Chapter 7, Chapter 13  or debt settlement? Client with $40K in credit card debt examines the differences

THE client is 42 and is going through a divorce. It was a short two-year marriage. He has moved out of the marital home and now lives by himself. He has a toddler who is with his wife, so he expects to pay child support. There is not alimony because the marriage has not lasted 10 years. So, if you are the higher income spouse and wondering why your spouse has not filed for divorce despite all of your philandering, it’s because in California you need to be married at least for a decade to claim alimony  or spousal support from the higher income spouse. 

In fact, I do have a client who was hit with divorce papers right after the ten-year period was reached, and being the higher income spouse, he has to pay $1,500 of alimony to his wife. We had to reorganize his financial affairs under Chapter 13 to handle $60K of credit cards, and to strip off $100,000 of 2nd trust deed. It is unusual nowadays to be able to strip junior liens because of the soaring prices of houses in Southern California. But in his case, a current appraisal report showed that his house was at least $10,000 under water after considering the balance of the first trust deed. His house had a fair market value of $220,000 while the balance owed on the first trust deed is $230,000, leaving the 2nd trust deed, a HELOC line , of $100,000 completely unsecured. 

Let’s go back to the client with the short-lived marriage. He left his wife a year ago and has not paid $40,000 of credit cards since then. He asks me what he can do to handle the $40,000 debt because his creditors have started to threaten lawsuits. After interviewing him, I determined that his was a classic Chapter 7 case. So I advised him to file for Chapter 7 to get a fresh start in life without the $40,000 of credit card debt. In Chapter 7, the court will discharge the entire $40,000, i.e., he doesn’t have to pay them at all. Here, the law gives him a chance to start all over again, without the burden of accumulated debt so he can become productive again. $40,000 requires him a minimum payment of $1,200 a month. 

But obviously, he hasn’t paid the cards anymore for the last 12 months since he left the marital home. So now that he is getting demand letters to pay, he is looking at the possibility of wage garnishments on the horizon. His income is a gross of $3,500 a month. Even for a single person, his gross income is below median for California. In California, a single person without any dependent living with him or her earning a gross of less than $4,000 a month is eligible for Chapter 7 under the means test. Of course, a single person making a gross of more than $4,000 a month, can still qualify for Chapter 7 under different circumstances. But for this client, we do not have to bother with other circumstances because $3,500 is less than $4,000, which is the applicable threshold. Since it’s below the threshold, the means test will conclude that there is no presumption of abuse for this client to file for Chapter 7. The presumption of abuse, if it arises, presents a major obstacle to a successful Chapter 7, although this is not to say that the obstacle cannot be overcome. We don’t want that kind of situation as much as possible.

There is no problem regarding house-ownership as client never owned one. If there was an issue regarding house-ownership with non-exempt equity, the preferred filing for debt relief would be Chapter 13, not 7. Client said that he was worried that he could not get new credit after filing but admitted that his current credit score was below 500. I informed him that with Chapter 7, he would be getting new pre-approved credit cards within months of discharge from banks and lenders that specialize in issuing cards to debtors who have just filed for bankruptcy under Chapter 7. These would have annual fees and higher interest than normal cards. And buying a car can be done immediately after discharge but interest rate would also be higher than for one with good credit. With Chapter 7 discharge, his credit score would increase pretty fast. It would go to 500 on filing and increase to 580 in one year. On year two, his credit score would be 620. On year 5 to 7, his credit score, if he handled new debt timely, would reach and surpass 700 which is very good. And on year 10, the fact of Chapter 7 filing would disappear from the credit report. On year 3, he can qualify to buy a house at higher interest assuming he handled new credit well. So, 

getting new credit after bankruptcy is no problem. I suggested to him, that new credit card use should be paid in full at the end of the month, so it doesn’t become bigger and bigger and go out of control. Further, he can get credit cards at Walmart, Visa or Mastercard, where the credit limit is set by the cash deposit on the account if he wants credit cards immediately for whatever reason. 

An alternative to Chapter 7 is Chapter 13, which I suggested he could use if he for some reason wanted to pay a portion of the $40,000. I don’t suggest a Chapter 13, if you qualify for 7 because it makes absolutely no sense to do so. He felt guilty I think, about discharging the entire $40,000 in Chapter 7. Credit card companies factor in their cost of bad debt between 7-10 percent. In other words, they expect that between 7 percent to 10 percent of their card users will not be able to pay them back anything so that cost is already added to the interest everyone pays. They don’t really lose money on unpaid credit card debt. They just write them off as bad debt and sell the account to third parties at a fraction of the outstanding debt. I informed him that he may pay between $150 to $300 in Chapter 13 for 36 to 60 months. So Chapter 13 costs $18,000 at $300 a month for 60 months. Then, if he completes 60 payments, the court will discharge $22,000. On this point alone, Chapter 13 will cost $18,000 more than Chapter 7 which costs zero.

Another alternative is debt settlement. This does not have a bankruptcy filing. Attempts to settle the $40,000  are made. Let’s just say the rule of thumb is that creditors will agree to cut the $40,000 by half for a lump sum payment to be made within 48 hours. In this situation, debtor has to have ready at least $20,000 for settlement. This is $20,000 more than Chapter 7, and inferior to Chapter 13 because Chapter 13 allows a five-year repayment plan supervised by the court.

The last alternative is just do nothing and change your phone number. The problem with this is that creditors are apt to file lawsuits and will get a judgment that will result in wage garnishments in due time. In this situation, your credit score has no chance of improving within your lifetime, and you live in the constant fear that your payroll department will receive a wage garnishment notice, or your bank will receive a notice of levy on your bank account. Can you imagine even if half of the $40,000 got wage garnishments and bank levies? Client would have nothing left to pay rent and food! Why live like a rat under the sewer when you can start fresh without accumulated debt and benefit from rapid increase in your credit score if you handle your new credit right? 

Walt Disney filed for Chapter 7 twice, yet Disney is now a billion dollar business worldwide. So, this is something good, not bad. You have to change the way you think about debt and opt for the most expeditious and simple way of getting fresh start in life without accumulated debt. Maybe you’re smarter than Mr. Disney and Chapter 7 may pave your way to being the next American below 50. Who knows? But certainly if you have accumulated debt that is not discharged, life will be very difficult for you and your family, and you will not get a fresh start in life.

If you need debt relief, set an appointment to see me. I will analyze your case personally.

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Lawrence Bautista Yang specializes in bankruptcy, business, real estate and civil litigation and has successfully represented more than five thousand clients in California.  Please call Angie, Barbara or Jess at (626) 284-1142 for an appointment at 1000 S. Fremont Ave, Mailstop 58, Building A-1 Suite 1125, Alhambra, CA 91803 or at 20274 Carrey Road, Walnut, CA 91789.

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