The long-term financial consequences of the coronavirus pandemic are just beginning to unfold.
America is facing a recession, with higher unemployment numbers and swifter economic destruction than during the financial crisis and Great Recession that began in 2007. This time around, more than 30 million Americans have filed for unemployment due to the coronavirus, and that number is expected to go even higher.
Then combine that with credit card balances reaching a $930 billion high, along with $9.56 trillion in mortgage balances at the end of 2019, according to the New York Fed's Center for Microeconomic Data. It’s anything but surprising to learn that bankruptcy courts are gearing up for a tidal wave of filings in the near future.
Because bankruptcy stays on your credit report for seven or more years after filing, it’s not a decision to be made lightly. In fact, research shows most people struggle financially for two years or more before filing and there are less drastic options consumers should consider before filing for bankruptcy. Here are four steps to consider.
1. Consider Consolidating Your BalancesIf you’re having a hard time keeping track of your debt payments, you could consider consolidating your debt.
Under debt consolidation, a consumer usually takes out another form of credit, whether it be a personal loan, home equity loan or 401(k) loan, and uses it to pay off multiple debt balances. Debt consolidation is beneficial because you’re essentially rolling various sources of debt into one loan with one payment. You also may qualify for a lower interest rate, compared to credit card and other debt. But keep in mind that you’ll need a strong credit score and a source of income to qualify for a debt consolidation loan—so if you’ve recently lost your job, you likely won’t qualify unless you can provide another source of income.
Debt consolidation can take the chaos out of having to pay multiple creditors each month, but it will only work if you’re able to keep up with your monthly payment. If you stop making payments on your debt consolidation loan, you’ll be right back where you started. Only consider this option if you know for a fact you can make the monthly payments.
If you do take out a loan from your retirement account, be aware that the CARES Act does make it easier to borrow from these accounts, but not every retirement plan servicer allows these loans. Participants can borrow up to 100% of their vested account balance, or $100,000 (whichever is less). The CARES Act also gives people an extra year to pay back their 401(k) loans.
Traditional personal finance advice almost always advises against borrowing from a 401(k)—in part because retirement savings, such as a 401(k) retirement account, are protected from bankruptcy proceedings. But in unprecedented times, like a global pandemic, it could be a viable option for some. Keep in mind that an advantage of a 401(k) loan is that you pay back interest to yourself, whereas with a credit card or personal loan, you’ll pay interest back to the creditor.
2. Prioritize Your BillsIf you’ve only recently started to spiral out of control with debt, there might still be an opportunity to recover. Leslie Tayne, a debt attorney in New York, says taking a step back and prioritizing your bills could be a good start to getting back on track.
“Keep a close eye on spending behavior and only spend on the absolute essentials that you and your family need,” Tayne says. “Prioritize your rent or mortgage, groceries, necessary clothing, and transportation when paying bills. Pay the most important bills first, meaning your rent or mortgage before your credit card.”
No one knows when the economy will fully bounce back from the COVID-19 crisis—some experts say it could be years. But economists are hopeful that employment numbers could start to tick back up in the near future, once stay-at-home orders start to lift and businesses reopen. Until then, paying as much as you can toward your most important bills is key. Only paying the minimum on credit card debt will cost you money in interest, but it can help keep you in good financial standing for the time being.
If you’re completely out of work and can’t afford your credit card or mortgage bills, many servicers are offering temporary hardship assistance for struggling customers. Call your creditors—or go online via their website or app—and ask what assistance they can offer you. Although you may still accrue interest during forbearance periods, this option could tide you over long enough to come up with a strategy for how you might next attack your debt.
3. Try Credit CounselingCredit counseling offers a handful of services, including help with getting on a debt management plan. Debt management plans are a form of debt relief where a company works on your behalf to reduce your monthly payment, lower your interest rate and get you onto an affordable payment schedule.
It’s important to take notice of any fees a credit counseling agency may charge you to use their service. According to the National Foundation for Credit Counseling (NFCC), any agency should be forthcoming about its fees. Any fees an agency does charge should be reasonable ($50 or less for setup fees and around $25 for monthly fees). Additionally, consumers should do their due diligence in asking how their payments will be used, when they will be disbursed to creditors, how deposits will be protected and if the agency will work with all of your creditors, not just a select few of them.
The NFCC, for example, is a nonprofit organization that staffs member agencies around the country and can help consumers get started with a financial action plan.
4. Negotiate the DebtIf you’ve reached the point where you’ve exhausted forbearance options on your debt, you might stop paying it entirely. Once an account is past due, the creditor will eventually sell it to a collections agency that will then be responsible for collecting the debt.
Many consumers aren’t aware that they can actually settle their debt with collectors, meaning they come to an agreement to pay less than the actual amount owed. Although collectors are known for calling debtors incessantly, consumers should take the opportunity to ask about any settlement options that may be available. Let the collections agency make the first offer—it could be less than the maximum amount you’re actually able to pay, which will save you money.
If you still don’t have money you can throw at the debt after negotiating, ask about going on a payment plan.
What to Know If You End Up Filing for BankruptcyIf you’ve considered all other options, and none will give you enough financial relief, then filing for bankruptcy could be a viable last resort. If you do go this route, you should have a clear understanding of how the process works and how it will affect your credit.
Here are a few things to know about bankruptcy:
- There are two types of consumer bankruptcy filings. These two filings are called Chapter 7 and Chapter 13 bankruptcy. In a Chapter 7, your assets—excluding certain exempt assets such as your 401(k) or pension, household goods and low value car—are
liquidated to pay off debts. Chapter 13 bankruptcy allows consumers to
keep more of their assets, including a home, if they successfully
complete a court-ordered plan to repay their debt.
- Not all debt can be discharged in bankruptcy. Most debt can be discharged or paid off in bankruptcy, including credit card debt, medical bills, civil judgments and past-due rent and utility payments. But it’s important to know not all debt can be erased in bankruptcy. Debts like child support, alimony, court fees, recent tax debts and most student loans cannot be discharged through Chapter 7 bankruptcy, according to Experian.
- Bankruptcy will stay on your credit report for up to 10 years. The length of time that bankruptcy will stay on your credit report depends on the type you file. Completed Chapter 13 bankruptcies stay on a credit report for seven years; Chapter 7 filings stay on a credit report for 10 years. As time progresses, the impacts of negative marks on your credit report become less severe.