Start Thinking Bankruptcy Now, to Maximize Your Options Later

If you’ve lost your job or struggle to pay your debt, you may need to file for bankruptcy. If that’s the case, you should ignore some common financial advice and start thinking defensively.

The coronavirus pandemic that upended the economy is also expected to send unprecedented numbers of people and businesses to bankruptcy court. Millions are out of work, and economic disruptions could continue until a vaccine is widely available, something that may be more than a year away.

“I am gearing up for having a tsunami of new cases,” says Jenny Doling, a bankruptcy attorney in Palm Desert, California, who serves on the American Bankruptcy Institute’s Chapter 13 Advisory Committee. “I think there will be a whole lot more people filing than what anyone's ever seen before.”

If bankruptcy may be in your future, here’s what you need to know now.

Don’t wait to talk to a bankruptcy attorney

People are usually advised to solve their debt problems on their own, if they can, or to consult a credit counselor, with bankruptcy as a last resort. But the people who come out of bankruptcy in the best shape tend to be the ones who got expert advice early, Doling says. You can get referrals from the National Association of Consumer Bankruptcy Attorneys, and the first meeting is typically free.

“If you even think that there's a possibility that you're going to be in debt trouble, or you're not able to pay something, go get a free consultation before you make any kind of financial move,” Doling says.

That doesn’t mean you should rush to file, however, says John Rao, staff attorney for the National Consumer Law Center. Your situation could improve, or things could get much worse. Since Chapter 7 liquidation bankruptcies can only be filed every eight years, you’d want to file when you can erase the maximum amount of debt.

Don’t touch your retirement money

This is one piece of advice that predates the pandemic: It’s never been a good idea to raid your retirement funds. It’s a particularly bad idea if bankruptcy might be in your future.

The new coronavirus hardship withdrawals allow people to take up to $100,000 from their 401(k)s or individual retirement accounts without penalty or mandatory withholding. The withdrawals are taxable, but people who can pay the money back within three years can amend their tax returns to get those taxes refunded.

But few people in financial crisis now will be able to pay the money back, Doling predicts. More important, money in retirement funds is typically protected from creditors and so should not be used to pay debt that could be erased in bankruptcy, such as credit cards and medical bills.

Don’t let cash pile up

A cash buffer is important, but money in bank accounts can be seized to pay creditors. Your attorney will advise you about where to put extra cash. One option may be a Roth IRA. Any amount you contribute can be withdrawn tax-free at any time, and in the meantime it’s protected from creditors.

Don’t sell stuff

People are often advised to sell unneeded possessions to pay down what they owe. If bankruptcy’s in your future, though, check with an attorney first since the sale may be unnecessary or may be needed more later.

“After the bankruptcy, if you needed it to pay your rent, you could sell it,” Doling says.

Also, don’t give away assets, because a bankruptcy trustee — the person administering your bankruptcy case — could sue the recipient to get them back, says Kate Nicholson, a bankruptcy attorney in Cambridge, Massachusetts.

Don’t pass up forbearance options

Because of the crisis, many lenders are allowing borrowers to skip some payments. The usual advice is to take advantage of such forbearance only if you really need to, since the debt will still have to be repaid.

But credit card debt and most other unsecured debt would be erased in a Chapter 7 bankruptcy, which is the type most consumers file. Secured debt, such as mortgages and car loans, usually isn’t erased, but forbearance could help you save money for other necessities, including food, utilities — and paying your bankruptcy attorney. (A Chapter 7 filing typically costs about $1,500, with Chapter 13 filings running $3,000 and up.)

“(Forbearance) is a great wait-and-see approach so that you're not (paying) out-of-pocket right now,” Doling says. “You can see what's going to happen with your job, with your spouse's job, your situation.”