As abankruptcy lawyer, one of the first things I advise my clients to do when they decide they are filing bankruptcy and hire me is to stop paying on their credit cards. More on this later in the post. Recently, though, before I could offer that advice, a client asked me: "What happens when I stop paying my credit cards?"

The short answer is, the collection process will begin. It usually goes something like this:

1. The original creditor will call you, your family, your place of employment, non-stop, for about 60-90 days trying to get you to pay something over the phone making all kinds of threats about how they are going to ruin you financially unless you pay them.
2. After 90 days or so, the account will be sold to a third party debt collector who will repeat the actions listed directly above.
3. After about 180 days since you stopped paying, you may get a call from a lawyer trying to collect on the debt who will repeat the actions listed in 1 and 2 above.
4. Finally, the lawyer may file a lawsuit against you seeking a judgment that would allow the creditor to attempt to collect on the judgment. By the way, then, and only then, can your wages be garnished.

Kind of a long process until a judgment is obtained, right? Over 6 months from the time payments stopped being made if I added correctly. So why, as a bankruptcy lawyer, do I advise my clients to stop paying on credit cards when they hire me?

Because the idea is for my client to be file bankruptcy sometime well before the judgment is entered. This way, garnishment is taken out of the equation. My client can use the payments she would have made to an abusive debt collector for a credit card debt to catch up on a car payment or a house payment she may want to keep through filing bankruptcy, or to start saving up money to create an emergency fund for the future.

And what about those abusive debt collectors? Some States, Florida being one, have tough laws against the type of abuse described above that some creditors engage in on a daily basis when collecting a credit card debt against my clients. There is also a Federal Law that prohibits those abusive acts by third party debt collectors in the collection of a debt. You can sue your creditors to enforce your rights, and you should.

The debt collection process can be an intimidating experience, or an empowering one. If you know how it works and you know your rights, the empty threats the debt collectors hurl at you in a typical phone call from them will seem laughable, and more often than not, actionable.

Bankruptcy can clear some types of tax debt.  It will not clear a federal tax lien that has attached to your assets.  However, when no tax lien has been filed, income tax debt can be discharged and cleared from your record if some very specific requirements are met in either a Chapter 7  or a Chapter 13 proceeding.  Not only can bankruptcy clear IRS income tax debt, it can get rid of state and local income tax debt as well.

Timing is an important issue in clearing a tax debt and there are some other basic steps that must be followed.  To discharge income tax debt, the following rules apply:

1. Your tax returns must have been due three years or more before the  petition was filed;
2. Your tax returns have to have been filed more than two years before the petition;
3. The tax you owe must have been assessed against you by the government for at least 240 days before the case is filed;
4. Your tax returns must have been truthful and not fraudulent; and,
5. You must not have been intentionally attempting to evade or defeat the tax when you failed to pay.

There are some technical rules that can complicate a discharge of tax, but in most cases the tax will be discharged if the above requirements are met.

If a notice of federal tax lien has been filed by the IRS, the tax debt covered by the lien becomes attached to any assets you own at the time it is filed.  What is worse is that it attaches to anything new you get so long as the lien is in effect.  This applies as long as you owe the tax.  Until the collection time limit expires or the tax debt is cleared the lien remain in place.

Often people come to see me who have been working with a debt settlement company but are unable to manage the payments to the debt settlement company or get discouraged with the whole process.  How can bankruptcy be better?

To be clear, a debt settlement company is an entity that will take your money in monthly installments and builds up a sum that will be used to settle your debts.  Once that sum is built up, the debt settlement company will then make a lump sum offer to your creditors for payment in full satisfaction of their claim.  For this "service," the debt settlement company charges a fee which is typically a percentage of the total debt.

For example, if you have three credit cards totaling $25,000.00 in unsecured debt, the debt settlement company will say that they can settle the accounts for $15,000.00 (approximately 60%) and will charge a fee of $3,750.00 which is 15% of the total debt.  Thus, your total payment to settle $25,000.00 in credit card debt is $18,750.00 ($15,000 paid to creditors and the fee of $3,750.00).  In order to have this money available to make the "settlement offer," you pay in approximately $800 a month for 24 months (of course, this may vary among companies).  Generally, the debt settlement companies want your accounts to go into "charge off" status.

So what happens if one of your creditors with whom you wish to settle refuses the settlement?  You are still obligated on the debt.  Just because a debt settlement company says that they can settle your debts, that does not mean that the creditor will actually accept the offer.  So, in the above example, if one of the creditors does not settle, you still must pay that creditor or seek some other alternative.

Another issue concerns your credit rating while you are paying the debt settlement company each month building up your "settlement funds."  Your credit rating or score goes down the tubes.  My colleague, Kurt O'Keefe, has just written a nice piece on that very topic.  See The Secret to New Credit After Bankruptcy. Your score is dependent on your paying your bills on time.  If you do not, such as through paying a debt settlement company, your score goes down.  So, assuming that you do settle with your creditors, your credit score is still trashed.

So how can bankruptcy be better?  First, the fees involved are typically much, much cheaper.  For example, in my area, a routine chapter 7 can typically be accomplished for $2,500.00 to $3,000.00 inclusive of the costs.  In a typical, "no-asset" chapter 7 case, you do not pay anything to your creditors so that you are not obligated to pay $15,000.00 towards your credit card debt (this scenario assumes the case is a "no asset" case).  That money is saved.

While it is true that bankruptcy does not help your credit, once it is done, you can start working toward building your credit back.  Unlike the above scenario with the debt settlement company, as soon as your bankruptcy case is over, you can start toward rehabilitating your credit.  Perhaps in your bankruptcy case, you reaffirmed a mortgage or automobile loan-those creditors will report that you are making your payments on time (assuming that you do).  This will start you on the road to credit rehabilitation.

I rarely recall seeing a debt settlement company that could offer a better "deal" than bankruptcy.  The bankruptcy fees are cheaper and the total cost is generally must less.  Plus, you can start rehabilitating your credit so much sooner with a bankruptcy filing than working through a debt settlement.

By Adrian Lapas, Eastern North Carolina Bk Attorney, posted in Bankruptcy Information