Cancellation of Debt

Back in January of 2009, as we were deciding if we were going to file bankruptcy or not, we had been talking to my husband’s creditors, which was really easy to do as they were calling us at least once every day. I encouraged him to let them know that we were close to filing and to ask them if they would be willing to 1) drop the principle, and 2) drop the interest rate. One of our creditors proposed a significant settlement deal that was really hard, but resulted in a cancellation of debt.

At the time, I was advised by a family member to look out for tax forms to include in our 2009 tax return, but that we shouldn’t be concerned about it affecting our taxes. This family member happens to work very closely with the IRS, so I trust them to steer me in the right direction.

When I started working on our taxes last month, I had forgotten that we were advised to take care of that debt cancellation form in a specific way. Luckily, when I got it in the mail, I talked to the family member and she clarified that:

If you are insolvent at the time that your debt is cancelled, you do NOT have to include the cancellation in your income (*)

You have to fill out a special form (IRS Form 982  – Reduction of Tax Attributes Due to Discharge of Indebtedness) and have records that show that you were, in fact, insolvent at the time of cancellation. In our case, were were (sadly) VERY insolvent – we had over $60K in debt and no real assets (under $20K worth of personal property), so we qualify for this.

So, we are able to take the $4,500+ that was written off and leave it out of our income, which helped to make our potential tax return even greater (yahoo!)…

We didn’t include this amount in our starting amount (and some of out other debts), because we started the blog after we had already started paying off our debt,  so the reality is that we actually started this journey at over $70K…yikes… but to know that we have reduced our debt by more than $30K in a year – that tells me that we can get to the end…

* I am not a tax advisor and every person’s situation is different. Consult your tax professional for information about your taxes.

Bankruptcy Research and What We Found

Today’s post is a little more about our history and what we learned from our Bankruptcy research.

I wrote before about how a conversation about our finances led my Mom to suggest that we needed to file for bankruptcy. She told us “stop paying your credit cards, meet with a lawyer and file the paperwork this week.” So the next Monday, we started researching the process and we found out the following:

  1. Before you can file for individual bankruptcy, you need to attend a pre-bankruptcy counseling session (either in person on online) to obtain a Bankruptcy Counseling Certificate. 
  2. Chapter 7 takes your assets and distributes them to your creditors and the rest of debt (except student loans and a few other types of debt) are discharged. Chapter 13 develops a payment plan so your creditors get as much as they can for 5 years. (These explanations are over-simplified – I’ll post some resources that help with providing more detail later).
  3. After you file, your creditors can no longer call you, until the Meeting of the Creditors where you have to face your creditors.
  4. Both filings stay on your record for 7 years.
  5. If you are married, only one spouse *can* file, but both incomes are taken into account, which adds to #6.
  6. It’s really difficult to qualify for Chapter 7. 

The bulk of the debt is only in my husband’s name ($42,000+) and filing might cause some complications with my job, so we decided that my husband would contact his Employee Assistance Program and get a referral for a Bankruptcy lawyer. He was connected with one and the lawyer did a phone consult with my husband. The lawyer was very terse and said, “you can’t file, you make too much money.” This seemed to conflict with a lot of the research that we had done, so we contacted the EAP again and my husband got a meeting with a new lawyer – one who worked at a Bankruptcy practice. He took all of our financial records with him and at the end of the meeting it was determined:

  1. We could file for Chapter 13.
  2. The payments would take 5 years.
  3. The firm would require $2,400 to file the paperwork.
  4. Our credit lines would be closed. 
  5. Our standard of living would be very, very low for 5 years. 

Both my husband and I felt a little defeated – it had already been a really touch 18 months, and we felt so hopeless. We had really hoped that we would be able to file for Chapter 7, but even though our debt (over $60,000) was more than our annual take home (under $60,000), we “made too much money” to have any of our debt discharged. 

So, as our creditors were calling every day (seriously, EVERY day), I asked my husband to try and cut a deal (settlement) with them. I suggested that he tell them that we were about to file for bankruptcy and did they want to work something out with us so that neither party had to go through the system – I told him we should ask them to drop the principal and interest rate. Here is what happened:

  • MBNA – dropped the interest rate to 4.25% (from 19.95%) and put us on monthly payments of $370/month, which lowered our monthly payments by almost $200.
  • Citibank – dropped the interest rate to 9.9% (from 32.24%) and put us on monthly payments for $319/month, which lowered them by $200-300
  • Direct Merchants (they weren’t as friendly, but they cut us a good deal) – they cut our principal by 25% and took the interest rate to 0% – *however* we had to pay the balance monthly within 6 months – those payments are the $1,600+ payments (only 2 left as of this writing). 

The “hitch” for all of this: (1) the cards/lines of credit are closed, (2) my husband cannot apply for any credit while paying these off or the terms will revert to the previous agreement – this is for 5 years, (3) if we miss a payment, all the terms will revert. 

But all in all, I’m actually glad that we went through with this process instead of going through the bankruptcy filing. Sure, there would have been more protection and it would be nice to have it a little more “out of our hands,” but I really think that this allows us to push even harder to reduce our debt as our circumstances change. And even though the payment plans are 5 years, we’re still committed to being done with this process in 3 years, 3 months.

Our “Out-of-Debt” Date and some news on the Financial Counseling front

Using out Microsoft Money Debt Reduction Planner (which takes all of your debts and liabilities, looks at minimum payments, interest rates and terms, and the maximum you can pay toward debt to determine a payment plan), we can project that our Out-of-Debt Date is….. July 20, 2012. Yes, that seems like it is quite a ways away, but it is so much better than “never.” 

My husband and I have already agreed that any additional money that comes in (non-salary or payment for a job) will be split up the following way:

10% – Charitable Contributions
10% – Savings
15% – My mad money
15% – His mad money
50% – Debt reduction

We think this is a balanced approach that will address the knee jerk reaction of “let’s go play” with what might feel like a bone crushing “we have no fun for 3.33 years.” All of the financial guides (including the bankruptcy counseling) said that it is important that we make sure that as we are responsible, that we balance it with things that will rejuvenate and excite us so that we can continue to be productive. 

We are supposed to be matched up with a Financial Counselor from our church’s program soon. The committment is a 4-6 month time of working on the steps that they identify. I am very curious to see what else they would suggest – we’ve REALLY made a lot of changes in the last year (especially the last 6 months) so I’m wondering what else we could do. I’m excited that we have the opportunity to learn even more and that there could be something else that would make our “out-of-debt” date come even closer than 3 years, 3 months, and 1 week.

The Earnings Gap and the Social Implications

I remember the day, about 12 years ago) that I found out that we weren’t going to talk about money amongst the social circle. It was after college and I had asked one of my good friends what he was offered when Microsoft was courting him. He said, “I don’t discuss money with friends.” It was really shocking to me, but I accepted it. After all, he had this great career and I was still working retail management and going to school part-time. And that was my experience all through my college career – I worked full-time and went to school part-time (I’m still doing it now during grad school). And I’ve never made very much money, because I needed to find the jobs that are flexible enough for me to attend classes, and those jobs don’t tend to invest much, because everyone involved knows that it is just temporary. 

But as I’ve gotten older, my husband and I notice that there is generally a very large gap between what we make and what we have discovered our friends make. One of our closest friends makes more by herself than we do put together. Now, she’s been in the same company for 10 years and has an MBA, but we’re in professional jobs, too, just at non-profits. And a large number of our friends own houses (in metro Los Angeles, nonetheless), while we can’t imagine that we will ever be able to afford to buy in this area when the median house price for the County is $360,000 and over $600,000 where we live. I’m sure that this is not uncommon for most people – if you are out there and being social, you’ll probably have a mix of people in your life that represent the whole spectrum of Net Worth. So why am I writing about this?

I’m writing about this because our experience of going through the financial crisises that we have over the last few years has further illustrated the gap between the “haves” and “have-nots” in our social circle. This is shown when we have to decline dinner plans at restaurants, or give homemade gifts because we can’t afford to eat out of purchase the $100 saute pan on the registry. And we haven’t had much luck talking to our friends about our money woes and our very real worry about filing for bankruptcy, because they talk about being broke, or money being tight, but they are also putting away several thousand in savings each month. It is simply two different scales of economy. So, we made the choice to reference it, but not to give details. I think this was a mistake – we should have been more transparent and explained to our friends that “no, we don’t make 6 figures with our combined incomes” and “yes, our total debt is more than we take home in a year.” We should have just told them. I think we were afraid that we would be judged and our friends (and family, to be honest) would think poorly of us and that it would affect our relationship with them. 

I guess this means that my husband and I need to think about letting all of that worry go and have honest conversations with the people that we care about – not ALL of our friends certainly, but I think the burden might not be so heavy if others were walking along side…

Have any of you had those conversations with your friends/family? What was the outcome? Were you surprised?

Have You Ever Considered Bankruptcy?

Please take the poll below and let me know what your experience has been.