Article from Bankruptcy Law Network – by Eugene S. Melchionne
It has been said that “if you fail to prepare, you are preparing to fail“. (Ben Franklin) When anyone is first faced with any sort of financial problem, there are certain steps that most people (including “financial planners”) will recommend that you take. Here’s a shortlist of some of (mis-) steps that can land you into trouble. This is not the way to avoid bankruptcy. In fact, bankruptcy may not be such a bad choice at all, given the options.
1. Borrow funds from your 401K retirement plan. Somewhere the idea got started that if you are really in trouble, you can just take the money out of your retirement savings and then pay it back. (Oh yeah, the IRS says it’s OK.) The concept is that since you put the money there, you can borrow it and then pay it back over time with interest. Since you are only paying yourself back, it’s better than paying creditors. The real problem with this is that you are only trading one debt for another and if anything happens to your income, you will not be able to pay it back and now you have created a tax problem. That “borrowed” money becomes regular income and you have to pay taxes on your debt. But most importantly, you now have nothing saved up for retirement.
2. Refinance the house, take out the equity, and use it to pay bills. Luckily, the Great Recession has slowed this substantially and only sterling credit will get you a re-finance. Your house is not a piggy bank. The original idea of a mortgage was to allow low payments in order to buy a home. This is where you live and your mortgage is not rent. It is meant to pay off the loan so, at the end of the loan, you own your home.
3. Raise your deductions on your paycheck so your employer withholds less from your pay so you have more take-home income every week. The IRS frowns on this. But worse yet, while you may be generating money to pay off your debt, you are exposing yourself to a tax claim at the end of the year. Given a choice of who I want to owe money to, it would not be the IRS.
4. Borrow from friends or relatives. So your brother is somewhat successful and has cash in the bank or worse yet, access to a credit line that you can use to pay your bills. Some call this “credit lending” where one person agrees to lend their credit so you can borrow money, but I call it the Vampire Effect. You are sucking the financial life out of others around you.
5. Engaging a credit counseling company online who promises to get you out of debt for little or no money. There are strict licensing guidelines for legitimate credit counseling agencies, but the airwaves and the internet are filled with questionable companies who will charge up large upfront fees, take your money and disappear in the night leaving you with nothing but even bills than what you started with.
You can see why these will cause problems, but they are even larger if you are ultimately left with no choice but to file bankruptcy. Repayment of 401K loans is not a legitimate expense when calculating the means test numbers in a Chapter 7 case. That means you could be forced into a Chapter repayment plan, possibly for five years or worse yet, forced out of bankruptcy altogether. Most states and the federal government recognize an exemption for home equity meaning your home would not be at risk in a bankruptcy case, but if you have spent that equity, you must pay that mortgage even after bankruptcy or you could lose your home. It goes without saying that the IRS get preferential treatment even in bankruptcy cases and your tax problems will likely survive a bankruptcy. Repayments to friends and family are recoverable in bankruptcy so the “friendly” loans paid within the year before bankruptcy get unpaid. And finally, once a crook disappears with your money, it is near impossible to recover it.
If you are experiencing financial problems or you can see it coming down the road, it is always best to get proper qualified information before you do anything. Even if you don’t plan on filing for bankruptcy, it doesn’t hurt to speak to a good bankruptcy attorney to make sure you see the situation properly and aren’t going to cause yourself any issues if things later go wrong.
Carolyn Secor is a Clearwater bankruptcy attorney and Clearwater foreclosure attorney serving Palm Harbor, New Port Richey, Oldsmar, Tarpon Springs, Seminole, St. Petersburg, and the Tampa Bay area.