Here’s How a Bankruptcy Works

money1This is off-topic, but I thought it was worth blogging about. I had a close family member file Chapter 7 bankruptcy in August of 2008 and the process reached a closing point on March 17. I’ll describe it a little bit and give some perspective. Hopefully you’re not in a position where you’re considering one of these, but if you are, here’s the skinny. Don’t go filing a bankruptcy without consulting an expert first.

We’ll call my family member Bill. Here are the factors that led to Bill going bankrupt:

  • $60k consumer debt (various credit cards) for something like $800/month minimum payment.
  • $160k mortgage for a house that’s worth $145. At the peak of the real estate boom the house was worth $180k and obviously it has since plummeted.
  • Negative amortization payments on the house. What that means is the monthly payment doesn’t quite cover the interest and the remaining interest gets capitalized. There’s a limit (120% of original mortgage amount) to how long you can do a negative am payment schedule, and Bill is 3-4 months away from hitting that limit. After that, the minimum payment goes up something like $350/month for an interest only payment.
  • $32,000 annual income with no chance of increase.

These numbers aren’t exact, but you get a pretty good idea. As you can see, Bill’s finances are a wreck and his budget is stretched hopelessly thin. Bill described the burden as “crushing.” Bill was at a point where he was borrowing from one credit card to pay the other ones.

Since I’m Internet savvy and Bill isn’t, Bill asked me to do a bunch of research and find out what the deal is on bankruptcies and also find some lawyers in our city. I got a list of names and called each one to get pricing. They all offered free consultations and most of them (75%) gave pricing over the phone. One guy told me that he wasn’t legally allowed to give pricing over the phone, which of course is complete bullshit. The costs included lawyer’s fees, filing the petition, and pre-filing and post-filing credit counseling services.

Total for all that was just over $2000 for the lawyer Bill chose. I did find a lawyer who quoted $1600 for the whole deal but we opted not to go with that guy.

The Consultation

I attended the free lawyer consultation with Bill. It took just over an hour and was generally informative. Basically, the lawyer asked a bunch of questions about Bill’s finances and made a determination on whether he qualified for chapter 7 bankruptcy. Bill did indeed qualify. The lawyer also made suggestions about what to do with the house and the car, both of which can either be surrendered or kept (affirmed), depending on your situation. Since Bill was current on payments on the house and car, Bill decided to keep both.

The lawyer instructed Bill to do two things:

  1. Stop making payments on all credit cards, but stay current on the house and car.
  2. Since Bill had automatic payments coming from various creditors, and it would be difficult to remove the automatic payments, Bill was instructed to close his accounts and simply open accounts at a new bank.

Interestingly, our lawyer tried to pitch us on these vitamins he was hawking as a side business. This was a huge red flag and should have sent us heading out the door, but it didn’t. Watch out for sketchy lawyers!

At the end of the meeting the lawyer asked Bill to write a check to get started. The lawyer accepted payments, so Bill wrote a check for $1000. Later, I did a little research and found some lawyers willing to accept payments of as little as $200.

Filling Out Paperwork

The process for the filer is also straightforward and surprisingly simple. You fill out paperwork and basically list the value of everything you own, your assets, debts and creditors, and all the other details of your financial life. Since Bill didn’t have any investments or complicated finances, this was a cinch. You have to provide tax returns, bank statements, paycheck stubs, etc. Expect to spend several hours doing this, especially if you don’t keep your documents well organized.

Online Credit Counseling

Bill also had to do an online credit counseling course, which covered the basics of bankruptcies and balancing your budget. It took about 2 hours and cost $35. Bill and I did the online class on my laptop and it wasn’t too bad. At the end you print up a certificate and deliver this to your lawyer. The course Bill used was at this website.

After Bill’s petition was filed, he was also required to take a pre-discharge course that delved more into personal finance and how to be smart with money. Again, we used my laptop and I thought the class wasn’t too bad. Cost was $25.

Lengthy Process

The whole bankruptcy process took Bill 7 months and there were two reasons why it took so long. First, Bill’s lawyer wouldn’t do anything until he was paid in full, which was difficult since Bill was broke. Secondly, communication with the lawyer took forever. Bill would leave messages and write emails and it would take 1-2 weeks to get an answer. Except for the initial consultation, he rarely communicated directly with the attorney, instead working through a paralegal.

I’m convinced this whole process can be done relatively quickly, like maybe in 2-3 months if you’re organized and have the cash ready. Of course, the ironic thing is bankruptcies are difficult to afford if you’re in a financial situation that caused a bankruptcy in the first place!

The Hassle

At some point in this process you’re going to stop making payments to your creditors, possibly before you start the bankruptcy process, and once that happens you’re going to get deluged with mail and phone calls. Bill was getting upwards of 30 phone calls per day, from 8:00 am to 9:00 pm, from debt collectors and credit card companies. The ringing phone and constant hassle was a huge source of stress for Bill and this went on for seven months. After Bill paid the lawyer in full, the lawyer sent letters to the creditors stating that he was filing Chapter 7 and that they were to cease debt collection activities. At this point the phone calls stopped.

Bill’s lawyer wouldn’t send the letters until he was paid, which sucked, but I asked around and I do know that some lawyers will send out the letters first thing even if you’re making payments. If you’re searching for a bankruptcy lawyer, I would absolutely make this a requirement.

I wasn’t aware of this until now, but apparently you can tell debt collectors to stop contacting you at any point by writing a letter. See this FAQ from the Federal Trade Commission on how to do that. The FAQ is very informative and a definite must-read it if you’ve got debt issues.

The Trustee Meeting

The turning point of the bankruptcy process comes when you meet with the bankruptcy trustee…the trustee is a Department of Justice employee who is basically a watchdog over the bankruptcy process. I attended the meeting with Bill for moral support. The meeting was very laid back…it takes place in a meeting room (not a courtroom) and lasts no more than 5′ if you have everything in order. You are accompanied by your lawyer at this point. The trustee swears you in and asks around 10 questions. Sample questions: “Have you received your 2008 tax return?” “Do you anticipate receiving an inheritance any time in the near future?” “Are you currently employed?” They’re all yes/no questions. The meeting is also open to the public and you can expect an audience if it’s a busy day. Which leads me to this…

…it was a busy day. Bankruptcy lawyers must be doing pretty well because there was a line down the hall for people waiting for their trustee meetings. The line was so long, in fact, that Bill’s meeting got delayed by a solid two hours.

There are a lot of people going bankrupt these days, from all walks of life, and seeing that part of the process kind of sucked. There were a lot of regular Americans who made mistakes, failed in their dream business, had bad luck, or just plain couldn’t afford to pay their bills.

After the trustee meeting, it takes several weeks for the debts to get discharged. Bill was super relieved after the meeting.

Thanks for reading, now back to our regularly scheduled dirty sex posts.

Takeaways

  1. Get a reference or read online reviews about the bankruptcy lawyers you are considering. They are not all created equal. Look for one with personalized service and insist on getting those letters mailed out first thing.
  2. It’s possible to do a bankruptcy yourself and avoid the hefty attorney fees. There were three individuals waiting in line who did this on the day that Bill met with his trustee and all three had no problems. Obviously, it’s complicated, but the option is there. I would say the difficulty level is roughly the same as purchasing a house without a realtor. I found this article on eHow outlining the process.

Other Resources:

  1. Understanding the Bankruptcy Rules
  2. Bankruptcy Basics
  3. I Will Teach You To Be Rich – Ramit Sethi’s Personal Finance Blog
  • http://dadshouseblog.com dadshouse

    Informative post. I hope I never have to use the information here. But I think it’s great you are sharing it with people who may need it.

    Will you be hawking vitamins on the side anytime soon?

    dadshouse´s last blog post…Men’s Playground

  • http://www.thedateabledork.com The Dateable Dork

    Eek. This is all very scary. I have a handful of friends who have recently been laid off, and there doesn’t seem to be any end in sight. I will officially be sitting on my humble little nestegg until the craziness subsides.

    The Dateable Dork´s last blog post…My ultimate sexual fantasy: the Lance-DD-EA threesome

  • http://casualencounters.com/blog/ Janak

    I feel so sorry for those guys. I’ve known some people whom it happened to as well; subcontractors who were left holding the can when a development deal collapsed.

    Some people see it as a kind of stigma that you carry around forever, but really it’s just one of those “shit happens” scenarios. It’s best to just take it on the chin and rock on.

    Janak´s last blog post…How to Find Sex: the Art of the One Night Stand – Part 19 “Potential Problems”