to the landlord or manager, the tenancy will terminate 30 days after the day that rent is next due. For example, if rent is due on the first of June and you mail a notice on May 28, the tenancy will terminate on July 1. This rule takes precedence over any longer notice periods that might be specified in your rental agreement or by state law. If state law or your agreement provides for shorter notice periods, the shorter notice periods will control.
* Leases. Once the notice is mailed or delivered, the tenancy will terminate 30 days after the day that rent is next due. For example, suppose a tenant signs a one-year lease in April, and rent is due on the first of the month. The tenant enlists or is called up on October 10. If the tenant mails a termination notice on October 10, the lease terminates on December 1, which is 30 days after the first time that rent is due following the mailing of the notice (November 1). This tenant will have no continuing obligation for rent past December 1.

Delaying Eviction for Nonpayment of Rent

The SCRA requires courts to postpone (stay), for up to three months, some residential evictions for nonpayment of rent.

Which tenants are affected? The SCRA applies if your spouse, children, or other dependents occupy the rental unit during a period of military service. (A dependent is someone you’ve supported in the past 180 days, by paying more than half of that person’s living expenses.)

Rental amount. The Act’s protections apply when the rent is $2,400 per month or less. That figure — chosen by Congress in 2003 – is adjusted to account for inflation or cost of living increases.

The effect on an eviction lawsuit. The Act does not prevent a landlord from serving a termination notice for the nonpayment of rent. But a landlord who has filed suit must tell the court that the tenant is an active service person (so be sure to notify your landlord when you are activated). The judge will decide whether the service person’s status in the military materially affects his or her ability to pay the rent. If the judge determines that it does, the judge may stay the eviction for up to three months. If the judge decides otherwise, the lawsuit will continue and may result in an eviction.

Requisitioned Pay

The Secretary of Defense or the Secretary of Transportation may order that part of your pay be allotted to pay the rent.

For more information on tenant issues, see Nolo’s Renter’s Rights Resource Center.

Protection From Court Actions and Repossessions

The SCRA also protects active duty service members from some court judgments and repossessions.

Delay of All Civil Court Actions

The SCRA allows active service persons to ask for a postponement (stay) of many kinds of civil actions in which the service person is a defendant. In addition, when calculating the statute of limitations (the time during which a person must bring a lawsuit, or lose the right to do so), the period of time that the person has been in the military is not counted.

These provisions of the Act have been used most frequently in foreclosure and domestic relations cases.

Foreclosure. No lender, including credit unions, banks, and individuals, may foreclose on, seize, or sell the homes of military personnel during active duty or up to three months after. To be eligible for this protection, you must have taken out the mortgage before you began active duty.

However, a mortgage lender can request permission from the court to foreclose if it thinks that a borrower’s active status has not materially affected his or her ability to pay the loan or appear in court. For example, a newly activated reservist whose income level has not dropped, who has been posted to a nearby city, and who can obtain leave to attend court will probably not qualify for a postponement of a foreclosure.

Divorce proceedings. Active military personnel may ask for a postponement (stay) of divorce proceedings if they can show that their active status makes it impossible to attend the proceedings.

Default Judgments

A default judgment occurs when you are sued and fail to appear in court, and the judge then rules against you in your absence.

Plaintiff must notify the judge that you are on active duty. Under the SCRA, a plaintiff — who brings a lawsuit — who seeks a default judgment against an absent active duty service member must notify the court that the service person is on active duty. If neither the service member nor his or her attorney appears in court, the court may appoint an attorney to represent the service member in his or her absence.

You may be able to reopen the case later. If the court enters a judgment against you during your military service, under certain circumstances you may be able to reopen the case later.

Repossessions

The SCRA prohibits repossessions performed without a court order (such as those done by merchants or “repo” specialists) of goods purchased by installment contract, such as consumer items or cars, as long as the purchase was made before active duty began.

If you are on active duty, the merchant must get a court order before it can repossess an item. Once in court, an active duty service member may apply for a stay of repossession proceedings. The judge will grant the stay if the service person’s ability to pay the debt has been materially affected by entering active service, in the judge’s view.

SCRA: Web Resources

The various branches of the United States military have helpful websites explaining the meaning and application of the Servicemembers’ Civil Relief Act. The following two sites explain the Act’s protections in detail:

* www.jag.navy.mil/documents/SSCRA.htm
* www.military.com

Once you get to military.com, type “SCRA” into the search box. The resulting links give information on the Act as well as financial, educational, and other support services for family of active duty service members.

For a comprehensive discussion of legal issues facing tenants, read Every Tenant’s Legal Guide by Janet Portman and Marcia Stewart (Nolo).

© 2010 Nolo

Most Student Loans Are Not Dischargeable in Bankruptcy

In general, student loans are not dischargeable in bankruptcy. That means you will still owe them when your bankruptcy is over. (They used to be dischargeable after seven years of repayment, but Congress changed all that in 1998.)

Now, they only way to get rid of your student loans in bankruptcy is to claim that repayment of the loans creates an “undue hardship”. The only way this can be proven is through what is called an adversary proceeding. This is like a separate lawsuit within your bankruptcy case. It involves litigation, and will require expert witnesses, depositions ad other witness testimony. As a result, it is not cheap.

Aside from costing you a good chunk of money, winning an undue hardship discharge is incredibly difficult. Most courts, including Colorado, follow the test set out in the Brunner case out of New York (831 F.2d 395). Brunner is a three-part test in you must prove:

1. That the debtor cannot both repay the student loan and maintain a minimal standard of living;
2. That this situation is likely to persist for a significant portion of the repayment period of the student loans; and
3. That the debtor has made good faith efforts to repay the loans.

This test is applied very strictly, with minimal standard of living judged as living at the poverty level with no discretionary expenses at all. Additionally, discharges are not usually granted absent permanent disability of the debtor (or possibly one of the debtor’s dependents). More information is available at FinAid.

The bottom line is that in the vast majority of bankruptcy cases, discharge of student loans is simply not an option.

Student Loans in Chapter 7 Bankruptcy

When you file for bankruptcy, you are instantly protected by the automatic stay, which prevents creditors from attempting to collect on the debts you owe them. This protection applies to student loan lenders, and as a result, your loans will be put into automatic forbearance once your case is filed.

Interest continues to accrue during the time your bankruptcy case is open, and you will be responsible for those amounts. However, you can take a break from paying your regular loan payments while your Chapter 7 bankruptcy is pending.  In fact, this is the easiest way to handle student loans in bankruptcy. Often, your loans are sold once you enter bankruptcy or are transferred to a different department and if you try to make your regular payment they may not be properly credited.

Therefore, if you plan to continue to make payments, it is important to communicate with your lender once you file your case, and to keep records of any payments you make while your bankruptcy case is open.

Student Loans in Chapter 13 Bankruptcy

In a Chapter 13 bankruptcy, which requires steady income and involves a monthly payment for the three-to-five-year life of the plan, student loans can be dealt with in two different ways. First, your student loans can be placed “in the plan” and a portion of your monthly payment will go toward the loan balance(s). However, this monthly amount is likely to be smaller than your regular payments and this approach will not stop interest from accruing on the loans. The automatic stay applies for the life of your Chapter 13 plan and the student loan lenders must accept the smaller payment amount while you are in Chapter 13 bankruptcy (3-5 years). While these payments will be credited to what you owe (interest and possibly even principal), the lender can hold you to the terms of your loan agreement in collecting remaining principal and interest after you exit bankruptcy.

There is a second way to handle student loans in Chapter 13 bankruptcy, and that is to pay the loans “outside of the plan”. The benefit of this approach is that you can continue to make regular payments on the loans and keep interest from piling up during the years you are in a Chapter 13 repayment plan. However, this is often limited as a practical matter because many do not have enough money to make their student loan payments while also making a Chapter 13 bankruptcy payment.

Furthermore, for those that can afford to continue making payments outside the plan, the bankruptcy Trustee may well challenge this approach if your other creditors are getting only a fraction of what you owe through the bankruptcy. Your ability to prevail in such a situation depends on a number of factors, and such cases are best handled by an experienced bankruptcy attorney.

What to do After Your Bankruptcy Discharge

Your student loans probably changed hands while your bankruptcy was pending.  (Most student loans are sold to a company called ECMC once you file bankruptcy.)  After your bankruptcy is over, or while your bankruptcy is pending if you plan to continue repayment, it is important to find out who holds your loans. The National Student Loan Data System can help you find out. Once you find out who your lender is, you should contact them to discuss your repayment options.

I f your student loans were in default before you filed for bankruptcy, they will continue to be in default until you work something out with your lender, such as loan rehabilitation or a default repayment plan. (Student loans go into default if you fail to make a payment for 270 days.)

Bankruptcy will not put your student loans into default. If your credit report after bankruptcy incorrectly reports the status of your loans (such as showing loans in default when you are sure they are not, or reporting that your loans were discharged in bankruptcy—they were not, unless you won an adversary proceeding against your lender) you must dispute the incorrect status with the credit bureau.

Having student loans can be a good way to begin rebuilding your credit score after your case is closed. Provided you make on-time payments and continue to pay down the balance, your student loan debt will provide a means of establishing a good credit history without taking on new debt after your bankruptcy is over.

Student loans are very difficult to get rid of in bankruptcy. You need to have real hardship and money to invest in a lawsuit (odd combination, I know). Assuming this is not you, you should have a plan for how to manage your student loans during and after bankruptcy. This is especially true in Chapter 13, where student loans present particularly thorny practical and legal issues while in bankruptcy. If you’ve read our blog in the past, you can probably guess the exciting conclusion – this is a good reason to hire a bankruptcy lawyer.

This article got a lot of press last week, seemingly because of the idea that the rich are “more ruthless” than other people, an opinion expressed in the article. However, I believe that the real hook of the story should be this:

“They may be less susceptible to the shame and fear-mongering used by the government and the mortgage banking industry to keep underwater homeowners from acting in their financial best interest,” Mr. White said.

This is the walk-away issue in a nutshell. Many people do not realize the extent of the PR push to keep underwater homeowners afraid and shameful about making the decision based on their financial best interest. The University of Arizona published a paper about this very issue recently, it is a disturbing read.

That this calculated message is not as effective on the wealthy is not surprising, they are used to making decisions on a financial basis, and also they have other resources to fall back on and walking away from the mortgage doesn’t necessarily mean they need to file for bankruptcy. Because of the potential for a deficiency judgment, for most people making the choice to get out from under an underwater mortgage is often accompanied by the decision to file for bankruptcy.

Filing for bankruptcy makes a great deal of sense for people with underwater mortgages. It protects you from any deficiency judgment from the lender and it can also wipe out the credit card debt that can result from struggling to pay that underwater mortgage and keep up with the costs of life. Additionally, in Colorado, where I practice, once you decide to let the bad investment go, you can live in the property rent free during the foreclosure process. We are currently seeing people take advantage of this rent-free living for six months to a year.

Whether or not walking away makes sense for you should be based on a financial benefit analysis. My husband, Mike, wrote a blog about this issue last year that is still appropriate to consider.

So, if you decide to let the mortgage go and move on to a new beginning without a mortgage payment that no longer reflects what the property is worth, remember that you are simply learning a lesson from the rich: you are simply looking out for your own bottom line.

WHAT CONSTITUTES FRAUD?

Bankruptcy law defines a fraudulent transfer as one which was done within the two years before filing bankruptcy AND was done with intent to hinder, delay or defraud any creditor. Bankruptcy law also yields to State law for fraud. In Colorado, where I practice bankruptcy law, this means they can look back four years on transfers of money or property.

THE TEN BADGES OF FRAUD

Of course, like many legal descriptions, this one begs another question – What does intent to hinder, delay or defraud mean? Well, since people almost never admit to defrauding their creditors, the courts generally look to 10 badges of fraud to determine intent.

While interpretation of these badges can vary, there is precedent which says that more than one may have to exist to establish fraudulent intent. They are:

1.    ‘Special equity’ – if you sell the property out from under a creditor’s interest, such as a security interest, this can be fraud.

2.    Special relationship – if you and the buyer or recipient of your gift are family, friends, or close business associates, you’ve taken a step toward committing fraud.

3.    Maintaining possession – if you had the great idea to sell property to your roommate who will still let you use it, you’ll likely find out this wasn’t such a great idea.

4.    Pattern of ‘sharp’ dealing – if you’ve engaged in a series of moves to keep property away from creditors, your sharp dealing may be deemed not-so-sharp. In this case, more is less.

5.    Transfer made you insolvent – if the transfer or gift leaves you unable to pay your debts, fraud can be found to exist.

6.    Transfer after judgment – if you decide to start getting rid of assets after a creditor sues you and gets a judgment against you, your procrastination can be ruled fraudulent.

7.   Less than fair value – if you decide to give the buyer a sweet deal on your property by selling it for less than it’s worth, well duh!

8.    Concealing transfer – this is the worst thing you can do. Worried about your debt, now you get to worry about criminal charges. Please, please, please – tell the truth.

9.    Use of credit – did you use credit to purchase exempt property? If so, you may have committed fraud.

10.    Total value of assets transferred – bigger is not better when the question is whether you committed fraud.

WHAT IT MEANS?

If a court finds you’ve committed fraud, you’re at the mercy of a judge. In bankruptcy court, the potential consequences of a finding of fraud can be as light as a ruling that a particular debt is not dischargeable to a ruling that none of your debts are dischargeable or that your case is dismissed. In extreme cases, you can even face criminal charges.

WHAT TO DO IF YOU’RE CONSIDERING A POTENTIALLY FRAUDULENT TRANSACTION?

If you’re unable to pay your bills and you have property you’re worried about losing – run, do not walk, to a bankruptcy attorney. I believe the most valuable function of a bankruptcy attorney is to help people keep their property. If the property turns out to be exempt, you can keep the property you’re worried about losing.

Believe it or not, I have encountered a client who fraudulently transferred property (by giving it to his mother) he would have kept through bankruptcy. Don’t let that be you!!

If the property is not exempt and you can’t keep it, you may be able to keep the value by legally selling the property before bankruptcy and putting the proceeds into other, exempt property. As you might imagine, this is risky business and should be done under the advice of counsel.

WHAT TO DO IF YOU’VE ALREADY COMMITTED A POTENTIALLY FRAUDULENT TRANSACTION?

If you’ve already violated one or more of the badges of fraud, my advice is the same. Go chat with an attorney immediately! The determination of fraud is very detailed, and there are often things which can be done to help mitigate any of the damage you’ve done by acting without the advice of a lawyer.

Lots and lots of people throughout history have struggled to pay debts, and lots of them tried tricks to keep their property away from creditors. Whatever ideas you’ve got have been tried before. Courts have seen it and ruled on it. This is an area of expertise amongst bankruptcy lawyers. Whether you have property you are worried about losing or you have already disposed of some property in way which may be deemed fraudulent, the best thing you can do is seek the advice of someone with this expertise. You will likely find you have a surprising amount of options for what you can do.

Because of the personal relationship shared by most codebtors, many people who are considering filing for bankruptcy are concerned about the effect their bankruptcy will have on their cosigner. This is a very valid concern, because the cosigner has agreed to be responsible for the full amount of the debt if the primary debtor defaults on the loan. That means that if one co-debtor files for bankruptcy, the other is on the hook for the full payment.

Additionally, the cosigner must be listed as a creditor in your bankruptcy case. This is so they have notice of your bankruptcy, but also so that any claim they may have against you for defaulting on the loan is wiped out and does not come back to haunt you after you receive a bankruptcy discharge.

Bankruptcy Options

Chapter 7: Unfortunately, the cosigner gets no protection in Chapter 7 bankruptcy. While the person filing bankruptcy will have their personal liability wiped out by the Chapter 7, the cosigner will still be on the hook for the full amount of the discharged debt. Sometimes, the debtor in Chapter 7 may continue to pay a certain debt such as a home loan or auto loan so they can keep the house or car after bankruptcy. In such cases, the impact on the codebtor may be minimal. However, in many cases the debtor in Chapter 7 debtor stops paying the debt. In such cases, it may make sense for the cosigner to file for bankruptcy as well, especially if the debt is for a large amount such as a mortgage.

Chapter 13: In Chapter 13, however, the cosigner gets some protection from the creditor and also can have their liability removed completely if the debt is paid for through the Chapter 13 repayment plan.

In Chapter 13 bankruptcy, the cosigner is protected by the codebtor stay, which prevents creditors from contacting them and trying to collect the debt. This stay applies if: 1) the cosigner is an individual (as opposed to a corporation or partnership), 2) the cosigner did not become liable for the debt in the ordinary course of business, and 3) the debt must be a consumer debt; that is, a debt primarily for personal, family, or household purposes.  If the debt meets these criteria, the automatic stay will apply unless the creditor petitions the court to have it lifted.

The creditor can argue that the stay should be lifted if: 1) your cosigner (rather than you) received the consideration for the debt (i.e., your cosigner received the property the funds were used to purchase); 2) your Chapter 13 plan does not include payment of that debt; or 3) the creditor’s interest would be irreparably harmed by the stay (for example, if the bankruptcy filer might dispose of the property or if the property is rapidly decreasing in value). If the Court agrees and lifts the stay, then the creditor can attempt to collect the debt from the cosigner as if no bankruptcy had been filed.

If the Chapter 13 plan provides for the debt to be paid in full during the plan (usually 5 years) then the cosigner will not be liable for the debt once a discharge enters in the bankruptcy case. However, if the debt is not paid for in full, then the creditor can still attempt to collect the debt from the codebtor if the remaining balance on the debt is not paid following the Chapter 13 discharge. The creditor may also proceed against the cosigner if your Chapter 13 case is dismissed or converted to Chapter 7.

Because most cosigners are people you have a close personal relationship with, it is important to know how your bankruptcy will affect them. Having the advice of a bankruptcy lawyer can ensure that you cosigner issues are dealt with properly.

What is wage garnishment?

A wage garnishment, or wage assignment, is a court ordered process through which your wages or earnings are withheld for payment of a debt to one of your creditors. Basically, it is a way for a creditor to hijack a significant portion of your wages directly from your employer. Even though your sweat earns this money, you don’t see it when garnished, other than as a cruel and crippling deduction on your paystub.

How does a creditor get a wage garnishment?

In order to get the right to yank your wages and cripple you financially, a creditor has to sue you and get a judgment against you. When you receive a summons notifying you that you’ve been sued, the creditor will probably be able to secure a judgment against you within 30 to 60 days if you do nothing. You may be able to extend this time by answering the complaint, and requesting more time. It never hurts to make the creditor prove their case by asking for a copy of the note or a summary of payments and interest charges.

However, these tactics only buy some time (perhaps another 60 days or so). In general, most debtors do not have a good defense to the lawsuit. If you owe the money and the creditor hasn’t waited too long (for many creditors, they can wait 6 years to sue you), then there’s not much you can do to stop a judgment against you for the amount of the debt plus interest plus their attorney’s fees in recovering the debt.

By the way, you should not simply ignore a summons. A recent article in the Star Tribune describes how some judges are issuing warrants for your arrest if you do not show up in court to answer for your debt or fail to make a court ordered payment. While these cases seem extreme, I wouldn’t want to see you spend a night in jail over a debt.

Once a creditor gets a judgment against you, they can get a writ of garnishment from the court. While the judgment gives the creditor a right to seize certain ‘non-exempt’ assets such as cash in a bank account, creditors pursue wage garnishment for many debtors. This is because many people have few, if any, non-exempt assets (which means they would keep all of their property in bankruptcy) and wages represent a stable source of income to draw upon.

Once a writ of wage garnishment is issued by the court, it is then served upon your employer, instructing them to withhold a portion of your paycheck and give it to your creditor. The employer is legally obligated to obey the garnishment order.

From the time of the judgment, creditors often can get the writ of garnishment issued and served to your employer within approximately 60 to 90 days. Therefore, from summons to garnishment generally takes 3 to 4 months if you do nothing (again, be wary of the risk of a warrant mentioned above), and can be extended a couple of months if you make the creditor prove their case.

How much can a creditor take through wage garnishment?

The answer depends on the state you live in and the type of creditor suing you. In Colorado, where I practice as a bankruptcy lawyer, most creditors can generally take 25% of your gross wages until your debt is paid (it is possible for them to take more if you make more than 30 times minimum wage).

The wage garnishment limit in Colorado is also the federal wage garnishment standard, and is law in most states. However, some states such as Texas and North Carolina, severely limit the amount of wages a creditor can garnishment. Not surprisingly, a recent study has found that bankruptcy filings in those states are lower.

In Colorado as in most states, only one creditor can garnish you at a time. If you are being sued by multiple creditors at the same time, they will have to get in line to drink from the wage faucet that comes from your hard work. But, they will get their turn at your wages if they have a judgment against you.

IRS wage garnishment

The IRS often takes more than the 25% wage garnishment limit because there are special federal laws which govern the amount of your wages the IRS can garnish. This amount is determined by a formula calculating the tax owed, the number of dependents you claim and other issues (view tables showing varying IRS garnishment amounts).  Generally, this formula lets the IRS take 30% to 70% of your income. YIKES!

These risk of losing this level of income means your really have to do something about your tax debt. Bankruptcy can help. Certain taxes can be discharged in bankruptcy, while other taxes can be paid over 60 months in a Chapter 13.

Student loan wage garnishment

Many student loan lenders, including the Department of Education and student loan guaranty agencies, have the authority to collect federally financed student loans that are in default through a wage garnishment of 15%. These creditors, which essentially represent the government’s money, are unique because they can get the garnishment without a court order. So, if you’re behind by federally financed student loans, you should know that they can easily get to 15% of your wages.

While Bankruptcy does not get rid of student loans for most people, it can help you wipe out other debts so that you can afford to repay your student loans.

Bankruptcy Ends Wage Garnishments

In summary, if you’re behind on debt payments and you have a job, a lawsuit and wage garnishment is coming your way sooner or later. Your creditors have plenty of time to sue you. There’s an entire industry filled with lawyers who specialize in suing debtors and getting garnishments. They’re good at what they do, and won’t let you slip through the cracks.

While this may seem bleak, you have a big stick of your own – bankruptcy. Bankruptcy can wipe out debts before the creditors have time to sue you. If you’re being sued, bankruptcy can stop the lawsuit. If you’re being garnished, bankruptcy can stop the garnishment. However, the costs of bankruptcy can be a much bigger hurdle at that point.

So, if this is your situation, time is not on your side. I suggest you meet with a bankruptcy attorney immediately. This will give you as much time as possible to collect the funds required to pay your attorney and gather the information required. By acting quickly and decisively to get out of debt, your total cost will likely be limited to attorney’s fees.

The Meeting of Creditors is described in section 341 of the Bankruptcy Code, hence the name “341 Hearing”. It provides for a United States Trustee to convene and preside at a meeting of creditors and directs the Trustee to “orally examine the debtor” in a Chapter 7 case to make sure they are aware of 1) the consequences of filing for bankruptcy, 2) their ability to file a petition under another chapter, 3) the effect of any discharge of debts and 4) the effect of reaffirming any debt.

What happens in reality is that the bankruptcy trustee reads an advisement and then begins calling cases by debtor name. Once you hear your name called, you and your attorney walk up to the desk or podium and the panel trustee places you under oath, checks your identification and asks you questions on the record about your bankruptcy petition and your financial situation.

In Colorado, where I practice bankruptcy law, you will also hand a completed “Trustee Information Sheet” to the panel trustee along with a bank statement and pay stub that covers the date your case was filed. Additionally, the trustee must already have received a copy of your most recent tax return. As I will discuss below, these requirements alone are enough reason to make sure you are represented by an attorney at your 341 Hearing.

In fact, if you meet with an attorney who does not provide representation at the 341 Hearing as part of their services, you should keep looking. If there is ever a time to have the services of a bankruptcy lawyer, it is when you are answering questions about your case under oath.

Who Is the Bankruptcy Trustee?

In a Chapter 7 bankruptcy, private trustees—or panel trustees—are appointed to administer estates under the supervision of the United States Trustee for their judicial district. That means there is a U.S. Trustee’s office in each judicial district (part of the Department of Justice), and then each U.S. Trustee’s office has a panel of private trustees who do the day-to-day work of administering Chapter 7 cases, which includes presiding at the 341 Hearings.

These panel trustees are usually private bankruptcy attorneys who do the work on a part-time basis. They take a cut of any assets they find in the bankruptcy estate, along with a flat fee for each case they administer.

So, in a Chapter 7 case, you have two levels of trustee involvement: 1) the U.S. Trustee, who is reviewing your case to make sure you qualify for chapter 7 and that your case is not an ‘abusive filing’; and 2) the panel trustee who is looking for assets they can sell to make some money.

What Is the Trustee Looking For?

Because the panel trustee has a financial stake in every Chapter 7 case they see, the 341 Hearing really boils down to one thing: money. The panel trustee is looking to see if you have assets they can liquidate because that is how they get paid. (The panel trustee takes 25% of the first $5,000, 10% of the next $45,000, etc.) Therefore, the questions you are asked are tailored to determine if your estate has any non-exempt assets.

For example, if you own a car, the trustee will want to know how you came to the value the vehicle(s) you listed for the car in your bankruptcy petition. If the trustee thinks the value is too low, they may order an appraisal.

A bankruptcy attorney is invaluable in preparing you for the types of questions you may be asked at the 341 Hearing.  This is because your attorney, in preparing your bankruptcy case, will know what property or interests you have that will be of interest to the trustee and can prepare you accordingly.

What About the Creditors?

Since the 341 is technically called the Meeting of Creditors, you may be wondering where the creditors are in the process. All of your creditors receive notice of your bankruptcy and also the date of your 341 Hearing. However, it is very rare for a creditor to appear at this meeting.

In fact, the only time you usually see creditors at the 341 Hearing is when the creditor is an ex: ex-wife, ex-husband or ex-business partner, someone with an opinion about your bankruptcy or who wants the trustee to know that they think you have some very fancy golf clubs in the garage that you didn’t list on your petition (another reason to have an attorney prepare your bankruptcy case!). In other words, you probably will never see Bank of America at the 341 meeting, they just aren’t emotionally involved and they don’t have the staff or money to send someone to every meeting of creditors when one of their customers files for bankruptcy.

The Role of the Attorney

The 341 Hearing is a perfect example of why having a lawyer prepare your bankruptcy AND represent you at the trustee meeting is essential. If you spend any time at all in the hearing room, listening to other cases as they go before the panel trustee, the benefits are obvious.

Last month, I saw an extreme example of what can happen when you aren’t prepared for or represented at the 341 Hearing. The trustee called the next case and the debtor approached the table, raised his right hand and took an oath. Once he sat down he was shaking and obviously nervous. The trustee asked him a few preliminary questions, checked his identification and then asked him if he had personal knowledge of the contents of his bankruptcy petition. This very basic question threw this guy for a loop. He asked to have the question repeated, and repeated again. And then he turned very, very pale and passed out. It was scary and sad because the poor guy was obviously nervous about his case and his petition and would have benefitted greatly from professional advice and representation. My client actually turned to me and said “Am I ever glad we have a good bankruptcy attorney!”

Fainting at the 341 Hearing is not at all common, but having your case dismissed for failure to provide your tax return to the trustee is, along with having to surrender property (like your tax refund) that you could have kept if you’d had legal advice.

Overall, the 341 Hearing is nothing to be scared of, as long as you are prepared and accompanied by an attorney who has prepped you for the meeting. Most 341’s go quickly and painlessly, especially when your case was properly prepared, you know what to except, and are ready for the specific questions that might come your way.

Don’t Do Anything Stupid

Well first let me tell you that it’s going to be OK. Do not panic. The worst thing you can do if you are researching bankruptcy and find that you have non-exempt property, say it’s an old baseball card collection or your inherited silverware set, is to give it away or “sell” it to a family member for pennies on the dollar. Giving property away or selling it for less than market value right before filing bankruptcy is a big No-No. Your bankruptcy petition requires you to list all transfers of property in the two years before you file and all gifts you have given in the year prior. You will sign this petition and be asked under oath if it is accurate. Additionally, every bankruptcy is subject to a random audit and if you are one of the unlucky ones and you lied on your petition, you likely won’t get a discharge and could even be charged with a crime.

It’s Probably Better Than You Think

If I have learned one truth as a bankruptcy attorney it is this: Everyone thinks their stuff is worth more than it is. Everyone. Especially in these tough economic times. For example, there is no market for diamonds right now. They are selling at extremely low prices. If you don’t believe me, check Craigslist. We tell our clients to get an appraisal if they have a piece of jewelry they are worried about losing in bankruptcy. NOT the replacement value the insurance companies use, but the resale value, what a jeweler or pawn shop or someone on Craigslist would actually pay you for the item. Many find that their finer things are worth less than they think and fit into the exemption limit (ex., in Colorado, you can keep $2,000 worth of jewelry).

Other items people are surprised to learn the true value of are their homes (don’t believe what your Realtor neighbor or friend tells you, you need a CMA—comparative market analysis—from someone who knows the realities of the housing market and isn’t selling anything), horses (you can barely give horses away right now) and their household goods.

What are Household Goods and What are they worth?

The definition of Household Goods in Colorado bankruptcy law is found in C.R.S. §13-54-101. Household goods are:

“household furniture, furnishings, dishes, utensils, cutlery, tableware, napery, pictures, prints, appliances, stoves, microwave ovens, beds and bedding, freezers, refrigerators, washing machines, dryers, exercise equipment, musical instruments, bicycles, sewing machines, toys, and home electronics, including but not limited to cameras, television sets, radios, stereos, computers, facsimile machines, telephones, and other audio and video equipment.”

This is a broad definition that reflects the technological world we live in today. It’s actually very generous compared to some states. It covers almost everything most Americans fill their lives with. Additionally, the value to be placed on your household goods is what we call “garage sale value”, and it is far below the price you originally paid for the items. We direct our clients to the Salvation Army website for guidance.

There are two big exceptions to household goods, though, and they can cause some problems in bankruptcy.

The first big exception to the Household Goods definition in Colorado is recreational equipment. Recreational equipment includes camping gear and guns. As you can imagine, this presents an issue for lots of people who need to file bankruptcy.  Lots of people have guns, and camping gear, for that matter.

Another exception is for antiques and collections, such as baseball cards. If you have property that falls into this category it can be very hard because it will almost always have sentimental value.

So what do you do if you have non-exempt property, be it guns, antiques or excess equity in your house or car?

Buy It Back or Let It Go (Sometimes it will come back to you)

The first option for non-exempt property in Chapter 7 bankruptcy is to make a deal with your bankruptcy trustee. This happens all the time and is a great reason to use a lawyer when you file bankruptcy. Basically, you are making an offer to buy the property back from the bankruptcy estate (once you file for bankruptcy, all your non-exempt property become property of the bankruptcy estate).

The key to this approach is to have a good, solid value for the things you want to keep such as an appraisal or some other evidence of the market rate for that type of property. Your attorney can help with recommendations for valuing the specific non-exempt items in your case. You do not want to overvalue your stuff, because the trustee is going to use that price if they think it’s high.

If the trustee thinks your value is low, they can order an independent appraisal. That’s where the negotiating part comes into play (and where you breathe a sigh of relief that you have a lawyer to help you, ha ha) with both sides asserting why their price is the one to use, and also how long you will have to pay the final sum. Most trustees will give you three to six months to pay for non-exempt property.

The second option is to let the property go, which does NOT mean let the bankruptcy trustee take it and sell it and give the money to your creditors. Although this is sometimes unavoidable, with good pre-bankruptcy planning it should be very rare. Rather, you should sell the non-exempt property before you file and then use the proceeds to either live off of (buying necessities, not luxury goods) or to purchase exempt property. This approach is accepted by the law, but there are guidelines you must be aware of and a certain amount of risk, especially if we are talking about large amounts of money. If you have non-exempt property and you want to sell it before filing, you must talk to a bankruptcy attorney. It’s essential.

There is one situation where you might not want to sell non-exempt property before filing bankruptcy. That is where you have a small amount of non-exempt property, such as the camping gear in the garage that isn’t worth a lot of money—you want to keep it, but it wouldn’t be the end of the world if you lost it. In this case, you may just want to cross your fingers and see what your trustee does. If there is nothing else in your case for the trustee to take, they will probably let you keep a small amount of non-exempt property. Most trustees will not open a case to distribute assets if the dollar amounts are small (each trustee is different, so there is no way to guarantee this, but most leave anything under a few hundred dollars alone).

In conclusion, having non-exempt property going in to a Chapter 7 bankruptcy is not uncommon. It’s also manageable, especially with good legal advice. If you are in that situation, it’s a great idea to find a bankruptcy attorney who offers free consultations to discuss your options so you can enter your bankruptcy in as strong a position to get a fresh start as possible.

It seems so harmless – borrowing from your bank. After all, once you trust an institution enough to hold your money, it’s hard to imagine why you wouldn’t take advantage of at least one of the various credit options they have to offer.

But I’m here to tell you, there’s something about loans from your bank which makes them worse than loans from other banks. It’s called cross collateralization. Try saying it ten times fast.

What does it mean? Well, it means banks can generally take money out of your bank account without your permission to satisfy a loan obligation you owe them. This is known as the bank’s right of setoff.

It may not seem like the kind of tenet to pass on to your children, especially since the vast majority of people who take out a loan never really consider the possibility of default. But think about – say you get laid off, or divorced, or sick, or your car just died, or any number of real life situations happens to you and you become unable to meet your loan payment to your bank. You may think your bank (or even better, your trusted credit union) will work with you. After all, you’ve probably been a customer for years and they seemed so nice when they gave you the loan.

But this is when banks earn their reputation as greedy mother-(insert expletive here)! By the way, your trusted credit union is no different. Just when you need forbearance, they take advantage of their trusted position as your bank to screw you when you most need some help. They take your money directly from your bank account. To make matters worse, the usually accelerate your loan, which means they can take the entire loan balance from your account. For many borrowers, this means they leave you with nothing. And they seem to have knack from taking the money right when you need it most.

Check out this real life story about a couple in Atlanta who took the full brunt of Wells Fargo’s right of setoff. She defaulted on a student loan because she couldn’t find a job and, WHAMMO, they accelerated her loan balance and took all of the money from her bank account – $4,059. Wells Fargo then hit them with $385 in overdraft fees because their outstanding expenditures at the time their account was raided suddenly could not be fulfilled.

Now you can’t make rent, or fix the car, or make your co-pay, or eat, or sleep at night. A bit dramatic? Not if it’s you!

At this point, you might feel the fury of a thousand loyal banking customers. You may decide to do some research. “Can they really do that?” you might say. You might decide to call the Better Business Bureau, or write a letter to your congressman, or talk to an attorney!!!

Let me stop your quixotic mission right there. You cannot win such a fight. First, it is all spelled out in the very fine print of your loan documentation. Second, don’t forget the golden rule – “He who has the gold, makes the rules” – and for purposes of cross-collateralization and the right of setoff, the banks make the rules.

My friend, you don’t stand a chance of redeeming this great wrong perpetrated by your bank. But you can avoid making this same mistake twice. Like the man who learned about yellow snow the hard way, you need just commit a simple principle to memory. DON’T BANK WHERE YOU BORROW.

For if you simply borrow only from banks where you don’t keep your money, you will never have a bank suddenly take money from your account without your permission. This is because cross-collateralization does not exist across different banks. For example, let’s say you miss a credit card loan payment with one of those large banks which nearly brought down our economy (you know the ones), but keep your money at the small local bank. Because you have no money with the large bank, they have no cross-collateralization. They must go through legal proper channels to get anything from you.

Suddenly, the large bank has more motivation to work with you. After all, they’d rather get paid than hire a lawyer. Of course, their willingness to work with you is limited, usually to two or three months. If you can’t start paying during this time, they will hire a lawyer and pursue a judgment against you.

However, absent the right of setoff, the legal process of getting to your bank account now requires getting a judgment and then a writ of garnishment. This is an additional 2-3 months from when the start the process. In case you’re counting, you’ve just bought at least 4 to 6 months by not banking where you borrow (2-3 months of attempts to collect followed by 2 to 3 months of legal proceedings). Furthermore, since you will receive notice of the lawsuit when it begins, you can simply liquidate your bank account and start living on cash at that point.

Of course, if you are in this situation, they will likely seek to garnish your wages (if your state allows wage garnishment as they do in Colorado, where I practice). We cover this little gem in a separate blog post, the bottom of line of which is that you should definitely consult a bankruptcy lawyer to find out your rights. Heck, it doesn’t hurt to consult a bankruptcy attorney as soon as you find yourself missing loan payments.

So there it is – DON’T BANK WHERE YOU BORROW! Say it to yourself over and over, like a mantra. Tell it to your friends. For as God as your witness, you will never be cross-collateralized again!!