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Avoid these deadly mistakes in a financial crisis.
(By: Diego G. Mendez, Esq. Consumer Bankruptcy Practitioner)

“It is the purpose of the Bankruptcy Act…to relieve the honest debtor from the weight of oppressive indebtedness, and permit him to start afresh free from the obligations and responsibilities consequent upon business misfortunes.” U.S. Supreme Court (1914)

Knowing when it’s time to stop paying creditors and seek bankruptcy protection. 

There is a saying in the bankruptcy legal world – “If you are asking about bankruptcy, you are probably bankrupt.”  No one goes to see a bankruptcy lawyer when things are good.

However, filing for bankruptcy does not necessarily mean that you will lose everything (especially in Florida, where I practice law) or that you will never recover financially.  It means that you need special Federal protection from the powers of your creditors .  It means that you need help.

Signs you need bankruptcy protection:

  • You are paying credit with credit. (ie Paying one credit card with another credit card)
  • You are only making minimum payment on credit card and foregoing basic necessities to do so.
  • You can’t pay your mortgage because you need the money to pay credit cards.
  • You are considering a line of credit on your primary residence to pay credit cards. (I’ll explain more later on this).
  • You are considering taking money out of your retirement account to pay credit cards. (I’ll explain more later on this – NEVER do this).
  • You are asking friends or relatives for loans to pay credit cards. (You’ll end up losing both).
  • You are fighting with your spouse, partner or family over credit cards.

Every situation is different, however, what I have listed above are the most common tell tale signs that I have seen in my practice of when it might be time to look for help.

How to handle a credit default situation without losing everything (or worse).

When the honest, but unfortunate debtor has made the decision to seek bankruptcy protection from his/her creditors, what are the actions to avoid to minimize the long term damaging effects?  Yes, there is a proper and legal way to default on credit and keep some of your assets and there are deadly mistakes to avoid.

  • Taking money out of retirement accounts to pay credit cards. Never, under no circumstances, ever take money out of your retirement account to pay any creditor (other than possibly to catch up on late payments on your primary residence).  401k and other similar retirement accounts are exempt (ie protected) from most[1] creditors as long as you leave your money in the account.  This means that in most cases you can file for bankruptcy and keep all of the money in these accounts.  However, if you take the money out then the money loses this special protection.   Don’t give away your future to your current creditors.  It makes no sense.  American Express does not care if you starve in retirement.  Don’t do it!
  • Taking out a line of credit on a primary residence in Florida to pay credit cards. I will never say never on this one, but I would say that use extreme caution and think it over at least 90 days before doing this.  Why 90 days? Because after 90 days all of the defaults would have kicked in and you will not be able to pay your credit card minimum payments any way.  If you can’t make your minimum payments, you are already bankrupt, don’t make it worse by creating a new debt.  In Florida, where I practice law, your homestead equity is completely protected from creditors if you’ve owned the home for more than 40 months.  This means that, other than in very limited situations, you can have a paid off house and keep it even if you default on all of your credit cards.  Why would you use this money to pay off creditors who can never collect against your home?  Don’t do it!
  • Giving away assets to protect them from creditors. It is not illegal to sell assets to normal buyers who paid market value (not in cash preferably) and to use that money to pay creditors and normal life expenses.  However, “gifting” your beach apartment, car, money in the bank, business interest or anything of value to anyone in hopes of protecting it from a creditor, will only result in you losing that asset and involving the person in nasty and expensive litigation. If you need money, by all means, sell your assets in a regular fashion to regular buyers and document everything about the sale.  “Selling” your Lamborghini to your cousin for $500.00 is not this and will result in a lost Italian sports car and a confused/angry cousin. Don’t do it!
  • Business owners who use their employees federal tax withholdings to keep the business afloat (AKA 941). This topic is so important that it deserves it’s own article, however I will say a little about it here because this mistake is truly deadly.  NEVER, under any circumstances, stop paying your company’s and your employee’s portion of their federal withholding to fund operations of your business.  This exposes the owner, and ANY manager of the company, to criminal liability. This is not a debt that you can discharge in a bankruptcy.  If you are doing this, it is time to seriously consider cutting your loses NOW and close the business.  Selling avocado toast for another month in a business that is likely to fail is not worth a couple years in Federal prison. Don’t do it!
  • Borrowing money from a relative or friend to pay creditors. Some things seem obvious, but still need to be mentioned in hopes of creating a complete record of bad decisions.  In this situation, you have two bad decision makers.  First is the borrower who is asking for the financial help, and second it the well-meaning relation who is giving the financial help.  Again, as with everything in life, some things sometimes magically work out for the best, and it is possible that the person asking for the loan has every intention of paying back the loan, however remember that there is a reason that the debt collection is a multi billion dollar industry.. even well intentioned borrowers cannot pay back a loan.  When you are in debt, and you cannot pay your creditors through your normal salary, don’t make it worse by involving your friends and family.  Citibank is not your friend.  It will get over you not paying it.  Your cherished college roommate “Frank the Tank” or Auntie Bee will not,. Don’t do it!

Ever case is different, and every personal situation is different.  However, in general, if you stick to my advice, in my opinion, you will probably survive any financial set back and be able to get on with your life.

[1] I say “most” because the IRS and ex-spouses sometimes can access these accounts, but not other regular creditors.