Introduction

Before you jump into rebuilding your credit, take care of any financial emergencies. Then you should tally up your debt burden and assess your options for handling what you owe.

If your debt problems are behind you and you're only concerned with cleaning up your credit report, skip ahead to Chapter 4, "Cleaning Up Your Credit File." Also read Chapter 2, "Avoiding Overspending."

Take Care of Financial Emergencies

A financial emergency is any situation that may leave you homeless or without some very important property or service. A pending eviction, a letter threatening foreclosure, an IRS seizure of your house, a utility cut-off, and a car repossession are financial emergencies. A nasty letter or threatening phone call from a bill collector, while unpleasant, is not an emergency. (If you are being hassled by a collection agency, see Chapter 3.)

If you face an emergency, act on it at once. Begin by contacting the creditor. You may be able to work out a temporary solution that will keep you off the street or on your wheels. If that doesn't work, you may need to get in touch with a lawyer to help you negotiate with your creditors. One option is to file for bankruptcy, assuming your overall debt burden justifies it. Filing for bankruptcy immediately stops most of your creditors in their tracks and can buy you some valuable time. However, some evictions may be allowed to proceed under the new bankruptcy rules. (See "File for Chapter 7 Bankruptcy," below, for more information.)

Face Your Debt Problems

Some people with debt problems believe that the less they know, the less it hurts. They think, "I'm having trouble paying a lot of my bills. I can't stand the thought of knowing just how much I can't pay." But you must come to terms with your total debt burden. You cannot take steps to rebuild your credit without knowing exactly where your money goes -- or where it needs to go instead.

Figuring out what you owe may result in a pleasant surprise. Most debt counselors find that people tend to overestimate -- not underestimate -- their debt burden. This may bring little comfort to those of you who find out that you owe more than you thought, but there is always a benefit: Knowing what you really owe will help you make wise choices about how you spend your money.

Use Form F-1, Outstanding Debts (in Appendix 3 and on the CD-ROM) to tally up your total debt burden. Look at the most recent bills you've received. If you've thrown out your bills without opening them, you can probably find out the balance by calling the customer service department of the creditor.

Many creditors' automated telephone systems provide balance and payment information automatically, without having to speak to a person. Some creditors may also provide account information on their websites.

If you must speak with a person and you've long been avoiding your creditors and fear they'll hassle you when you call, ask for balance information only. If the customer service representative turns into a bill collector, explain that you are exploring your options and need to know how much you owe before you proceed. Let the representative know that you will contact the company as soon as possible, but for now you need only to know how much you owe. If the representative still hassles you, hang up and use your best guess as to how much you owe that creditor.

Total up your past due installment bills, such as credit cards and loans, plus any regular monthly obligations that are overdue, such as your utility bill.

Understand Your Options for Dealing With Your Debts

You normally have about a half-dozen options for dealing with your debts -- probably more than you imagined. Read this entire section before taking action.

Do Nothing

Surprisingly, the best approach for some people deeply in debt is to take no action at all. If you have very little income and property and don't expect this to change, you may be what's known as "judgment proof." This means that anyone who sues you and obtains a court judgment won't be able to collect, simply because you don't have anything they can legally take. You can't be thrown in jail for not paying your debts. And state and federal laws prohibit a creditor -- even the IRS -- from taking away such essentials as basic clothing, ordinary household furnishings, personal effects, food, most Social Security benefits, disability benefits, unemployment, or public assistance.

So, if you don't anticipate having a steady income or property a creditor could grab, sit back. Your creditors may decide not to sue you because they know they can't collect. Many will simply write off your debt and treat it as a deductible business loss on their income tax returns. In several years, the debt will become legally uncollectible under state law. (See Chapter 3 for information on how to stop communications from collection agencies.)

Keeping exempt property. You can find a complete list of property you get to keep even if your creditors sue you or you file for bankruptcy, called "exempt property," in Solve Your Money Troubles: Get Debt Collectors Off Your Back & Regain Financial Freedom, by Robin Leonard and John Lamb (Nolo).

Find Money to Pay Your Debts

If you can come up with a chunk of cash to pay off some of your debts, your financial woes may lessen. But, even if you feel desperate, don't jump at every opportunity to get cash fast. If you make a bad choice, you'll get yourself into deeper debt. This section discusses some of the options you should consider to raise money, as well as the options you should avoid. It's not a complete list. Unfortunately, new scams and bad deals crop up every day. Keep in mind that if an offer or deal seems too good to be true, it probably is. So, proceed cautiously, whatever you are considering.

Sell a Major Asset

One way you can raise cash and keep associated costs to a minimum is to sell a major asset, such as a house or car. This may be a good idea if you can no longer afford your house or car payments. You will almost always do better selling the property yourself rather than waiting to get cash back from a foreclosure or repossession.

With the proceeds of the sale, you'll have to pay off anything still owed on the asset and any secured creditor to whom you pledged the asset as collateral. Then you'll have to pay off any liens placed on the property by your creditors. You can use anything that's left to help pay your other debts. But, before you take this step, be sure you have affordable alternative housing or transportation available. If not, you'll be in worse shape than before -- without a roof over your head or a car to get to work.

If you own a house, consider all the pros and cons carefully before you sell it. In today's housing market, your house may be worth more in six months or a year than it is today. Selling it will deprive you of an asset that can make you money over time and may result in your being locked out of the housing market once you are back on your feet. At the very least, consider whether you may get more for your house if you sell it later on, giving you more money to pay your creditors.

Cut Your Expenses

Another excellent way to raise cash is to cut your expenses. This will also help you in negotiating with your creditors, who will want to know why you can't pay your bills and what steps you've taken to live more frugally. Here are some suggestions:

• Shrink food costs by clipping coupons, buying on sale, purchasing generic brands, buying in bulk, and shopping at discount outlets.
• Improve your gas mileage by tuning up your car, checking the air in the tires, and driving less -- carpool, work at home (telecommute), ride your bicycle, take the bus or train, and combine trips.
• Conserve gas, water, and electricity.
• Discontinue cable (or at least the premium channels) and subscriptions to magazines and papers. Most cable companies offer a low-rate basic service that they don't advertise. Be sure to ask.
• Instead of buying books and CDs, borrow them from the public library. Read magazines and newspapers there, too.
• Make long distance calls only when necessary and at off-peak hours. Also, compare programs offered by the various long distance carriers to make sure you are getting the best deal.
• Carry your lunch to work; eat dinner at home, not at restaurants.
• Buy secondhand clothing, furniture, and appliances.
• Stop buying gifts and taking vacations until you're back on your feet.
• Stop spending money on luxuries that can add up, such as expensive coffee drinks.
• Don't charge anything that you can't pay off, or that won't exist (like groceries or meals), when the bill comes.

Withdraw or Borrow Money From a Tax-Deferred Account

If you have an IRA, 401(k), or other tax-deferred retirement account, you can get cash to pay off debts by withdrawing money from it before retirement -- but in most cases, you'll pay a penalty and taxes. Or, with a 401(k) plan, you may be able to borrow money from it (instead of withdrawing it). There are serious disadvantages to both options -- you should only consider doing either to pay off debts if you have other substantial retirement funds or you are truly desperate. And, even then, this should be a last resort. Always look to raise money from nonretirement resources first.

Different plans have different requirements for borrowing and withdrawing money. Withdrawing money early from a tax-deferred account is expensive. Generally, any money that you take out of your 401(k) plan before you reach age 59 1/2 is treated as an early distribution. The one exception to early distribution penalties and income taxes on early withdrawals from retirement accounts applies to Roth IRAs.

Instead of withdrawing money, you can usually borrow up to half of your vested account balance, but not more than $50,000. Then you pay the money back, with interest, over five years. If you can't pay the money back within five years (or immediately, if you leave your job), your "loan" will be treated like an early withdrawal and you'll pay both an early distribution tax and income tax.

If you're seriously considering using the money in your retirement plan or IRA to pay off your debts, get a copy of IRAs, 401(k)s & Other Retirement Plans: Taking Your Money Out, by Twila Slesnick and John C. Suttle (Nolo).

Obtain a Home Equity Loan or Credit Line

Many banks, savings and loans, credit unions, and other lenders offer home equity loans (also called "second mortgages") and home equity lines of credit (also called "HELOCs"). Lenders who make these loans will loan only a percentage of your equity in the market or appraised value of the house -- typically between 50% and 80%. For example, if the current value of your house is $200,000 and you owe $100,000 on it, you might qualify for an equity loan of $60,000. A $60,000 loan would increase your total housing debt to $160,000, or 80% of the house's value. The lender will also consider your credit history, income, and other expenses when deciding whether, and how much, to loan to you.

Obtaining a home equity loan has both advantages and disadvantages. If all of your debts are unsecured and your house is exempt from collection, it's almost never a good idea to put your home into jeopardy by getting a second mortgage or home equity line of credit. If you're behind on your house payment, you'll be better off negotiating a mortgage workout with your lender. (For more on mortgage workouts, see S olve Your Money Troubles: Get Debt Collectors Off Your Back & Regain Financial Freedom, by Robin Leonard and John Lamb (Nolo).) If you decide that you do want a home equity loan because you aren't able to negotiate a mortgage workout or for some other reason, be sure you understand all the terms before you sign on the dotted line. It is extremely important that you find out how much the loan will cost you each month and determine whether you can afford it. If you can't afford it, you will likely lose your home.

Consider the following pros and cons of home equity loans and credit lines.

Advantages of Home Equity Loans and Credit Lines

• You can borrow a fixed amount of money and repay it in equal monthly installments for a set period of time (home equity loan). Or, you can borrow as you need the money, drawing against the amount granted when you opened the account; you'll pay off this type of loan as you would a credit card bill (home equity line of credit or HELOC).
• The interest you pay may be fully deductible on your income tax return.

Disadvantages of Home Equity Loans

• Some home equity loans are sold by predatory lenders at very high rates. Predatory lenders target people in financial trouble or with past credit problems. Often, predatory lenders count on the borrower not being able to make the loan payments and expect to foreclose on the house (force the sale of the house) when the borrower fails to make payments. The Federal Trade Commission (FTC) recommends avoiding any lender who tells you to falsify a loan application, pressures you to apply for a loan, or for more money than you need, or pressures you to take on monthly payments you can't afford. (For more on predatory lenders and mortgages for people with poor credit, see Solve Your Money Troubles: Get Debt Collectors Off Your Back & Regain Financial Freedom, by Robin Leonard and John Lamb (Nolo).)
• You are obligating yourself to make another monthly or periodic payment. If you are unable to pay, you may have to sell your house or, even worse, face the possibility of foreclosure (the lender forcing a sale of your house to pay off what you owe). Before you take out a home equity loan, be sure you can afford the monthly payment.
• While interest may be deductible, it can be high.
• Some loans are "interest only" loans -- your monthly payments pay only the interest on the loan and do not reduce the principal amount that you borrowed. You could make payments for years and still owe the full amount you borrowed.
• You may have to pay an assortment of up-front fees for an appraisal, credit report, title insurance, and points. These fees can run as high as $1,000 or more. In addition, for giving you an equity line of credit, many lenders charge a yearly fee of $25 to $50.
• You must pay off the equity loan, plus what you still owe on your mortgage, when you sell your house.

Use the Equity in Your Home If You Are 62 or Older

A variety of plans help older homeowners make use of the accumulated value (equity) in their homes without requiring them to move, give up title to the property, or make payments on a loan. The most common types of plans are reverse mortgages.

Reverse mortgages are loans against the equity in the home that provide cash advances to a homeowner and require no repayment until the end of the loan term or when the home is sold. The borrower can receive the cash in several ways: a lump sum, regular monthly payments, a line of credit, or a combination. Because the borrower does not make payments, the amount of money owed increases over the life of the loan. While the borrower retains title to the home, he or she must pay the property taxes, insurance, and the costs of keeping up the property.

There are pros and cons to reverse mortgages. In general, a reverse mortgage works best for people who are 62 or older and have a lot of equity in their homes. In most cases, the reverse mortgage lender will look at your age, the amount of equity you have in your home, and current interest rates to determine the amount it will lend you. All reverse mortgages cost money due to closing costs (title insurance, escrow fees, and appraisal fees), loan origination fees, accrued interest, and, in most cases, an additional charge to offset the lender's risk that you won't repay. (A reverse mortgage is usually paid back from the proceeds of selling the house after the owner's death.) Almost every state allows lenders to offer reverse mortgages.

There are some drawbacks to reverse mortgages. Your heirs cannot inherit the house from you unless they pay off the loan after your death. A reverse mortgage may also affect your continued eligibility for need-based government benefits programs like Supplemental Social Security (SSI) and Medicaid.

The most widely available reverse mortgage plans are the FHA's Home Equity Conversion Mortgage Program and Fannie Mae's Home Keeper Mortgage Program.

The lender or another party may suggest that you purchase an annuity in conjunction with a reverse mortgage. An annuity is an insurance product, financed out of the home's equity, that provides monthly payments to the borrower beginning immediately or some years later.

Think carefully about whether an annuity is right for you. Many consumer experts recommend against purchasing an annuity because it ties up the money from the reverse mortgage for an extended period, imposes additional transaction costs, imposes substantial penalties for early withdrawal, and may not benefit elderly homeowners (who may not live to see their first annuity payment, if there is a delay of several years or more). Indeed, California now prohibits lenders from requiring homeowners to purchase an annuity as a condition of obtaining a reverse mortgage.

Borrow From Family or Friends

In times of financial crisis, some people are lucky enough to have friends or relatives who can and will help out. Before asking your college roommate, mom and dad, uncle Paul, or someone similar, consider the following:

• Can the lender really afford to help you? If the person is on a fixed income and needs the money to get by, you should look elsewhere for a loan.
• Do you want to owe this person money? If the loan comes with emotional strings attached, be sure you can handle the situation before taking the money.
• Will the loan help you out, or will it just delay the inevitable (most likely, filing for bankruptcy)? Don't borrow money to make payments on debts you will eventually discharge in bankruptcy.
• Will you have to repay the loan now, or will the lender let you wait until you're back on your feet? If you have to make payments now, you're just adding another monthly payment to your already unmanageable pile of debts.
• If the loan is from your parents, can you treat it as part of your eventual inheritance? If so, you won't ever have to repay it. If your siblings get angry that you're getting some of Mom and Dad's money, be sure they understand that your inheritance will be reduced accordingly.

Borrow Against Your Life Insurance Policy

If you've had a life insurance policy for some time, you have probably accumulated "cash value" in the policy, which you may be able to borrow. The insurance company will expect you to repay the amount borrowed (typically, in installment payments), and, if you don't repay it before you die, the proceeds received by your beneficiaries will be reduced by the unpaid amount. Your insurance broker or the insurance company can explain more about borrowing against your insurance policy.

Options to Avoid

Borrowing From a Finance Company
A few finance companies lend money to consumers. These companies make secured consolidation loans, requiring that you pledge your house, car, or other personal property as collateral. The loans are just like second mortgages or secured personal loans: You'll usually be charged interest of 10% to 15%, and, if you default on the loan, the finance company can foreclose on your home or take your property.

Finance companies and similar lenders also make unsecured consolidation loans -- that is, they may lend you some money without requiring that you pledge any property as a guarantee that you'll pay. But the interest rate on these loans can be astronomical, often reaching 25% or more. Lenders also charge all kinds of fees -- many not disclosed -- bringing the effective interest rate closer to 50%.

If you want to take out a consolidation loan, you are better off borrowing from a bank or credit union than a finance company. Many finance companies engage in illegal or borderline collection practices if you default and are not as willing as banks and credit unions to negotiate if you have trouble paying. Furthermore, loans from finance companies may be viewed negatively by potential creditors who see them in your credit file. They often imply prior debt problems.

Tax Refund Anticipation Loans
Although getting a tax refund fast is often a good way to get quick cash, you should probably avoid a refund anticipation loan (RAL). An RAL is a loan offered by a private company for the short period between the date when the taxpayer receives it and the date when the IRS repays it by depositing the taxpayer's refund into the lender's account (usually only a week or two). The amount of the loan is the amount of your anticipated refund minus the loan fee (which is often quite high), the fee for electronic filing, and the tax preparation fee. For example, if your refund is $2,150 (the recent average), the loan fee would be about $100 and the filing fee about $30. That results in an effective annual percentage rate (APR) of 235% for the loan! If you also paid the average tax preparation fee of $146, your total loan costs could be as much as $276.

It is usually better to be patient and wait for your refund, rather than pay the high fee for an RAL. In most cases, you can file your return electronically or by fax and get the money quickly (by having the refund deposited directly into your account, for example).

In addition to being extremely expensive, RALs also pose some risks. You must repay the loan even if your refund is denied, is less than expected, or is frozen. If you can't repay the loan, the lender may assign the debt to a collection agency. The unpaid debt will appear on your credit report. And, if you apply for an RAL again next year, the lender may take that refund to pay this year's unpaid RAL debt.

For more information on how to get a refund sooner and for answers to other tax questions, contact the IRS at 800-829-1040 (voice) or 800-829-4059 (TDD), or visit its website at www.irs.gov.

Payday Loans
The payday loan industry is growing fast. In many states, these loans are illegal. In others, lenders may offer a similar type of loan, but call it something else. Either way, think twice before you get one of these loans.

A payday loan works like this: You give the lender a check and get back an amount of money less than the face value of the check. For example, if you give the lender a check for $300, it may give you $250 in cash and keep the remaining $50 as its fee. The lender holds the check for a few weeks (often until your payday). At this time, you must pay the lender the face value of the check ($300), usually by allowing it to cash the check. If you can't make the check good, the lender requires you to pay another fee ($50 in this example). At this point, you owe the lender $300 (the $250 borrowed plus the first $50 fee), plus a new fee of $50. Looking at it another way, you owe $350 on a $250 loan. Many people who can't make the original check good get into a "treadmill of debt" because they must keep writing new checks to cover the fees that have accumulated, in addition to paying off the amount borrowed.

Payday loans have been a particular problem for members of the military in recent years. A new federal law limits to 36% the annual percentage rate that lenders can charge active duty service members or their dependents in extensions of consumer credit, including payday loans. This means, for example, that now a payday lender cannot charge a service member more than $1.38 in interest on a $100 loan for two weeks.

A payday loan is a very expensive way to borrow money. To find out more about the payday loan laws in your state, visit the National Consumer Law Center's website at www.consumerlaw.org.

Pawnshops
Visiting a pawnshop should be one of the last ways you consider raising cash. At a pawnshop, you leave your property, such as jewelry, a television, or a musical instrument. In return, the pawnbroker lends you approximately 50% to 60% of the item's resale value; the average amount of a pawnshop loan is $50 or so.

You are given a few months to repay the loan, and are charged interest, often at an exorbitant rate. If you default on your loan to a pawnshop, the property you left at the shop becomes the property of the pawnbroker.

Auto Title Pawn
In an auto title pawn (a "title loan" in some states), you borrow money against the value of your paid-for motor vehicle. You keep and drive the vehicle after receiving the loan, but the lender keeps the vehicle's title as security for repayment and also keeps a copy of your keys. If you cannot make the loan payments, the lender repossesses the vehicle, sells it, and keeps the proceeds. Some lenders might try to come after you for any deficiency -- the difference between what you owe and what the lender was able to get for your car. The lender may repossess the vehicle even if you miss only one payment. The monthly cost of these loans can be as high as $63 to $181 for a one-month, $500 title loan. Monthly finance charges of 25% (300% annual interest) are common. Online title lenders quote annual percentage rates of up to 651%.

Auto title loan businesses often target members of the military. Under a new federal law, creditors cannot take a vehicle's title as security when extending consumer credit to active duty service members or their dependents (other than loans to purchase the vehicle).

Debt Consolidation or Negotiation Companies
Debt consolidating, debt pooling, budget planning, debt adjusting, or debt prorating companies produce poor results. They siphon off your limited resources in debt consolidation charges, pay only a few (if any) creditors, and jeopardize much of your property. Some charge outrageously high interest. Others charge ridiculously high fees. Some promise a quick fix to your financial problems, by which they mean filing for bankruptcy.

Debt consolidating is either regulated or prohibited in most states. These laws usually don't apply to nonprofit organizations, lawyers, and merchant-owned associations claiming to help debtors.

Debt negotiation companies claim that they can negotiate with creditors on your behalf, promising substantially reduced payments and an end to collection calls from creditors. Debt negotiators charge hefty fees for this service, which most consumers can do on their own. Instead of helping you obtain relief and work your way out of debt, the debt negotiator may leave you with even more negative information in your credit report and being sued by collectors. In extreme cases, companies reportedly have used consumers' money to pay the company's operating expenses instead of paying the consumers' creditors. Even if the company provides the services promised, you're better off using the money you would spend on the negotiation fee to make payments to your creditors. If you cannot negotiate with your creditors or make payments on your own, see "Get Outside Help to Design a Repayment Plan," below.

Negotiate With Your Creditors

If you can get some money, consider negotiating with your creditors. Negotiation can buy you time to get your finances in order. You can also negotiate to get your creditors to agree to accept considerably less than you owe as a complete settlement of your debts.

You can find suggestions and forms for negotiating with your creditors in Chapter 3.

Beware of the IRS if you settle a debt. A tax law could cost you money if you settle a debt with a creditor or if a creditor writes off money you owe -- that is, ceases collection efforts, declares the debt uncollectible, and reports it as a tax loss to the IRS. Debts subject to this law include money owed after a house foreclosure, after a property repossession, or on a credit card bill you don't pay.

Any bank, credit union, savings and loan, finance company, credit card company, other financial institution, or federal government agency that forgives or writes off $600 or more of the principal of a debt (the amount not attributable to fees or interest) must send you and the IRS a Form 1099-C at the end of the tax year. These forms are for reporting income, which means that when you file your tax return for the tax year in which your debt was forgiven or written off, the IRS will consider the amount reported on the Form 1099-C as part of your income.

There are several exceptions to this rule. For example, even if the financial institution issues a Form 1099-C, you do not have to report the income on your tax return if:

• a nonbusiness debt was canceled as a result of Hurricane Katrina (see IRS Publication 525, Taxable and Nontaxable Income for details)
• a student loan was canceled because you worked in a profession and for an employer as promised when you took out the loan (see IRS Publication 525, Taxable and Nontaxable Income, for details)
• the canceled debt would have been deductible if you had paid it
• the cancellation or write-off of the debt is intended as a gift (this would be unusual)
• you discharged the debt in Chapter 11 bankruptcy, or
• you were insolvent before the creditor agreed to waive or write off the debt.

Insolvency means that your debts exceed the value of your assets. Therefore, to figure out whether or not you are insolvent, you will have to total up your assets and your debts, including the debt that was forgiven or written off. You can avoid reporting the forgiven debt as income only to the extent of your insolvency. For example, if you have debts of $40,000 and assets worth $38,000, you are insolvent by $2,000. If a creditor forgives a debt of $3,000 you must report as income the amount that exceeds your involvency -- $1,000 in this example.

If the debt was discharged in bankruptcy or you conclude that you are insolvent, you must complete IRS Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness, and attach it to your tax return. You can download the form and instructions for completing it from the IRS's website at www.irs.gov. Unfortunately, this form is quite complicated; you might need some advice from an accountant to complete it correctly.

Get Outside Help to Design a Repayment Plan

Many people are not well equipped to negotiate with their creditors. They may feel that they are obliged to make full payment. Or, their creditors may be so adamant that the process is too unpleasant to stomach. Some people just haven't honed their negotiation skills.

If you don't want to negotiate with your creditors, there are people and organizations available to help you. Creditors are often more than happy to work with respected organizations that work with debtors who are serious about repaying their debts. Reputable nonprofit credit and debt counseling agencies (see Appendix 1), the United Way, or a church or synagogue are all excellent prospects. These organizations will help you figure out how much you owe, how much you can afford to pay each month, and what your various options are -- including bankruptcy. A credit or debt counseling agency will also talk to your creditors for you. Check your phone book's yellow pages under "Counseling." Before signing up with any credit counseling service, talk to others who have used the service and check it out with your local Better Business Bureau.

Use caution with lawyers, credit repair clinics, and for-profit organizations. A lawyer can help, but lawyers charge high fees that are rarely justified, especially when you're heavily in debt. Whatever you do, don't use a credit repair clinic. (For more information on this, see Chapter 6.) As a general rule, you should also avoid for-profit credit and debt counseling agencies. They often charge high fees and may not provide the services they have promised. Avoid debt consolidators and debt negotiators as well.

File for Chapter 7 Bankruptcy

Chapter 7 bankruptcy is the bankruptcy plan most people have heard about. It allows you to wipe out most consumer debts: credit cards, medical bills, and the like. In exchange, however, you might have to surrender some of your property, such as a second car, valuable electronic equipment, or a vacation home. To file for Chapter 7 bankruptcy, you fill out a packet of forms that describe your property, current income and expenses, debts, and any recent purchases and gifts. Then you file the forms with the federal bankruptcy court in your area.

Filing for bankruptcy puts into effect an "automatic stay" that immediately stops most of your creditors from trying to collect what you owe them. So, at least temporarily, creditors cannot legally "garnish" (take) your wages; empty your bank account; go after your car, house, or other property; or cut off your utility service.

The automatic stay may not protect you from eviction. Under the old bankruptcy law, filing for bankruptcy prohibited landlords from proceeding with an eviction, unless they got a court order allowing them to move forward. The new law is different: If the landlord already has a judgment for possession, he or she can evict you despite the automatic stay. Even if the landlord doesn't yet have a judgment, you can be evicted -- despite your bankruptcy filing -- for endangering the property or illegal use of controlled substances on the premises.

Until your bankruptcy case ends, your past financial problems are in the hands of the bankruptcy court. Nothing can be sold or paid without the court's consent. You keep control, however, of virtually all property and income you acquire after you file for bankruptcy.

At the end of the bankruptcy process, most of your debts are "discharged" (wiped out) by the court. You no longer legally owe the debts you owed when you filed for bankruptcy. If you incur debts after filing, however, you are still obligated to pay them. And you can't file for Chapter 7 bankruptcy again for another eight years from the date of your filing.

Before the bankruptcy process ends, a creditor might try to convince you to "reaffirm" (commit to paying off) a debt after the bankruptcy court has discharged your other debts. Think twice before you reaffirm a debt. You do not have to reaffirm any debt; if you do, you must pay it off even though your other debts have been discharged. Any agreement to reaffirm a debt must be written and filed with the bankruptcy court. You can cancel a reaffirmation agreement before your debts are discharged or within 60 days after the agreement is filed with the court.

If an attorney did not help you negotiate the reaffirmation agreement, it must be approved by the court.

Of course, bankruptcy isn't for everyone. One reason is that many types of debts cannot be erased in Chapter 7 bankruptcy, including:

• child support or alimony obligations
• student loans, unless repaying would cause you undue hardship (which is very tough to prove)
• court-ordered restitution -- payments you're ordered to make after a criminal conviction
• most federal, state, and local income taxes less than three years past due, and any money borrowed or charged to pay those tax debts
• debts arising from intoxicated driving
• debts from a marital settlement agreement or divorce decree, unless the bankruptcy judge rules it would be impossible for you to pay or that the benefit you'd get from discharging this debt outweighs any harm to your ex-spouse, and
• debts that a bankruptcy judge rules were incurred as a result of a wrongful act on your part -- for example, debts incurred from fraud (such as lying on a credit application or writing a bad check); intentional injury (such as assault, battery, false imprisonment, libel, or slander); larceny (theft); or breach of trust or embezzlement.

Not everyone can use Chapter 7 bankruptcy. You won't be eligible if:

• You received a previous discharge of your debts in a Chapter 7 case within the last eight years, or a Chapter 13 case within the last six years.
• You defrauded your creditors.
• A previous bankruptcy case you filed was dismissed within the previous 180 days because you violated a court order, the court found that your filing was fraudulent or constituted an abuse of the bankruptcy system, or you requested a dismissal after a creditor asked the court to lift the automatic stay.
• Your average income in the six months before you file is higher than the median income in your state for a family of your size, and you would have sufficient money left -- after subtracting certain allowed expenses -- to pay certain debts over a five-year period. This requirement is referred to as "the means test," and those who flunk it can be required to use Chapter 13 rather than Chapter 7.

For more information on Chapter 7 bankruptcy, see How to File for Chapter 7 Bankruptcy, by Stephen R. Elias, Albin Renauer, and Robin Leonard, or The New Bankruptcy: Will It Work for You?, by Stephen Elias, both published by Nolo.

Pay Over Time With Chapter 13 Bankruptcy

If you have steady income and think you could squeeze out regular monthly payments, Chapter 13 bankruptcy may be a good option. Chapter 13 allows you to keep your property and use your disposable income (net income less reasonable expenses) to pay all or a portion of your debts over three to five years. You can use wages, benefits, investment income, business earnings, or any other income to make your payments.

Your "income" may be higher than you think. The new bankruptcy law requires filers to use some odd (and possibly inaccurate) figures when calculating how much they will have left over each month to repay their debts. For example, your "income" is not the actual amount you bring home each month; it is your average gross income during the six months before you filed for bankruptcy, which could well be higher than your current income. And, filers who earn more than the median income for their state cannot deduct their actual expenses when figuring out their disposable income. Instead, they must use expense figures set by the IRS, which might be lower than actual expenses, especially in metropolitan areas. For more information, see Chapter 13 Bankruptcy: Repay Your Debts, by Stephen Elias and Robin Leonard (Nolo).

Most people file for Chapter 13 bankruptcy to make up missed mortgage or car payments and get back on track with their original loan, or to pay off a tax debt or student loan. These are not the only reasons people file for Chapter 13 bankruptcy, however.

If you cannot complete a Chapter 13 repayment plan -- for example, you lose your job six months into the plan and can't make the payments -- the bankruptcy court has the authority to change your plan. If the problem looks temporary, you may be given a grace period, an extended repayment period, or a reduction of the total owed. If it's clear that you can't possibly complete the plan because of circumstances beyond your control, the bankruptcy court might even let you discharge (cancel) your debts on the basis of hardship.

If the bankruptcy court won't let you modify your plan or give you a hardship discharge, you have the right to:

• convert to a Chapter 7 bankruptcy, or
• dismiss your Chapter 13 case. A dismissal of your case would leave you in the same position as you were in before you filed, except that you'll owe less because of the payments you made. Your creditors will add to the debt the interest that was suspended from the time you filed your Chapter 13 petition until it was dismissed.

For more information on Chapter 13 bankruptcy, see Chapter 13 Bankruptcy: Repay Your Debts, by Stephen Elias and Robin Leonard, or The New Bankruptcy: Will It Work for You?, by Stephen Elias, both published by Nolo.