Clear That Credit-Killing Debt!
A Comprehensive Guide to Credit Card, Student Loan & Mortgage Debt
What Is Credit Debt?
Simply put: Debt is that which is owed; usually referencing assets owed, but the term can also cover moral obligations and other interactions not requiring money. In the case of assets, debt is a means of using future purchasing power in the present before a summation has been earned. Some companies and corporations use debt as a part of their overall corporate finance strategy.
A debt is created when a creditor agrees to lend a sum of assets to a debtor. In modern society, debt is usually granted with expected repayment; in most cases, plus interest.
Types of debt
A company uses various kinds of debt to finance its operations. The various types of debt can generally be categorized into: 1) secured and unsecured debt, 2) private and public debt, 3) syndicated and bilateral debt, and 4) other types of debt that display one or more of the characteristics noted above.
A Debt Obligation
A debt obligation is considered secured if creditors have recourse to the assets of the company on a proprietary basis or otherwise ahead of general claims against the company. Unsecured debt comprises financial obligations, where creditors do not have recourse to the assets of the borrower to satisfy their claims.
Private debt comprises bank-loan type obligations, whether senior or mezzanine. Public debt is a general definition covering all financial instruments that are freely tradable on a public exchange or over the counter, with few if any restrictions.
A Basic Loan
A basic loan is the simplest form of debt. It consists of an agreement to lend a principal sum for a fixed period of time, to be repaid by a certain date. In commercial loans interest, calculated as a percentage of the principal sum per year, will also have to be paid by that date.
In some loans, the amount actually loaned to the debtor is less than the principal sum to be repaid; the additional principal has the same economic effect as a higher interest rate (see point (mortgage)), and is sometimes referred to as a banker’s dozen, a play on “baker’s dozen” – owe twelve (a dozen), receive a loan of eleven (a banker’s dozen).
A syndicated loan is a loan that is granted to companies that wish to borrow more money than any single lender is prepared to risk in a single loan, usually many millions of dollars. In such a case, a syndicate of banks can each agree to put forward a portion of the principal sum. Loan syndication is a risk management tool that allows the lead banks underwriting the debt to reduce their risk and free up lending capacity.
A bond is a debt security issued by certain institutions such as companies and governments. A bond entitles the holder to repayment of the principal sum, plus interest. Bonds are issued to investors in a marketplace when an institution wishes to borrow money. Bonds have a fixed lifetime, usually a number of years; with long-term bonds, lasting over 30 years, being less common.
At the end of the bond’s life the money should be repaid in full. Interest may be added to the end payment, or can be paid in regular installments (known as coupons) during the life of the bond. Bonds may be traded in the bond markets, and are widely used as relatively safe investments in comparison to equity.
Debt is not inherently a bad thing. Credit and debt allows people and organizations to do things that they would otherwise not be able, or allowed, to do. Commonly, people in industrialized nations use it to purchase houses, cars and many other things too expensive to buy with cash on hand. Companies also use debt in many ways to leverage the investment made in their assets, “leveraging” the return on their equity.
This leverage, the proportion of debt to equity, is considered important in determining the riskiness of an investment; the more debt per equity, the riskier. For both companies and individuals, this increased risk can lead to poor results, as the cost of servicing the debt can grow beyond the ability to pay due to either external events or internal difficulties.
Excesses in debt accumulation have been blamed for exacerbating economic problems. For example, prior to the beginning of the Great Depression debt/GDP ratio was very high. Economic agents were heavily indebted. This excess of debt, equivalent to excessive expectations on future returns, accompanied asset bubbles on the stock markets.
When expectations corrected, deflation and a credit crunch followed. Deflation effectively made debt more expensive and, as Fisher explained, this reinforced deflation again, because, in order to reduce their debt level, economic agents reduced their consumption and investment. The reduction in demand reduced business activity and caused further unemployment. In a more direct sense, more bankruptcies also occurred due both to increased debt cost caused by deflation and the reduced demand.
It is possible for some organizations to enter into alternative types of borrowing and repayment arrangements which will not result in bankruptcy. For example, companies can sometimes convert debt that they owe into equity in themselves. In this case, the creditor hopes to regain something equivalent to the debt and interest in the form of dividends and capital gains of the borrower. The “repayments” are therefore proportional to what the borrower earns and so cannot in themselves cause bankruptcy. Once debt is converted in this way, it is no longer known as debt.
Credit Card Debt
This one subject is on millions of peoples’ minds these days. Credit card is the single most notorious form of credit debt that haunts people for years. Credit card debt is infamous because the interest rates are generally higher and the companies are generally less forgiving than any other type of loans and lenders. These days you can consider yourself lucky if you have under $10,000 in credit card debt, blessed if you have less than $5,000 and people with no credit card debt at all are a dying breed!
Credit card debt is extremely stressful and it can take over your life but it’s not insurmountable. Before you get consumed by the seemingly endless torrent of bill collector calls and fruitless interest payments, consider some of the many options that you have to take care of credit card debt. It’s important to tackle credit card debt with the right order of operations. Start with simple tactics like snowflake payments and then move onto risker ones like loans. Bankruptcy should be your last-ditch effort when all else has failed but it is certainly the best and sometimes the only option for some people. The Bankruptcy Facts chapter is entirely dedicated to bankruptcy information.
How To Prevent Credit Card Debt
Let’s start with the preventative measures. This may be a moot point to you since you purchased this book but you can keep these in mind for the future and make sure your family and friends are aware as well.
Don’t Get A Credit Card
This is pretty simple and straight forward. If you don’t think you can handle the responsibility of a credit card then just don’t get one! There are other ways to attain credit without having a credit card. You can focus on paying your standard bills on time or paying off a car loan. As an alternative to owning a card you could get a joint credit card with someone else and let them manage the card.
Pay As You Go
Don’t use your credit card to buy things that you can’t afford so you can slowly pay them off later. This is pointless because you end up paying way more for the item anyway. Only use your credit card to build credit: buy things you can afford and pay off the balance immediately. If you can’t afford something you want, make yourself a “payment” to your savings account every paycheck until you have the money and pay for it outright.
Get A Card With Strict Limits
If you’re absolutely worried that you will just “need” a credit card for an emergency, find one that has a very small credit limit and a very low interest rate. Often times your bank will offer a card through their company; these are sometimes (but not always) better than going through a major company like Visa or Mastercard. A good place to start would be a credit card with a $300 limit; that’s a reasonable amount of money for an emergency. More important than the limit is the interest rate; don’t even bother getting a card with a high interest rate, regardless of the credit limit.
Pay What You Really Can Afford
If you are making payments on a credit card debt, do not pay the minimum payment unless that is truly all you can afford. Pay as much as you possibly can every time so that you can get rid of the debt as soon as possible. The minimum payment usually only covers your interest so these payments are COMPLETELY USELESS. You could pay the minimum payment for 500 years and if it never touches the principle balance, your debt is never gone. Sometimes this might mean sacrificing to save enough money to pay the debt. If you can handle eating peanut-butter sandwiches and riding your bike to work for a week so that you can pay off a credit card debt, you will ultimately not regret it. Better to live far below your means for a week than to have your entire financial situation ripped apart by the ever-hungry credit card debt storm. Sell your appliances, shine some shoes, work overtime, whatever it takes. Do not let your credit card balance sit for any longer than 6 months (Don’t even let it get that far if you can help it).
Getting Rid of Credit Card Debt
Now this is the section that I’m sure everyone will have their eyes glued to. Getting rid of credit card debt is one of the most sought-after accomplishments of any individual in today’s society. Luckily there are a lot of options for people to get rid of their debt. The tried a true method that works every time is to simply pay them off as soon as possible.
Make Cut Backs To Increase Income
You’ve got to pay off the debt, that’s just how it goes. But, as you may have read earlier, just paying the minimum payment is pretty useless. If the minimum is all you seem to be able to afford, consider making some cut backs in your life until your debt is clear. You can do the following:
Take public transit or ride a bike to work
Cancel your cable/telephone/internet service. Just keep what you absolutely need. (Select the lowest speed internet and limit yourself to 1 cell phone for example.)
Stop being picky about your brand of food. Debt is quite a bit more serious than your morning breakfast cereal preference; get the cheapest!
Learn to drink water. If you’re in the U.S. you have no excuse not to drink tap water. You can save thousands on drinks every year by drinking tap water or even making drinks like tea, coffee and drink mix (koolaid).
Cut your Utilities Down. Use evaporative coolers in the summer and blankets in the winter. AC’s and Heaters really drive up electricity costs.
Try Snowball Payments
The primary way of getting past your credit card debt is to pay off your smallest balances first so. If you have a $1000 credit card to pay for an a $3000 card as well, pay off the $1000 first so that you can get it out of the way and use the money you were paying on it for the next one. Work up from smallest to largest until all of your debts are paid off. This is the best thing to do because it ultimately keeps your costs down.
Let’s say you go the opposite and pay off your high-dollar debts first. It will take you substantially longer to pay off a $10,000 debt than a $1,000 debt. By the time you actually pay off the $10,000 debt the $1,000 may be almost the same amount! The $1,000 debt can be paid of fairly quickly and by the time your down with it, the larger debt has not increased nearly as drastically. Instead of having a net cost of around $20,000 to pay off all your debts you will have closer to a $13,000 cost (depending on interest rates, these are just examples).
This sounds similar but is somewhat different than the previous method. Making snowflake payments means that you pay small amounts of money whenever you have a little extra. These could be ridiculously small payments like $1.45 or $7.34. If you do this whenever you find/have a little extra money you’ll find that they add up faster than you’d think. You’re not going to pay off an entire debt with snowflake payments but you could significantly reduce the time it takes to pay the debt off.
Direct Loans and Federal Family Education Loans – FFEL
Direct Loans and Federal Family Education Loans (FFEL) are the two largest government federal loan programs. FFELs are guaranteed loans made by private lenders. That means the government reimburses the lender when borrowers default, or otherwise fail to pay back the loan. Before getting reimbursed, lenders are required to make certain efforts to collect the loans.
Congress passed legislation in March 2010 that ends the FFEL program. After June 30, 2010, no new student loans will be made under the FFEL program. The Perkins loan program is not affected by this new legislation. The department of education advises students who have previously received a federal student loan from a private lender under the FFEL program to complete a new promissory note to receive loans under the direct loan program. The department advises borrowers to check with their school financial aid offices for more information.
Federal Student Loan Amounts and Terms for 2010-2011
Stafford loans are for undergraduate, graduate and professional students enrolled at least half-time. As of July 1, 2010, Federal Stafford Loans are made to students only through the Direct Loan program. Stafford loans may be subsidized or unsubsidized. A subsidized loan is awarded on the basis of financial need and the government pays the interest before repayment begins or during authorized periods of deferment. Unsubsidized loans are not awarded on the basis of financial need, and borrowers are responsible for all interest. Interest payments are usually deferred while the borrower is in school, but is added to the principal of the loan (capitalized) when repayment begins. Borrowers can choose to pay interest while in school or during an authorized period of deferment to avoid capitalization.
For loans first disbursed on or after July 1, 2006, Stafford loans have a fixed 6.8% interest rate. This is the maximum interest rate. Lenders can set lower rates. Most Stafford loans taken out before July 2006 have variable rates that are capped at 8.25%.
Interest rates will gradually be reduced for new Stafford subsidized loans over the next few years. These cuts will apply only to loans disbursed after 2007.
The new rates will be:
6% for loans first disbursed July 1, 2008 to July 1, 2009
5.6% for loans first disbursed July 1, 2009 to July 1, 2010
4.5% for loans first disbursed July 1, 2010 to July 1, 2011
3.4% for loans first disbursed July 1, 2011 to July 1, 2012.
The Department of Education establishes annual and aggregate limits for the various federal loan programs. Stafford loan limits vary depending on whether you are financially dependent or independent.
The total amount of Stafford loans, including both subsidized and unsubsidized, that undergraduates can borrow is $31,000 for dependent students and $57,500 for independent students. Subsidized loans can be no more than $23,000 of this aggregate amount. The limits vary for each year of study, depending on the length of the program and the student’s year of study. There is more information on Stafford loan limits on the Department of Education’s web site and in the Department’s publication, Funding Education Beyond High School (2010-2011).
In 2005, Congress passed a law that reduced Stafford loan origination fees over time. Prior to this law, the fee limits were usually 4%. The maximum fee for FFEL Stafford loan dropped to 1.5% on July 1, 2007 (for loans disbursed on or after that date) and dropped again to 1% on July 1, 2008. The fee was eliminated as of July 1, 2010 for FFEL Stafford loans, but so was the FFEL program. For all Direct Subsidized and Unsubsidized Loans for which the disbursement date is on or after July 1, 2010, the origination fee dropped to 1%.
Lenders are required to disclose the amount and method of calculating the origination fee. In addition, you should not be charged for any costs related to processing or handling applications or data required to determine your eligibility to borrow.
Both the Direct and FFEL loan programs offer PLUS loans. As of July 1, 2010, the FFEL program has been eliminated, so all PLUS loans will be through the Direct Loan program. These loans are available for parents borrowing for the education of dependent undergraduate children enrolled in school at least half time. “Grad PLUS” loans are also available for graduate and professional students.
For parent PLUS loans, in cases where parents are divorced or separated and more than one wants to borrow a PLUS loan, each parent should complete a separate application form. The total amount borrowed by both parents cannot exceed the PLUS loan limit, which is the cost of attendance minus any other aid received by the student.
Unlike Stafford loans, PLUS borrowers are generally required to pass a credit check. Unless the lender determines that extenuating circumstances exist, you will not pass the credit check if you are:
90 or more days delinquent on the repayment of a debt;
If you have been the subject of a default determination, bankruptcy discharge, foreclosure, repossession, tax lien, wage garnishment, or write-off of a federal government student loan debt, during the five years preceding the date of the credit report.
PLUS borrowers with poor credit may still get loans if they can find someone with a better credit history to co-sign. Lenders may have additional discretion to find “extenuating circumstances.” You will get a letter that looks like this if your initial credit check is approved. This letter informs you of a denial due to adverse credit history.
PLUS loans taken out after July 1, 2006 have fixed interest rates. There is a difference in the maximum fixed rates between the FFEL and Direct Loan programs. The fixed rate for Direct PLUS after July 1, 2006 is 7.9% while the fixed rate for FFEL PLUS is 8.5%. Interest rates for PLUS Loans taken out prior to July 1, 2006 are variable and capped at 9%. This is a maximum rate. Lenders can set lower rates. With all new PLUS loans coming through the Direct Loan program, the rate for the loans will be 7.9%. This Department of Education information sheet includes interest rates for Stafford, PLUS, and consolidation loans for the period July 1, 2010-June 30, 2011.
There are also origination fees for PLUS loans, up to 4%.
There is no specific limit on the amount of PLUS loans a student or parent can borrow. The maximum amount is the cost of attendance minus any other financial aid received.
Perkins Loans (formerly called National Direct Student Loans, and before that National Defense Student Loans) are low-interest loans for both undergraduate and graduate students with exceptional financial need. Perkins Loans are originated and serviced by participating schools and repaid to the school. The government does not insure the loans, but instead provides money to eligible institutions to help fund the loans.
Perkins loan interest rates are fixed, currently at 5%. There are no origination fees or other fees/charges for Perkins loans.
Perkins loan amounts depend on when the borrower applies, the level of need, and the school’s funding level. As of 2008, undergraduate students can borrow up to $5,500 for each year of undergraduate study up to a total of $27,500 for students who have completed two years of education leading to a bachelor’s degree.
The amount you can borrow might be less than the maximum available. Each school participating in the Perkins loan program receives a certain amount of Perkins funds each year. When all available funds for that award year have been given out, no more awards can be made for that year.
The private loan business has grown rapidly thanks to the rising cost of college and limits of federal student loans. These loans are intended to fill the gap between available federal aid and what students and families can afford to pay out-of-pocket for college costs. Unfortunately a lot of college students take out these private loans without completely exhausting their other options (federal loans, scholarships and grants). Private loans don’t have affordable fixed rates and payment plans like federal loans do. Prospective borrowers should exhaust all federal grant and loan options (even PLUS loans) before considering a private student loan.
Banks and other financial institutions make private student loans without any financial backing from the federal government. Some schools also have their own private loan products.
Interest accrues on all private loans from the time they are disbursed, although interest costs can sometimes be deferred and capitalized when repayment begins. There are many different types of private loans, each program with its own rules and requirements. Private loans are also called private-label or alternative loans, and are often provided by the same lenders that also provide federal FFEL loans. Because the government does not subsidize private student loans, the rates and terms are not regulated the way they are for federal loans, which makes private loans more risky and expensive.
Private loan terms and conditions, including interest rates and fees, are generally based on your credit history or a co-signer’s credit history. This means that low-income students or those with negative credit histories will likely receive more expensive loans. Like government loans, private loans are supposed to be used only to finance postsecondary education (including books, transportation, and room and board). Check your school’s estimated cost of attendance and consult with the financial aid office before deciding on a private loan amount.
Private lenders may pressure or even require you to get a co-signer. A co-signer is a relative, friend or someone else who agrees to be responsible for your debt. Co-signers must understand that they are responsible for paying back the debt just as if they had received the money.
There are very important differences between government loans and private loans. If you take out a private loan, you will not be eligible for the same types of discharge, deferment and forbearance options that are available for federal loans. However, some private lenders are now offering limited discharge options for private loan borrowers. Sallie Mae, for example, has announced a disability discharge for Smart Option Student Loans; unfortunately that’s about the only reasonable repayment option that company offers (Well, They will also forgive any unpaid balance if a primary borrower dies but that’s definitely not a good strategy for getting rid of your student loans). Some private student lenders also offer deferments and forbearances, but these vary by program. Read your loan contract very carefully to learn about your private loan’s particular terms, conditions, benefits, rates, fees, and penalties. Private lenders do have to honor any promises they make about terms and benefits.
Working on Student Loan Debt
These loans are just like any type of debt. Your best bet is to pay them off incrementally as much as possible. If you have federal loans then you have a lot of different repayment options. If your income is not sufficient to pay the loans you can apply for a low-income payment plant (this generally requires that you work full time). You can also put these loans on forbearance for up to a year. Forbearance is generally not recommended because the interest will accrue and add to your principle balance but sometimes it’s the only option. The down side of federal loans is that if you don’t pay, the federal government has a bastion of collection tools to use against you. They can garnish wages (15% of your disposable income) and take your tax refunds.
Private loans are not nearly as forgiving as federal loans. Luckily they have fewer collection options than the government. Generally private lenders have tight restrictions on how many months you can be in forbearance and how many times you can go into forbearance (you also generally can’t do it twice in a row). The repayment options also aren’t nearly as flexible. Sallie Mae, for instance, offers an interest-only payment option and that’s pretty much it. Snowball payments may not be very effective for getting rid of student loans because loan companies make it very difficult to pay for just one loan when you have multiple loans. A better solution is a modified version of snowflake payments, I guess you could call them “baseball-sized hail” payments. You might find that your payments are somewhere in the neighborhood of $800 a month. If you obviously cannot afford this and the loan officers will not work with you, pay what you can afford every month to show that you’re trying to settle your debt. Giving something is better than giving nothing and showing that you’re willing to repay could be your ticket to filing Chapter 7 bankruptcy or Chapter 13 bankruptcy. For more information on filing bankruptcy, refer to the Bankruptcy Facts chapter.
The word mortgage basically means to pledge. Your mortgage on your house is your pledge to repay a special loan given to you for that house. Honestly these are a bit silly because they make it seem like you’re under some type of special circumstances, as if anything more than a tiny percentage of the population could ever afford to just pay cash for an entire house. They can’t anyway, most of the time; mortgage companies rely on your interest to make more profit than you care to know about and will often charge ridiculous fees to people who want to pay outright instead of getting a loan (car salesmen do the same, sometimes they just flat won’t sell you a car for straight cash.)
Ridiculousness aside, mortgages are serious business. If your delequent on your house payments you could have your very place of living taken away from you. Unlike credit card companies, the federal government and student loan lenders, banks, dealerships and mortgage companies have the ultimate tool of collection at their disposal: Repossession. You’re not just getting a loan for yourself, you’re getting a loan specifically for a house (or car or yacht, whatever it is) and if you fail to make payments you will have a hard time getting out of it. Most of the time when you owe money on an item it can be repossessed regardless of whether or not you filed bankruptcy as well! This is mainly an issue for vehicles, you don’t want to file for bankruptcy just because of your mortgage. Lender’s generally aren’t just looking for reasons to foreclose, they want you to keep the house and to keep paying them.
The main issue people have with mortgages is prioritizing. They assume that since it usually takes such a long time for mortgages to become a serious problem that they can afford to forego the house payment for something else. Then they get to that “serious problem” point and are disparaged because they’ve painted themselves into a corner. Aside from food and other life-sustaining costs your mortgage should be your top priority. Think of it this way: You can live without amenities and even some utilities but if you lose your house you’ve got absolutely nothing. Having shelter from the elements and a safe place to stay is pretty rudimentary, aside from groceries there really is no other expense that should go above your house payment.
Consult Your Lender
If you’re having problems being able to make your payments you should always consult your lender sooner rather than later. The sooner you talk to them the more willing they are to help you. It’s important to keep record of your conversations so that you always have proof that you did everything in your power to try and do right by your lender to pay off the loan. Sometimes it may be possible to get interest-only or reduced payments.
Refinancing replaces your current mortgage with a new loan that has a more favorable interest rate and terms that you can afford to manage. The new loan is secured on the same property as your current loan. The new loan funds are used to pay down the current mortgage while any remaining money can be used to your best advantage.
Refinancing comes with its own costs and caveats; don’t think that it’s a magical solution to your problems. If you’re already having a debt crisis then this may be the last thing you should attempt. If you can refinance and get a substantially lower interest rate, you might be able to lower your payments and give yourself a little monetary relief.
When it’s a Good Idea
Build up equity:
You can refinance when you have built up at least 10% equity in your home. It is possible for you to refinance if you have less than 5% equity, but you may have to pay a certain amount of money in order to make up the difference in equity.
Check if mortgage refinance interest rates are low:
It’s better to follow the 2% Rule. The 2% Rule allows you to enjoy the benefits of home refinance if the refinance interest rate is 2% lower than your current loan’s interest rate. The savings in interest will help you recoup the costs of the new loan. There are no-cost as well as low-cost refinance loans where the costs of getting the loan are included but these loans usually have higher rates and your options are limited when the credit market is slow.
Pay off any late payments:
There is no such limit on the number of times you can go for home refinance loans. Most lenders prefer that you have no late payments in the last 12 months before you refinance.
Improve Your Credit Score:
Refinancing is mainly an option when you already have decent credit. The better your credit, the better the interest rates. That’s why this is best used as a preventative measure against debt, not a cure for it.
When it’s a Bad Idea
Your property value has gone down:
If your property value goes down and you refinance up to 80% of the appraised value, your original mortgage amount may be higher than the amount you borrow. Therefore, the new loan will not be enough to pay down the existing one.
You have been paying off the first loan for a long time:
If you are almost finished paying off a 30 year fixed mortgage, then refinancing is not a good idea. You will lose equity in proportion to the amount you borrow over and above the remaining loan amount.
You have used up enough equity:
Refinancing is not a good idea if you have already reduced the amount of your equity by taking out a 2nd mortgage or a home equity loan. Refinance loans for 100% of the loan are rare, and with the mortgage market currently in a crisis, are hard to find.
You have a few years left on the current loan:
If there are only a few years left on your current loan, then refinancing is not a good idea. Taking out a new loan will only put you deeper into debt just when you were about to become debt free.
You’re Already In Debt:
If you’re already knee-deep in debt and struggling to make payments then this is a terrible option for you. Chances are you don’t have the world’s greatest credit which means that you won’t get a rate that’s very good; it may be as bad or worse than the one you have now. The point of this is NOT to get a bunch of extra cash, it’s to try and lower your payments.
Bankruptcy is a legally declared inability or impairment of ability of an individual or organization to pay its creditors. Creditors may file a bankruptcy petition against a business or corporate debtor (“involuntary bankruptcy”) in an effort to recoup a portion of what they are owed or initiate a restructuring. In the majority of cases, however, bankruptcy is initiated by the debtor (a “voluntary bankruptcy” that is filed by the insolvent individual or organization). An involuntary bankruptcy petition may not be filed against an individual consumer debtor who is not engaged in business.
The concept and origin of bankruptcy law as it is now known in the United States originated in England. The first English bankruptcy law is generally agreed to have been enacted in 1542. (34 and 35, Henry VIII, c.4 (1542) England.)
Bankruptcy was originally planned as a remedy for creditors — not debtors. During the reign of King Henry VIII, bankruptcy law allowed a creditor to seize all of the assets of a trader who could not pay his debts. Additionally, on top of losing all of one’s property, the unfortunate debtor also lost his freedom and was subject to imprisonment for failure to pay his debts. This left the family of the debtor in the position of having to pay the debts in order to obtain the release of the debtor.
As time progressed, however, so did the rights of debtors in England. In the 1700s, for example, debtors were often released from prison and many fled to the United States to live. Many emigrated to Georgia and Texas, which became known as debtors’ colonies. Finally, by the early 1800s in England, debtors were often released from prison and their debts discharged. However, for many years, bankruptcy continued to be a remedy favoring creditors, involuntary in nature and largely penal in character. It was generally used only against traders.
Bankruptcy in the U.S.
Bankruptcy in the United States is permitted by the United States Constitution (Article 1, Section 8, Clause 4) which authorizes Congress to enact “uniform Laws on the subject of Bankruptcies throughout the United States.” Congress has exercised this authority several times since 1801, most recently by adopting the Bankruptcy Reform Act of 1978, codified in Title 11 of the United States Code, commonly referred to as the Bankruptcy Code (“Code”). The Code has been amended several times since 1978, most recently in 2005 through the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 or BAPCPA. Some law relevant to bankruptcy is found in other parts of the United States Code. For example, bankruptcy crimes are found in Title 18 of the United States Code (Crimes), tax implications of bankruptcy are found in Title 26 of the United States Code (Internal Revenue Code), and the creation and jurisdiction of bankruptcy courts are found in Title 28 of the United States Code (Judiciary and Judicial procedure).
While bankruptcy cases are filed in United States Bankruptcy Court (units of the United States District Courts), and federal law governs procedure in bankruptcy cases, state laws are often applied when determining property rights. For example, law governing the validity of liens or rules protecting certain property from creditors (known as exemptions), derive from state law. Because state law plays a major role in many bankruptcy cases, it is often unwise to generalize some bankruptcy issues across state lines.
There are six types of bankruptcy under the Bankruptcy Code, located at Title 11 of the United States Code:
Chapter 7: basic liquidation for individuals and businesses; also known as straight bankruptcy; it is the simplest and quickest form of bankruptcy available
Chapter 9: municipal bankruptcy; a federal mechanism for the resolution of municipal debts
Chapter 11: rehabilitation or reorganization, used primarily by business debtors, but sometimes by individuals with substantial debts and assets; known as corporate bankruptcy, it is a form of corporate financial reorganization which typically allows companies to continue to function while they follow debt repayment plans
Chapter 12: rehabilitation for family farmers and fishermen;
Chapter 13: rehabilitation with a payment plan for individuals with a regular source of income; enables individuals with regular income to develop a plan to repay all or part of their debts; also known as Wage Earner Bankruptcy
Chapter 15: ancillary and other international cases; provides a mechanism for dealing with bankruptcy debtors and helps foreign debtors to clear debts.
The most common types of personal bankruptcy for individuals are Chapter 7 and Chapter 13. As much as 98% of all U.S. consumer bankruptcy filings are Chapter 7 cases. Corporations and other business forms file under Chapters 7 or 11.
In Chapter 7, a debtor surrenders his or her non-exempt property to a bankruptcy trustee who then liquidates the property and distributes the proceeds to the debtor’s unsecured creditors. In exchange, the debtor is entitled to a discharge of some debt; however, the debtor will not be granted a discharge if he or she is guilty of certain types of inappropriate behavior (e.g. concealing records relating to financial condition) and certain debts (e.g. spousal and child support, student loans, some taxes) will not be discharged even though the debtor is generally discharged from his or her debt. Many individuals in financial distress own only exempt property (e.g. clothes, household goods, an older car) and will not have to surrender any property to the trustee. The amount of property that a debtor may exempt varies from state to state.
Chapter 7 relief is available only once in any eight year period. Generally, the rights of secured creditors to their collateral continues even though their debt is discharged. For example, absent some arrangement by a debtor to surrender a car or “reaffirm” a debt, the creditor with a security interest in the debtor’s car may repossess the car even if the debt to the creditor is discharged.
The 2005 amendments to the Bankruptcy Code introduced the “means test” for eligibility for chapter 7. An individual who fails the means test will have his or her chapter 7 case dismissed or may have to convert his or her case to a case under chapter 13.
Generally, a trustee will sell most of the debtor’s assets to pay off creditors. However, certain assets of the debtor are protected to some extent. For example, Social Security payments, unemployment compensation, and limited values of your equity in a home, car, or truck, household goods and appliances, trade tools, and books are protected. However, these exemptions vary from state to state. Therefore, it is advisable to consult an experienced bankruptcy attorney.
In Chapter 13, the debtor retains ownership and possession of all of his or her assets, but must devote some portion of his or her future income to repaying creditors, generally over a period of three to five years. The amount of payment and the period of the repayment plan depend upon a variety of factors, including the value of the debtor’s property and the amount of a debtor’s income and expenses. Secured creditors may be entitled to greater payment than unsecured creditors.
Relief under Chapter 13 is available only to individuals with regular income whose debts do not exceed prescribed limits. If you’re an individual or a sole proprietor, you are allowed to file for a Chapter 13 bankruptcy to repay all or part of your debts. Under this chapter, you can propose a repayment plan in which to pay your creditors over three to five years. If your monthly income is less than the state’s median income, your plan will be for three years unless the court finds “just cause” to extend the plan for a longer period. If your monthly income is greater than your state’s median income, the plan must generally be for five years. A plan cannot exceed the five-year limitation.
In contrast to Chapter 7, the debtor in Chapter 13 may keep all of his or her property, whether or not exempt. If the plan appears feasible and if the debtor complies with all the other requirements, the bankruptcy court will typically confirm the plan and the debtor and creditors will be bound by its terms. Creditors have no say in the formulation of the plan other than to object to the plan, if appropriate, on the grounds that it does not comply with one of the Code’s statutory requirements. Generally, the payments are made to a trustee who in turn disburses the funds in accordance with the terms of the confirmed plan.
When the debtor completes payments pursuant to the terms of the plan, the court will formally grant the debtor a discharge of the debts provided for in the plan. However, if the debtor fails to make the agreed upon payments or fails to seek or gain court approval of a modified plan, a bankruptcy court will often dismiss the case on the motion of the trustee. Pursuant to the dismissal, creditors will typically resume pursuit of state law remedies to the extent a debt remains unpaid.
In Chapter 11, the debtor retains ownership and control of its assets and is re-termed a debtor in possession (“DIP”). The debtor in possession runs the day to day operations of the business while creditors and the debtor work with the Bankruptcy Court in order to negotiate and complete a plan. Upon meeting certain requirements (e.g. fairness among creditors, priority of certain creditors) creditors are permitted to vote on the proposed plan. If a plan is confirmed the debtor will continue to operate and pay its debts under the terms of the confirmed plan. If a specified majority of creditors do not vote to confirm a plan, additional requirements may be imposed by the court in order to confirm the plan.
Chapter 7 and Chapter 13 are the efficient bankruptcy chapters often used by most individuals. The chapters which almost always apply to consumer debtors are chapter 7, known as a “straight bankruptcy”, and chapter 13, which involves an affordable plan of repayment. An important feature applicable to all types of bankruptcy filings is the automatic stay. The automatic stay means that the mere request for bankruptcy protection automatically stops and brings to a grinding halt most lawsuits, repossessions, foreclosures, evictions, garnishments, attachments, utility shut-offs, and debt collection harassment.
Student Loans & Bankruptcy
Student loans are difficult, but not impossible, to discharge in bankruptcy. To do so, you must show that payment of the debt “will impose an undue hardship on you and your dependents.”
Courts use different tests to evaluate whether a particular borrower has shown an undue hardship. A common test is the Brunner test which requires a showing that 1) the debtor cannot maintain, based on current income and expenses, a “minimal” standard of living for the debtor and the debtor’s dependents if forced to repay the student loans; 2) additional circumstances exist indicating that this state of affairs is likely to persist for a significant portion of the repayment period of the student loans; and 3) the debtor has made good faith efforts to repay the loans. (Brunner v. New York State Higher Educ. Servs. Corp., 831 F. 2d 395 (2d Cir. 1987). Not all courts use this test. Some courts will be more flexible.
blocks_hat-01-01If you can successfully prove undue hardship, your student loan will be completely canceled. Filing for bankruptcy also automatically protects you from collection actions on all of your debts, at least until the bankruptcy case is resolved or until the creditor gets permission from the court to start collecting again.
Assuming you can discharge your student loan debt by proving hardship, bankruptcy may be a good option for you. It is a good idea to first consult with a lawyer or other professional to understand other pros and cons associated with bankruptcy. For example, a bankruptcy can remain part of your credit history for ten years. There are costs associated with filing for bankruptcy as well as a number of procedural hurdles. There are also limits on how often you can file for bankruptcy.
How to Discharge Student Loans in Bankruptcy
Whether a student loan is discharged based on hardship is not automatically determined in the bankruptcy process. You must file a petition (called an adversary proceeding) to get a determination. You’re going to have to prove that you cannot reasonably be expected to pay your debt. This could be presented in a number of ways. Perhaps you have a large debt and it will be impossible to pay off before your planned retirement age. If you are working in, what is deamed as, a worthwhile job and simply not making nearly enough to cover your debt, you might also win your case.
It’s impossible to know for sure how it will go. Some people have been denied for trying to use alcoholism as a case against paying off debt while others have one cases with the same story. There have been quite a few cases where the loans were discharged because the borrower did not benefit from the education or went to a fraudulent school. If you have a mental or physical illness or disability that will likely persist for the remainder of your life and inhibits your ability to work, you might be able to use it to your advantage in this case.
If you already filed for bankruptcy, but did not request a determination of undue hardship, you may reopen your bankruptcy case at any time in order to file this proceeding. You should be able to do this without payment of an additional filing fee. Chapter 7 of NCLC’s Student Loan Law manual includes extensive information about discharging student loans in bankruptcy.
Even if you cannot prove undue hardship, you still might want to consider repaying your student loans through a Chapter 13 bankruptcy plan.
Chapter 13 and Student Loans
A case under chapter 13 is often called “reorganization.” In a chapter 13 case, you submit a plan to repay your creditors over time, usually from future income. These plans allow you to get caught up on mortgages or car loans and other secured debts. If you cannot discharge your student loans based on undue hardship in either a chapter 7 or chapter 13 bankruptcy, there are still certain advantages to filing a chapter 13 bankruptcy. One advantage is that your chapter 13 plan, not your loan holder will determine the size of your student loan payments. You will make these court-determined payments while you are in the Chapter 13 plan, usually for three to five years. You will still owe the remainder of your student loans when you come out of bankruptcy, but you can try at this point to discharge the remainder based on undue hardship. While you are repaying through the bankruptcy court, there will be no collection actions taken against you. You may have other options, depending on how judges decide these cases in your judicial district. For example, some judges allow student loan borrowers to give priority to their student loans during the Chapter 13 plan. You should discuss these options with a bankruptcy attorney.
Most, but not all, student loans will require proof of undue hardship to discharge in bankruptcy. You may be able to avoid this higher standard if you can show that your loans are not really “educational loans” as defined by the Bankruptcy Code.
For example, the standard does not apply to payments for tuition or room and board if you did not receive an extension of credit. Also, the higher standard applies only if you went to an “eligible educational institution.” That means an institution that is eligible to participate in one of the government student financial assistance programs.
Most, but not all, schools fit this category. You should consult a lawyer for more information about whether your loans meet these definitions.
If you were previously denied an undue hardship, you can renew your request if there has been a change in your circumstances.
Showing that you have tried other strategies besides bankruptcy to get a bankruptcy discharge is not not required, but many courts will want to see that you have tried other options such as the income-based repayment plans. You should be prepared to discuss any strategies you have tried or if you haven’t tried anything, be prepared to explain why other options were not suitable for you
Generally, interest on your student loans will accrue during the course of your Chapter 13 plan. You may be able to restructure or defer the interest that accrues during the plan, but this won’t make it go away.
Bankruptcy discharges should not affect your ability to get new federal loans and grants. PLUS loans are an exception.– The government will look at prior bankruptcies in considering your creditworthiness for a PLUS loan. A prior bankruptcy will affect your ability to get a private student loan and will also affect the cost of that loan. Private student lenders almost always use credit scores to evaluate loan applications. A bankruptcy discharge will lower your credit score.
Bankruptcy in the U.K.
Bankruptcy in the United Kingdom does not have a singular law. There is one system for England and Wales, one for Northern Ireland and one for Scotland.
Across the United Kingdom, bankruptcy refers only to insolvency of individuals and partnerships. Other procedures, for example liquidation, apply to insolvent companies.
Bankruptcy in England and Wales is governed by Part IX of the Insolvency Act 1986 (as amended) and by the Insolvency Rules 1986 (as amended). The term bankruptcy applies only to individuals, not to companies or other legal entities.
An individual may be made bankrupt only by court order following the presentation of a bankruptcy petition. An individual may present his own petition on the ground that he is insolvent, i.e. unable to pay his debts. A creditor or creditors may also petition for a bankruptcy order to be made against an individual debtor.
Before a creditor presents a bankruptcy petition he must usually first serve on the debtor a statutory demand in the prescribed form requiring the debtor to pay the sum claimed within 21 days of service of the demand. The debtor may apply to the court to set aside the demand on the basis that the debt is disputed on bona fide grounds or that he has a counterclaim, set off or cross-demand which equals or exceeds the amount of the debt claimed by the creditor. If the debtor fails to pay the sum claimed in the demand or to apply to set aside the demand or if his application to set aside the demand is dismissed by the court, the creditor may present a bankruptcy petition. Alternatively, a creditor may petition without first serving a demand if execution on a judgment has failed. In either case the debtor must owe the creditor at least £750 and the claim must be for a liquidated sum, i.e. a fixed sum of money (not, for example, damages).
A bankruptcy petition must generally be served on the debtor personally, but if he evades service the court may order substituted service, i.e. service by post or some other method which is likely to bring the demand to the debtor’s attention.
At the hearing of the petition the court may make a bankruptcy order if the debt is undisputed or not capable of being disputed, dismiss the petition (for example if the debt has been paid) or adjourn the petition to give the debtor time to pay.
If a bankruptcy order is made the administration of the bankrupt person’s affairs is handled by a trustee in bankruptcy who must be either the Official Receiver (a civil servant) or a licensed insolvency practitioner appointed either by the Secretary of State or by the creditors at a meeting called for that purpose. The bankrupt’s assets (excluding tools of his trade and other essentials) vest in his trustee who is obliged to realise them (generally by selling them) to pay a dividend to creditors.
A bankrupt person is subject to certain restrictions, principally that he may not raise credit without informing the person from whom he is borrowing that he is a bankrupt, and that he may not act as a director of a company. He is also subject to obligations to give information to his trustee and to cooperate with him in the administration of his affairs. Extensive powers are available to enable the court to compel the bankrupt to do so. Similarly the court has power to undo a range of transactions entered into by the bankrupt with a view to dissipating or reducing the value of his assets in the period before his bankruptcy.
Following the coming into force of the Enterprise Act 2002’s bankruptcy provisions in April 2004, an England & Wales bankruptcy will now normally last no longer than 12 months and maybe less, if the Official Receiver files in Court a certificate that his investigations are complete. At the end of that period the bankrupt is discharged and he ceases to be liable for his bankruptcy debts. However, in cases where the bankrupt is considered culpable for his or her insolvency, a bankruptcy restrictions order may be made to extend some of the restrictions of bankruptcy for up to 15 years.
As an alternative to bankruptcy a debtor may propose an Individual Voluntary Arrangement (IVA) to his creditors (see Part VIII of the Insolvency Act 1986) or a Debt Relief Order if debts do not exceed a certain threshold. An IVA takes the form of a proposal to creditors to pay some or all of the debtor’s debts over a period of time by selling assets or making payment out of income or a combination of the two. The proposal must be approved by a licensed insolvency practitioner who will convene a meeting of creditors to consider it. Approval requires a majority vote in value in excess of 75%. If the proposal is approved it binds all the debtor’s creditors whether or not they have voted in favour of it.
In theory it is also open to a debtor to make a proposal to his creditors by deed of arrangement under the Deeds of Arrangement Act 1914, but this procedure has fallen into disuse since the introduction of voluntary arrangements under the Insolvency Act 1986.
Credit Score Facts (U.S.)
A credit score in the United States is a number representing the creditworthiness of a person or the likelihood that person will pay his or her debts. It has shown to be very predictive of risk, made credit more widely available to consumers, and lowered the cost of providing credit.
A credit score is primarily based on a statistical analysis of a person’s credit report information, typically from the three major American credit bureaus: Equifax, Experian, and TransUnion. Lenders, such as banks and credit card companies, use credit scores to evaluate the potential risk posed by lending money to consumers and to mitigate losses due to bad debt. Using credit scores, lenders determine who qualifies for a loan, at what interest rate, and to what credit limits. The Fair Isaac Corporation, known as FICO, created the first credit scoring system in 1958, for American Investments, and the first credit scoring system for a bank credit card in 1970, for American Bank and Trust.
Each of the three credit bureaus may have different information about any particular person, and there are many different credit scoring models in use, which means a person may have several different credit scores simultaneously. Many lenders use third-party credit scoring systems, such as the FICO scoring model, NextGen, VantageScore, and the CE Score, to evaluate the creditworthiness of a borrower. Because a score does not consider race, sex or ethnicity, it is generally considered to be the most fair and objective underwriting tool available to lenders. The Federal Reserve Board did a study that noted scores have increased the availability of credit and reduced the cost of credit. Scores have also proven to be very predictive in assessing risk.
FICO is a publicly-traded corporation (under the ticker symbol FICO) that created the best-known and most widely used credit score model in the United States. The FICO score is calculated statistically, with information from a consumer’s credit files. The FICO score is primarily used in credit decisions made by banks and other providers of secured and unsecured credit. It provides a snapshot of risk that banks and other institutions use to help make lending decisions. Banks may deny credit, charge higher interest rates, demand more collateral, or require extensive income and asset verification if the applicant’s FICO credit score is low. Applicants with higher FICO scores may be offered better interest rates on financial instruments such as mortgages or automobile loans. Lenders usually establish different credit score cut-offs to determine to whom they are willing to lend.
Credit reporting agencies
The three credit reporting agencies in the United States of America, Equifax, Experian, and TransUnion, collect data about consumers used to compile credit reports. The credit agencies use FICO software to generate FICO scores, which are sold to lenders. Each individual actually has three credit scores at any given time for any given scoring model because the three credit agencies have their own databases, gather reports from different creditors, and receive information from creditors at different times.
In the United States, a resident is permitted by law to view their credit report once a year at no charge by visiting the website Annualcreditreport.com. The individual’s “credit score” information is available for an additional fee from each of the three credit reporting agencies. In addition, the Fair Isaac corporation sells FICO scores directly to consumers using data from Equifax and TransUnion.
The NextGen Score is a scoring model designed by the FICO company for assessing consumer credit risk. It is similar to the traditional FICO scores with regard to intended use and general design. It has not enjoyed the same level of adoption as the traditional FICO score, but is used by some creditors. Other credit consumer scores are published by Community Empower as the CE Score.
In 2006, to try to win business from FICO, the three major credit-reporting agencies introduced VantageScore. VantageScore uses a number range (501 to 990), which is different from FICO’s, and assigns letter grades (A to F) to specific score ranges. A borrower’s VantageScore may differ from bureau to bureau, but discrepancies stem from data differences in the reported credit information, not because of differences among credit-scoring mathematical models, similar to FICO. Since FICO remains as the widely-used score by money lenders, the agencies continue offering FICO scores or something similar.
Your credit score can affect everything from buying a new house or car to even getting certain jobs. You can sign up for a credit score monitoring service if you like but most people find them to be an unnecessary cost. You’re allowed one completely free credit check per year with all the major credit bureaus. A good website to see them all on is www.anualcreditreport.com. Make sure to keep detailed records of your report as you will only be able to see it one time every year unless you pay for it.
Your Path to Success
Hopefully the tips and information in this book has empowered you to rid yourself of the three common self-inflicted debts the world of debt. No one has the power to turn your life around like you do. Stop placing the blame on other entities and accept that your debt is the result of poor decisions or unexpected circumstances on your part. There really is no fast and easy way to clear yourself of debt, you have to understand that it’s a slow and steady process. Keep your chin up and don’t let yourself get too stressed out just because a few bill collectors call; you can do it!