Many people are debtors, whether their payments are a mortgage, a car, home improvement loans, hospital bills, or credit cards. And Americans are carrying more credit card debt than ever before, according to the latest data from the 2019 Experian Consumer Credit Review.
Some debtors are so overwhelmed that they search out options. One of those they might not want to take is bankruptcy.
Bankruptcies were down in Kentucky the last couple of years, however, that may be changing due to inflation.
Rule change
In 2004 and 2005, bankruptcies were high due to an anticipated change in the bankruptcy code.
“There was so much misinformation,” said John Robinson, Shelbyville attorney who handles bankruptcy and personal injury at the Robinson Salyers law firm. “The bankruptcy code was amended in October 2005, and people thought they could no longer file after the code went into effect. That wasn’t true.”
Bankruptcy
Robinson noticed an uptick in Shelby County bankruptcy filings last year. In the past two years prior, he thinks filings were down because of government protections due to COVID-19 relief funds. Unpaid rent and mortgage payments were tacked onto the end of payments. “Those protections are waning, and there is an acute uptick,” he said.
Bankruptcies fall off credit reports in eight to 10 years, depending on the credit reporting agency.
Through bankruptcy, mortgages and car loans with high interest rates can be decreased. “For a $16,000 to $22,000 car loan, I can get the car payment under $400 a month,” Robinson said.
Types of personal bankruptcy
There are two types of personal bankruptcy: Chapter 7 and Chapter 13.
Chapter 7 is known as "straight bankruptcy." All the debtor’s property is liquidated to pay creditors unless they are exempt under federal law. After this process, the debtor exits bankruptcy with no debt.
Chapter 13 allows filers with a steady income to keep assets such as a mortgaged house or car, according to the American Bankruptcy Institute. After assessing the filer’s income and regular expenses, the bankruptcy trustee sets a fixed monthly payment the filer must pay, but after a certain number of years — typically two to five — the debtor owes nothing for bills included in the original filing.
Factors
According to the American Bankruptcy Institute, there are three main reasons for personal bankruptcy: job loss, medical bills, and divorce, however, the No. 1 reason may have changed last year due to inflation. Robinson explained that inflation is the top reason clients come to him now.
Inflation raises the price of nearly everything — food, utilities, clothing, supplies.
“Before, inflation pressures were offset by government policies due to the pandemic,” he said. “With so much government subsides, inflation is the result. There was extraordinary government assistance. Credit card interest rates are tied to government metrics.”
COVID assistance
The government allowed renters and mortgage payers to miss payments during the salad days of the pandemic, Robinson said. “They allowed people to miss mortgage payments, miss rent, not pay student loans, plus consumers and businesses have cash due to stimulus checks, but the government handouts are waning.”
Inflation is causing consumers to not be able to pay high interest rate credit cards.
“Cards average an interest rate of 20 percent — I think that’s highest on record — but not only does the amount accumulate, there is interest continually added to the balance,” Robinson said. The problem comes when the debtor cannot pay the interest.
Robinson emphasized that in an inflationary environment, every dollar counts.
Killer interest
An individual can pay $4,500 in interest alone on a balance, and a couple can pay $4,500 to $6,500.
“When the budget math doesn’t work anymore, bankruptcy is the most effective means to correct inflationary pressure on households,” Robinson said. “Bankruptcy is the most effective way to make household math work again. So many people, their budgets are on the wrong side of math because of high car loan installments, credit card payments, and higher energy, food, rent and mortgage rates.”
Medical debt
Robinson said he doesn’t see medical debt as the primary reason for bankruptcies on which he’s worked, although those bills are often a portion of the debt.
“A bankruptcy may include some medical debt and often does, but for 95 percent, that’s not the cause," he said. "It’s rare when medical debt causes the bankruptcy filing. It’s lawsuits and collections.”
Wages
Although wages are slightly higher on average, median income went down, according to Robinson.
“There are a lot fewer people in the workforce, but real wages are down and absolute wages are up,” he said. “That pushes people into Chapter 13, and when individual wages go up, that may push employees out of Chapter 7 eligibility.”
Lost income
Job loss was the most common reason debtors file for bankruptcy protection in years past. According to the institute, “This is fairly obvious, but many people still erroneously think that most people filing bankruptcy have simply lived beyond their means.”
Robinson disagrees.
“My clients are not lavish spenders, that’s not what brought them to my office,” Robinson said.
One of Robinson’s clients is a Shelby County resident who filed for Chapter 13 bankruptcy protection. He was willing to speak with The Sentinel-News, but asked to remain anonymous, so he is referred to as John Doe. “I don’t want the entire county knowing my business,” he said.
Falling behind
Doe suffered an injury and missed several months of work.
“I had no pay," he said. "I got behind, and I couldn’t work enough hours to get caught up. There weren’t enough hours in the week."
He missed three months of mortgage payments. He also carried an auto loan and medical bills.
“Three months, that’s when they [the bank] get ready to foreclose,” he said, but he didn’t want to file Chapter 7, which wipes all the debt out. “It was my fault, so I didn’t want to do Chapter 7.”
Doe filed Chapter 13, which consolidated bills he owed into one manageable monthly payment.
Process
Bankruptcy starts with a means test — how much income the filer brings home.
Bankruptcies are heard in federal court, and Jones said the federal trustee pulled his credit report to know what he owed. The trustee factors in how much a filer brings home, plus the cost of groceries, fuel, car insurance, etc., to determine a payment.
“They added all the debt up, plus my auto loan, and came up with a payment,” Doe said. “They take that payment out of my checking account every month for three years.”
After three years he doesn’t owe anything more to creditors.
“They don’t make the monthly payment something you can’t afford. They reduced the amount owed and cut the interest rate out.”
All is not lost
Most filers think they won’t be able to get credit for a car loan after bankruptcy, but that isn’t so, Robinson said.
“Many credit scores improve within 12 months of filing. Their credit scores are likely to improve over 100 points because they don’t have debt.”
“Credit is a function of debt to income,” Robinson said. “It’s critical to understand that bankruptcy doesn’t mean you can’t get credit. It’s far from a death blow to credit. It’s normal for clients to get car loans and be eligible for credit cards within months of filing, but I don’t encourage them to jump into credit immediately.”
Doe didn’t want a credit card after bankruptcy, but he did need a dependable vehicle, so he got a loan for a used pickup.
“I had no problem getting a loan, but it was about 6 points higher than if I hadn’t done a bankruptcy,” however, his credit score rose.
Down payment saves interest
Cash is king, so Robinson encourages clients to save cash for a down payment on a car loan or house.
“Debt-to-income determines interest rates, but be careful," he said. "Like mortgages, most car loans are sold on the secondary market to larger lenders. I tell clients not to let car lots use bankruptcy as an excuse to add a higher interest rate. That’s why it’s important to have a down payment.”
Advice
Doe said if you’re in a similar situation and loss of income lands you behind in payments, look at what you worked for.
“I didn’t want to file — no one wants to file, but nobody wants to lose what they’re worked for," he said. "It’s either file or lose what you worked for when what you owe is beyond your control.”
He also said not to be ashamed.
“It isn’t a stigma. I had reservations and I thought bankruptcy would ruin me, but it didn’t at all.”