When you’re down to your last dollar

Associated Press

SAN FRANCISCO — With unemployment expected to persist above 10 percent through 2010, more Americans whose debt has ballooned may wonder whether they should seek protection from their creditors.

Last year was the seventh-worst on record for personal bankruptcy: 1.4 million new cases were filed nationwide. Richard Chang, a bankruptcy lawyer in San Diego, said his current cases often result from the recession — from a client losing a job or having work hours cut or from a mortgage rate resetting higher than a client can afford, or a combination.

Deciding whether to take the plunge is the result of art more than science or accounting norms. Many financial advisers recommend considering filing for bankruptcy if you can’t figure out a way to pay off your unsecured debt within five years.

But most agree that if you can avoid filing, you should. Bankruptcy is for people who can’t make their debt payments and can’t earn more income or refinance or renegotiate their debts.

If that is your situation, here are a few tips:

Avoid scams

Above all, be wary of anyone who demands money to help settle your debts. In a common ploy that Brent Neiser of the nonprofit National Endowment for Financial Education has seen, the scam artist starts by getting you to set aside a large sum — in his or her care.

In what’s often called debt settlement, the scammer then advocates for you with creditors. But he can’t arrange better payments than you could on your own — and he charges a fee. Not only can this cost you up front if he takes a cut of your initial payment. His monthly fee (sometimes in fine print) can end up setting you back further than if you’d handled things on your own.

Counselors suggest instead that you negotiate on your own behalf.

Counseling requirements

A 2005 change in bankruptcy laws means people must go through two counseling sessions that can run one or two hours or longer, the first before filing and the second after resolving their debt.

“The purpose of the pre-filing counseling is not to dissuade or point an individual in any one direction,” says Catherine Williams, vice president of financial literacy at Money Management International in Houston. “It is to get a sense of what does it cost to run your house.”

A former counselor, Williams said roughly half the people who complete the pre-filing session immediately hire a lawyer and file a case. The other half usually try cutting more expenses.

The counselors must be government-approved. During the bankruptcy process, you also must complete a government-approved debtor education class. The sessions should cost $50 each, according to the Federal Trade Commission’s Web site. The $150 total can, by law, be waived for people who cannot afford to pay it.

The FTC, which regulates businesses, offers information on bankruptcy and finding approved credit counselors at tinyurl.com/y96r3m5.

Chapter 7 or 13?

What type of case you’ll file depends on your situation. The rules for the two most common types of cases are in two sections of federal bankruptcy law known as Chapter 7 and Chapter 13.

In Chapter 7 cases, generally reserved for people who make less than their area’s median income, a court-appointed trustee sells your assets and distributes whatever cash he can get to your creditors.

Chapter 13 covers people who have steady income, own property they want to keep and have too much unsecured debt. This process helps them create a plan to pay off their unsecured debts in three to five years. It can offer more leeway.

It’ll cost you

Even in financial distress, you must pay the court where you file your case. Federal law sets the fee for filing a Chapter 7 case at $299 and a Chapter 13 case at $274. Either amount can be paid in installments.

On top of that you’ll usually pay a lawyer, and attorneys’ fees vary greatly.

In Chapter 7, lawyers are paid at the beginning of the case under court rules. Richard Chang, a partner at Chang &Diamond in San Diego, said his law firm charges a $1,000 minimum for Chapter 7 cases.

For Chapter 13, he said, many courts regulate lawyers’ fees and set a flat rate, because those cases are more complicated and can take more time. In San Diego, that fee is $3,300.

Debtors may file for bankruptcy without a lawyer but lawyers and counselors advise against it. Call your state’s bar association for help evaluating a lawyer or verifying her credentials.

Consequences

You’ll complete the process in five years at the longest, and the filing is supposed to be removed from your credit record in seven to 10 years. But for the rest of your life — each time you apply for a credit card, mortgage or other loan — you must disclose you once filed for bankruptcy. And that can make it hard to get competitive interest rates — or get credit at all.