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While it's possible to plan your finances to weather the worst life can throw at you, COVID-19 has shown us that even the best strategies can fall short. Many people, even those who had been financially comfortable, are now wondering how they will pay their bills.
In a recent Experian survey, 63% of respondents said they are now more worried about their personal finances than they were before the crisis began. When there isn't enough money to go around, bankruptcy may seem like the best or only option.
Take heart, though. Options do exist, and you can avoid bankruptcy in many cases. Here's what you need to know about dealing with debt during this pandemic—and beyond.
Can You Meet Your Payments?
This is the first question you need to ask yourself, and the answer will bring you clarity on your next steps. Anxiety about your debt and bill payment obligations isn't enough of a reason to start the bankruptcy process.
First, determine whether you have the capacity to keep your accounts in good standing now and in the coming months. To find out, follow these four steps:
- List your monthly net income. This can be money you receive from a job, unemployment insurance or any other dependable source of income. Make sure to count your net income, which is what's deposited into your bank account after all taxes and other deductions are removed.
- Tally and subtract your expenses. Add up all of your monthly bills and necessities, such as food, housing and utilities. Subtract the total of those expenses from your net income to identify the amount you have remaining for your debt obligations.
- List your debts and payments. Now turn to your debt, which may include loans and credit cards. List each account, along with the minimum payment required each month to keep the account in good standing. Add up all the minimum payments on your accounts to get your minimum overall monthly debt payment obligation.
- Subtract your total monthly debt payment amount. Subtract this amount from your remaining monthly income (after necessary expenses). If you have enough to maintain at least minimum payments, you can breathe a sigh of relief. Cash may be tighter than normal, but bankruptcy can be off the table for now.
On the other hand, if you do not have enough money to cover all your minimum debt payments, explore actions you can take and how quickly they can be accomplished:
- Pare down to essentials. Revisit your expenses and look for ways to reduce your spending. Be realistic. If you've been spending $1,000 on groceries per month for a family of four by scouring for the best deals, odds are you can't slash that number in half. Cutting your entertainment purchases, however, may be a doable option.
- Consider alternative income opportunities. Even now, there may be a way to bring more money into the picture. You may sell things from around your home or take on part-time, gig or freelance work to add to your income.
- Determine whether this is a short- or long-term setback. You may not be able to adjust your income and expenses, so project into the future. If you believe your finances will improve within six months to a year, you may be able to implement other strategies to stay afloat. If it really is a permanent deficit, more extreme measures might be necessary.
The Downsides to Going Bankrupt
Due to the toll it takes on finances, credit and potentially your assets, bankruptcy should be considered only as a last resort. Having a bankruptcy on your credit report will make it much harder to borrow money in the future and could compromise your future goals, such as buying a house or starting a business.
There are two common types of bankruptcies available for consumers to file: Chapter 7 and Chapter 13. Both can help to relieve your debt and prevent things like foreclosure, utility shut-offs and wage garnishment. They do, however, address your debt in different ways, and have their own requirements and consequences. Here's what you should know.
Chapter 7 bankruptcy, otherwise known as liquidation bankruptcy, could result in the loss of personal property, including cars, houses and electronics. Certain types of property are protected (including your retirement savings and, possibly, your home) and you'll be allowed to keep property up to a certain value limit. Anything beyond that may be seized and sold to repay your creditors. This type of bankruptcy can forgive eligible unsecured debts, including credit card bills, unsecured loans, and collection accounts. Debts that may not be forgiven include outstanding mortgages, car loans, student loans, recent tax obligations and back child support payments.
Requirements and consequences:
- Your income must be below a certain amount. If the amount of money you earn exceeds the median income for your state and you have enough to pay both your necessary monthly expenses and your debts, the bankruptcy may be denied.
- You could lose property. Each state has its own exemption lists, which spells out the things you get to keep if you discharge your debt. Nonexempt assets are subject to liquidation, meaning you'd have to give them up to pay those you owe. This may result in you having to forfeit a second car or a special piece of family heirloom jewelry, for example.
- Long-lasting and severe credit damage. Chapter 7 bankruptcy will be listed on your credit reports for 10 years, during which time it will have a negative effect on your credit scores. A past bankruptcy may cause a lender to charge you higher interest rates or refuse your application altogether.
The other type of bankruptcy available to individuals is Chapter 13, which allows you to work out a plan with your creditors to pay at least a portion of your unsecured debts and potentially keep your property.
A Chapter 13 bankruptcy plan will have you make smaller-than-normal debt payments over three to five years. If any unsecured debt remains at the end of the bankruptcy, it may be discharged. You may be able to stop foreclosure proceedings, though you do have to make all your mortgage payments in full and on time. Your arrangement may reschedule secured debts such as a car loan to lower payments and make them easier to manage.
Requirements and consequences:
- You need an income. If you're not working—or your income is too low or inconsistent—this option will not be available to you.
- You could be forced into a tight budget. Your creditors will be paid from what the court determines is disposable income. That means you may be required to stop spending on things you consider important.
- Long-lasting and severe credit damage. Chapter 7 bankruptcy remains on your credit reports for seven years from the filing date. Even if it allows you to repay a percentage of your debts, a bankruptcy on your credit reports will have a significant negative effect on your credit scores for as long as it appears.
Alternatives to Filing Bankruptcy
If you worry either type of bankruptcy may be in your future, and reducing expenses and adding income isn't giving you enough extra money to cover your debt obligations, now is the time to explore your alternatives and any available relief options. Here are a few strategies that may help you avoid filing:
- Put major payments on hold. To help address the economic strain caused by the COVID-19 outbreak, the federal government has stepped in to enact the Coronavirus Aid, Relief and Economic Security (CARES) Act. Among the new law's provisions are expanded protections for homeowners with federally backed mortgages. If you don't think you'll be able to meet your home mortgage payments, contact your lender. You may be eligible for a forbearance plan, which can reduce or suspend your payments for up to 12 months. Federal student loan payments have also been suspended until September 30, 2020. Without having to pay these large monthly obligations, you may be able to meet your other expenses.
- Look into expense breaks. Local governments are also helping people make ends meet right now. Visit your state, county or city website to find out about options you have that may help you lower your necessary bills. For example, in response to the COVID-19 outbreak, utility providers and communications companies in California have enacted provisions such as payment assistance programs as well as discounts on service. Find out what you can get in your state, and then apply. Every little break counts.
- Consider a hardship program. If you can't pay the minimum to your credit card accounts or loans, contact your lenders directly and ask if they can work something out with you. As required by the CARES Act, an accommodation where you pay less than the normal payment for a period of time will not cause your consumer credit scores to go down. Many credit card companies are assisting their customers right now, so don't delay.
- Enter into a debt management plan. Nonprofit credit counseling agencies help consumers repay their credit card debts. Counseling consultations are free, and include a detailed review of your income, assets, expenses and liabilities. Your counselor will work with you to develop a plan based on your needs and goals.
If a debt management plan (DMP) makes sense, it will be presented as a sound option against bankruptcy. DMPs are arranged so you can be free of much of your debt in no more than five years (though not all types of debt are covered). With DMPs, you make one payment to the agency and they distribute the funds to your accounts. Credit counselors can sometimes negotiate lower interest or a lower payoff amount, though paying less than the full amount owed could hurt your credit. Find a member agency though the National Foundation for Credit Counseling or the Financial Counseling Association of America.
- Look into the Paycheck Protection Program. If you're a small business owner, you may be eligible for a special loan that's backed by the Small Business Administration, as part of the CARES Act. With it you could have eight weeks of cash-flow assistance. It's intended to cover payroll expenses as well as the additional amount you need to make your debt payments.
- Get help from friends and relatives. If members of your family or close friends are in a better financial position than you are, this may be the time to turn to them for assistance. They may agree to lend or even gift you enough money to get by. If you borrow money from family members or friends, be sure to document the agreement, noting your repayment plan and any interest.
- Borrow against your home equity. If you've amassed a substantial amount of equity in your home, you may also consider using it to help you stay afloat. A home equity line of credit (HELOC) could give you access to up to 85% of your home's appraised value, at a low interest rate. You can use that money to pay your bills until you get back on your feet. Just keep in mind that you could lose your home if you can't keep up with equity payments.
- Tap into your retirement account. When finances are tight, taking money out of your retirement savings can be a tempting way to bridge the shortfall. Under normal circumstances there is an early withdrawal penalty of 10% of what you take out before the age of 59½, but if your financial hardship is related to the pandemic, the CARES Act waives that penalty. You may be hit with a higher tax bill, though, and withdrawing retirement savings can reduce the amount of money you have for your retirement years. That's why you should only consider this step if bankruptcy seems like the only other option.
Bankruptcy: A Financial Last Resort
In the end, the best way to think about whether bankruptcy makes sense is if there are no other reasonable alternatives to pursue. By running the numbers and exploring feasible options, your best course of action should soon become evident. Filing for bankruptcy is a serious decision that has long-term financial and credit implications. You'll want to look ahead and decide if future sacrifices are worth the immediate relief.
In the event that bankruptcy seems like it really may help, make an appointment at a credit counseling agency that offers bankruptcy education and counseling programs. They will guide you to an appropriate decision, without judgment or excess cost.