If Your Ship is Sinking, Don’t Give Away Your Life Vest!

One of the saddest things is when a person comes into my office explaining that they have waited to come in until they have used up all their savings, retirement funds, equity in their home and/or have gotten a loan on their car just to keep paying their credit cards and other debts.  This just breaks my heart because it was completely unnecessary.

The Bankruptcy Code does not want or encourage people to wait until they have used up all of their assets to file bankruptcy.   In fact, the Bankruptcy Code and California law discourages these actions by specifically protecting certain assets in a bankruptcy case from the reach of creditors.  So what  are some of the assets which are generally protected and what actions should you be taking to protect these assets?

Retirement Accounts- All private retirement plans and profit sharing plans are exempt.   Also, exempt are IRAs, IRA rollovers, Roth IRA and Keogh plans held by self employed individuals to the extent necessary for the support.   Therefore, you should not be using retirement accounts to pay credit cards, bringing home loan payments current on a house that is underwater or other bills which could be discharged in a bankruptcy.  Every withdrawal from a retirement account will be taxed on both federal and state levels as well as incurring the 10% penalty for early withdrawal unless it falls under an exception for early withdrawals.  If you are in your 30’s-40’s, a withdrawal of $1,000 will amount to a loss of $10,000 in retirement income.  If you are in your 20’s, a withdrawal of $1,000 will amount to a loss of $20,000 in retirement income.  The withdrawal of even smallest amount will be a huge reduction in retirement income later.

Homestead Exemption- The California homestead exemption applies to your principal “dwelling” on the date the bankruptcy petition is filed.  The minimum homestead exemption in California effective January 1, 2010 is $75,000.  The exemption is increased to $100,000 if the you or your spouse reside in the homestead or at least other one member of the family resides in the residence and does not own an interest in the residence.  The homestead exemption is increased to $175,000 if you or your spouse meets the minimum age of 65, is disabled or meet the “low income” qualifications’.  Therefore, if you still have equity in your home, do not use it to pay dischargeable debt such as credit card or personal loans.

Personal Property, Cars and Jewelry-   A person can generally exempt all household furnishing and goods, wearing apparel, appliances, books, animals, crops or musical instrument held primarily for personal, family or household use as long as any individual items could not be sold at a garage sale for more than $525.00.  In addition, a person can have  equity in a car and certain amounts of jewelry depending on the exemptions used in the Bankruptcy case.  Therefore, no loans should be taken out on a vehicle which is paid off.

Wildcard Exemption-  If the homestead exemption is not used as discussed above, a person can have in addition to the car, jewelry and household goods and furnishing exemptions, retirement accounts and the other exemptions provided under California law, a person can have up to $23,250 in cash and other assets at the time of the bankruptcy petition which will be exempt.  That means there is no reason to sell the RV, boat or use up your savings unless that is really want you want to do so.  However, if you are not going to be paying your credit card or other installment debt, you should make sure that you are not putting money in a bank or credit union where you have debt.  Many banks and credit union have agreements that allow set-offs if a loan is in default from other checking or savings accounts.

Personal Injury and Workers Compensation Awards-  Personal injury settlements are generally exempt under “lost compensation” and future earning awards are exempt to the extent reasonably necessary for support.  In addition, Workers Compensation Awards are exempt.

Life Insurance-  Term Life Insurance is generally exempt and Universal or Whole Life up to a cash value of $11,800.  Therefore, term life/whole life insurance should not be cancelled since it is much more expensive to obtain as you get older.

The purpose of the Bankruptcy Code is to provide people with a fresh start.  A fresh start does not mean empty cupboards, empty retirement accounts, empty savings accounts or no equity in a car or home.  We are all living longer and we will need food in our cupboards, money in our retirement accounts and a car that is paid off. 

If you do not have sufficient income to pay your bills as they come due and owing, you should seek legal counsel before withdrawing any monies from a retirement account, savings account or taking a loan against your home or car.  These are difficult times, but do not miss the help and protection provided by the Bankruptcy Code and California law by waiting too long.   Just because this ship is underwater does not mean that you should give up your life vests that you will need to keep you afloat!  

THIS INFORMATION IS NOT PROVIDED AS LEGAL ADVICE AND SHOULD NOT BE RELIED UPON IN MAKING ANY DECISION REGARDING A VOLUNTARY DEFAULT, SHORT SALE, FORECLOSURE OR BANKRUPTCY.  THIS INFORMATION IS NOT A SUBSTITUTE FOR OBTAINING TAX & LEGAL ADVICE REGARDING AN INDIVIDUAL SITUATION.              

© 2010 Joan Grimes

Should I Stay or Should I Go?

To say that these are difficult times in the real estate market would be an understatement.  The melt down began with an extended boom fueled by cheap money followed by a rapid contraction of the credit supply.  This lethal combination has led to an unprecedented decline in housing values.  I have no doubt that the real estate market will come back and thrive.  However, in the meantime, does it make financial sense to stay in a home that is underwater; where the value may not come back for 10-15 years and you may only be paying interest on the loan?  What is a person to do?

The mortgage industry and government would like us to feel a moral obligation to repay our debts.  The argument goes that we are sending the wrong message to our children and community if we default on a loan where we had the ability to make the payments.  Never mind that Wall Street banks and investors are voluntarily defaulting on office building, hotels and commercial properties across the nation.  Morgan Stanley recently decided to stop paying on five San Francisco office buildings and no one is saying they have a moral obligation.  It was a strategic decision to let the properties go rather than invest more money.

  A decision to voluntarily or strategically default on a loan can be a very emotional decision.  However, if we take the emotional side out of the equation, what does it look like from a purely financial and legal standpoint?  From a legal standpoint, there are three questions when contemplating a default on a home loan.  They are the following: 1) how will default affect my credit? 2) will there be any personal liability from the default? and 3) will there be any tax liability?  In addition, from a financial standpoint, how does the continuing payment of this debt affect other areas of my life?

As a general rule, under California law, a short sale or foreclosure can remain on a person’s credit for up to 7 years.   Personal liability on a home loan is determined by the character of the loan at the time the loan was originated and then by the manner in which the lender chooses to foreclose.  Generally, a loan or loans used to purchase a 1-4 unit property occupied by the borrower will have no personal or tax liability unless it is excluded loan product such as many types of governmental loans such as VA loans.  On the other hand, home loans which were not used to purchase a 1-4 unit property occupied by the borrower such as refinances, lines of credit or loans on investment properties, may have both personal and tax liability.

Even after considering the legal issues, we still need to think about a voluntary default from a financial point of view.  Is being “house poor” causing you to not properly fund your retirement, your children’s college education or preventing you from paying bills as they come due or taking your family on vacation? 

In conclusion, a voluntary default may be the right decision for you just as it was for Morgan Stanley.  It was a business decision for Morgan Stanley and it should be for you too.  This is a complicated area of the law, but a real estate or bankruptcy attorney should be able to make to an analysis of your particular situation fairly quickly which will allow you to decide if a voluntary default is the right decision for you and your family.

WE ARE A DEBT RELIEF AGENCY. WE HELP PEOPLE FILE BANKRUPTCY RELIEF UNDER THE BANKRUPTCY CODE. THIS INFORMATION IS NOT PROVIDED AS LEGAL ADVICE AND SHOULD NOT BE RELIED UPON IN MAKING ANY DECISION REGARDING A VOLUNTARY DEFAULT, SHORT SALE, FORECLOSURE OR BANKRUPTCY.  THIS INFORMATION IS NOT A SUBSTITUTE FOR OBTAINING TAX & LEGAL ADVICE REGARDING AN INDIVIDUAL SITUATION.              

 © 2010 Joan Grimes