I Have $23K of Credit Card Debt. Is Bankruptcy My Best Option?

Q. I owe $23,000 on credit cards, and I can’t keep up with the payments. The debt came from when I was out of work for nine months, but I have a good job now, I just make less money. I’ve already tried negotiating with them to lower the interest rate, but they won’t. I’m thinking of filing for bankruptcy but I don’t want to totally trash my credit. What do I need to think about before deciding?

A. Declaring bankruptcy is a big decision.

Most individuals seek relief either under Chapter 7 or Chapter 13 of the Bankruptcy Code, said Ilissa Churgin Hook, an attorney with Hook & Fatovich in Wayne, N.J.

“In a Chapter 7 filing, a debtor seeks a discharge from his/her debts in exchange for exposing his/her assets to an examination by a third party trustee, who acts as a fiduciary for creditors,” Hook said. “One of the trustee’s obligations is to look for assets that have equity — after taking into account the costs of sale, any liens against the asset, and any relevant bankruptcy exemptions — and can be liquidated to pay creditors.”

Hook said, assuming you qualify for a Chapter 7 bankruptcy, depending on your income and expenses, you would have the opportunity to achieve a Chapter 7 discharge, which Hook said would give you a fresh start. It would prevent the credit card companies that you currently owe money to from taking any further collection action.

How Chapter 13 Is Different

A Chapter 13 filing works differently. This option is for individuals or a married couples with regular income who are seeking to reorganize his/their debts and retain assets, Hook said.

“A Chapter 13 case normally lasts three to five years and involves a payment plan which allows a debtor to, among other things, repay mortgage arrears and non-dischargeable taxes over time,” Hook said. “If you have other debts, you may want to consider Chapter 13 as an option.”

And if you don’t qualify for a Chapter 7 bankruptcy, you may be able to seek relief under Chapter 13 and pay back the credit cards via a payment plan.

Hook said the length of the plan depends on your income and ability to make monthly payments. Importantly, additional interest on the credit card debt does not accrue under the plan.

In a Chapter 13 plan, you would have to pay the credit card companies the greater of your excess monthly income, or what the creditors would have received in a Chapter 7 liquidation, Hook said.

Therefore, a liquidation analysis of your assets is essential.

“It is important to run through this analysis prior to filing, as you may not be able dismiss your case and walk away if a trustee seeks to liquidate an asset, or Chapter 13 creditors demand higher payments in your plan based upon the value of your assets,” she said.

Know Creditors’ Rights

Keep in mind that creditors also have rights in a bankruptcy case.

“If you used your credit cards for necessities, such as food, gas, reasonable clothing expenditures, that is usually fine,” she said. “However, if you charged any luxury items recently, including but not limited to a vacation, jewelry, expensive electronic items, or if you took cash advances in the past few months, you may need to wait to file.”

She said the purchase of luxury items or withdrawal of cash advances in a short period of time prior to the filing of a bankruptcy is a red flag, and a creditor or your trustee could argue that those debts should not be discharged because the purchases were not necessary and were made at a time when you knew that you did not have ability to service the debt you were incurring, she said.

“Regarding your credit score, if you have missed payments and the credit card companies have reported defaults to the credit bureaus, your credit score may already be damaged,” she said.

You should check your credit reports — you can get your credit reports for free once a year — to see what has been reported.

Hook said credit card companies can commence lawsuits against you for breach of contract based on your failure to pay the outstanding debt. The statute of limitations for breach of contract is six years in New Jersey, so pending lawsuits can further damage your credit score.

If you ultimately decide to file a bankruptcy case, the filing will remain on your credit report for seven to 10 years, but you can begin to rebuild credit immediately after your discharge.

One way to rebuild credit is with a secured credit card.

“This may be done by depositing funds with a bank which will issue you a credit card with a credit limit in the amount of your deposit,” she said. “Your goal is to charge and pay the purchases immediately to begin establishing a positive credit history,” she said.

Whether and when the bank will increase the limit on the credit card above your initial deposit amount varies among banks.

Further, if you make monthly payments to secured creditors, such as a mortgage company or car financing company, a positive, timely payment history reported to the credit bureaus will also increase your credit score over time, Hook said.

[Editor’s Note: If you want to see how your credit card debt is impacting your credit, you can get a free credit report summary and personalized explanation of your biggest credit challenges on Credit.com]