January 18, 2018

Dave Ramsey hates bankruptcy – but don’t listen to him

If you’ve found yourself in need of financial help, and have searched the internet for information on financial matters, you have undoubtedly come across Dave Ramsey’s website and his financial management products designed to help people get out of debt and manage their finances.  I used to be a big fan of Mr. Ramsey, and most of the information you find on his website is useful.  However, his stubborn disdain for bankruptcy is illogical and borders on being deceptive.

I would like to point out, before I get started on why Dave Ramsey is wrong about bankruptcy, that I am in fact a bankruptcy attorney.  I meet with people on a daily basis that have run out of options for paying down their debt.  They are often in the process of being sued, or having the family home foreclosed, and they live under daily harassment from creditors.  These people need relief now!  On the other hand, I also run into people who only have $10,000 of debt, and simply need to manage their finances appropriately to pay down their debts.  For those people, bankruptcy may not be the right option.  I do not try to sell bankruptcy to people if they don’t need it.  I merely use the appropriate tool when necessary, and there are some situations where bankruptcy is the right tool.

Here is why I think you should disregard Dave Ramsey’s advice on bankruptcy.

1.  Dave Ramsey has a specific counseling service that is targeted at people considering bankruptcy. It strikes me as disingenuous to take the position that bankruptcy is never a good option when you are selling a service that competes with bankruptcy.  It’s hard not to draw the conclusion that he is trying to push his product.

2.  He claims that “bankruptcy is a gut-wrenching, life-changing event that causes lifelong damage.” It is true that the process of filing bankruptcy can be “gut wrenching,” but when compared to the reality of shouldering a large amount of debt for years to come, it is not as gut wrenching as being sued, and having the phone ring for months day in and day out from creditors calling to collect unpaid debts. I’ve seen many people struggle to make interest payments on an enormous amount of debt for years, only to reach retirement age and realize they are out of time and penniless, and they are then forced to file bankruptcy anyway.  That’s gut wrenching!  If they had just admitted to themselves earlier that they needed a fresh start, they could have been saving for retirement instead of paying interest on a debt that they really had no hope of repaying.

3. Dave Ramsey uses his own personal experience of bankruptcy to support his claims of detrimental emotional effects caused by bankruptcy.  However, Dave Ramsey’s bankruptcy experience is very out of the ordinary.

  1. Dave Ramsey was an overleveraged real estate speculator that couldn’t liquidate his assets fast enough when the bank called his loans, leaving him with millions of dollars of debt.  Most people who face the possibility of filing for bankruptcy are not overleveraged real estate speculators, but rather are normal families with both parents working to keep food on the table and pay the bills.  They might have experienced an income reduction due to the loss of a job, the loss of a spouse’s ability to work, or another life changing event such as divorce. (See The Two Income Trap, by Elizabeth Warren.)
  2. Dave Ramsey waited years before filing for bankruptcy.  He allowed himself to be sued, harassed, and frustrated.  If Dave Ramsey had realized the state of his financial situation sooner, and realized that bankruptcy is not a defeat, but a tool created to help people, he could have avoid the anguish he endured.
  3. If Dave Ramsey had not filed for bankruptcy, it is very unlikely that he would have enjoyed the success that he has today.  It was because he filed bankruptcy that he was able to move past his debt and begin his new life debt free.

4. One reason Dave Ramsey has become so successful is that he has explored the spiritual component of debt that people experience. This experience is often times very dark and humbling and can cause emotional distress. And it is precisely because the experience of being a debtor is so dark and serious that I believe that bankruptcy relief is essential for many people. Dave Ramsey encourages people in a spiritual way and helps them get through their dark hours, and they need that. However, it strikes me as abusive to prey on people’s religious beliefs and feelings of guilt to guide them away from a fresh start in bankruptcy. “Pay your debts” is generally good advice, but not for those at rock bottom who have no ability to repay. If it becomes clear that they can’t pay their debts, you have to give them a way out that is achievable, reasonable, prompt, and realistic. They need relief. They have already been struggling for so long. When I meet with potential clients about bankruptcy, the topic of suicidal thoughts comes up surprisingly often. Getting them relief and a fresh start can literally be a life or death issue.  Divorce also comes up a lot.  Getting a debtor relief can also save his or her marriage.  This is serious stuff, with deep spiritual implications.

5. Using Christianity to lead people away from bankruptcy is ironic, because forgiving debts every 7 years comes straight from the Bible. Deuteronomy 15:1 says “at the end of every seven years, you must cancel debts.” This passage was the basis for the practice of debtor’s relief in the ecclesiastical courts of old, which evolved into courts of equity, which were a forebear of modern U.S. Bankruptcy Courts. In my bankruptcy law practice, it has been striking to me how many of the judges, trustees, and attorneys in the bankruptcy legal field are deeply spiritual people.  (Note: Our bankruptcy law says that if you get a bankruptcy discharge, you can’t file bankruptcy again for 8 years.  Until the bankruptcy law changed in 2005, the rule was that you couldn’t file bankruptcy again for 7 years.  If you trace the origin of that 7 year rule, it goes all the way back to Deuteronomy.)

6. It is immoral to borrow if you know you are not going to repay, and it’s also immoral to not repay your debts if you have the money to do so. But it’s not immoral to not pay if you can’t pay. If you borrowed in good faith, with an honest intent to repay, and your plans simply didn’t work out, and you just can’t repay your debts, there is nothing morally wrong with that. Acknowledging facts is moral. Coming to terms with the truth (such as “I am never going to be able to pay off this debt”) is a good thing to do.

7. Dave Ramsey also argues that bankruptcy will harm your credit. That’s hogwash for many reasons.

  • If you are a good candidate for bankruptcy, your credit is already ruined.
  • Also, filing bankruptcy helps your credit recover more quickly because it discharges your debt, thus giving you a better ability to repay any new, post-bankruptcy debt. Creditors like that. Many of my bankruptcy clients have been former realtors, mortgage brokers, and auto salesmen who have been in the business of trying to get people approved for loans.  They consistently tell me that it is much easier to get someone approved for a loan if they filed bankruptcy and waited 2-3 years than if they didn’t file bankruptcy and still have all that old debt and all those late pays on their credit report.
  • Also, you can only file bankruptcy every 8 years, so if you have recently filed bankruptcy, any new lender doesn’t have to worry about you running out and filing bankruptcy. This is  another reason why some lenders SEEK OUT people who have just filed bankruptcy.
  • Also, as Dave Ramsey states so clearly in his books, you are probably better off never borrowing again. So who cares what your credit score is?

8. It is true that the fact that you filed bankruptcy will be on your credit report for 10 years, but most lenders don’t give much weight to events older that 2 -3 years.  They know that many people hit bumps in the road and then get their financial lives bank on track.

I’m not the only person who thinks that Dave Ramsey has missed something important when it comes to bankruptcy. A quick search on the internet lead me to discover several other blogs that discuss the same arguments and opinions I have discussed above.

Common Myths About Bankruptcy

1) Filing bankruptcy will destroy my credit forever.

This is probably the biggest myth people believe when they begin the process of filing bankruptcy.  There are several problems with this myth.

1)  A credit report is merely a list of fact reported by financial institutions to track and assess the risk of their lending.

2) Most people who are filing bankruptcy have exhausted all other avenues, and have taken out lots of debt to support themselves.

3) The best way to have good credit is to pay down your debt, and not miss payments.

4) After you file bankruptcy, you will be able to manage your finances more effectively, and thereby more your credit back towards good standing.

In sum, although filing bankruptcy reflects negatively on your credit report, the bankruptcy clears away the other debts to allow you to move forward living a healthy productive financial life, and in the end will allow to rebuild your credit much faster.

2) Filing bankruptcy will force me to lose everything I have

Although every state is different, all states some version of asset protection referred to as exemptions. The exemptions allow protection of certain assets defined by the individual states.

3) I can file bankruptcy on certain debts but not others.

All assets and all debts MUST be included in your bankruptcy filing.  You can repay any debt after you file bankruptcy, however there is no obligation to repay any discharged.

4) Filing bankruptcy is wrong.

The forgiveness of debt is found in many religions.  Bankruptcy exists as a means for people to begin anew.  There is nothing wrong with acknowledging the reality that you can not repay your debts.

5) Everyone will know that I filed.

The petition filed with the bankruptcy court will be available as a public record, and all creditors will receive notice of your filing.  However, not many people browse the bankruptcy filings to find out who has filed, and most of the creditors who receive notices are banks who just file away the notice.  Consider this, there are more people in the U.S. that file for bankruptcy per year than file for divorce.  Now, compare how many people you know who have filed for divorce with then number of people you know who have filed for bankruptcy.

6) Creditors will continue to harass me after I file.

When you file bankruptcy, the automatic stay goes into place.  The automatic stay is an injunction that halts the actions of your creditors.  This includes the action of contacting you.  Once your bankruptcy is finished and you receive you discharge, you are no longer legally responsible to repay the debts owed before bankruptcy.  It is illegal to collect a debt from someone who does not owe it, and therefore, it is illegal for your creditors to contact you to repay the debts discharged in the bankruptcy.

7) My boss will find out and fire me, if I file bankruptcy.

There is a specific provision in the bankruptcy law that prevents discrimination against people who have filed for bankruptcy.  You are more likely to be fired from a job if you are distracted and worried by a large financial burden.  Moreover, it is likely that creditors will begin to contact you at work if you are unable to pay your debts.  Filing bankruptcy is more likely to save your job than cause you to lose your job.  I’ve been doing bankruptcy law a long time, and I’ve never had a single client come back and say, “Hey thanks a lot, I lost my job because of you.”‘ In fact, the usual reaction after filing bankruptcy is, “Wow.  I can’t believe how good it feels to get a fresh start, and I’m surprised at how painless you made that process.  Thanks.”

Filing Bankruptcy: More Common Than You Might Think

About 1.5 million people file bankruptcy per year.  There are only 300 million people in the United States.  The very rich don’t file, and the very poor don’t need to file because they usually never were able to get credit in the first place.  The very young don’t file bankruptcy either.  So, if you look at middle class Americans, and you consider that over a 40 year span, approximately 60 million people have filed or will file, you start to realize just how common bankruptcy is for the average, middle class American.  I bet that if you walk down the street in the average middle class neighborhood in the U.S., inside every third or fourth home would be a person who has filed bankruptcy, or will file bankruptcy in the future, or who has a child or parent or sibling who has filed.  It is very, very common.

Consider this fact – bankruptcy is more common than divorce.  How many people do you know who have been divorced?  You know more people that have filed bankruptcy, even if you are not aware of precisely who filed and when.

Why Chapter 13’s Rarely Make Sense

In many states, Chapter 13 Bankruptcy is more common than Chapter 7 Bankruptcy. However, in my bankruptcy practice in Texas, I rarely recommend Chapter 13. In this blog post, I will attempt to explain why. (Below, I discuss other states.)

In any state, it is almost always preferable to file a Chapter 7, if you qualify (see my other post on Qualifying for a Chapter 7), because in a Chapter 7 your debts are discharged within a few months. By contrast, in a Chapter 13 bankruptcy, you must make monthly payments for five years to the Chapter 13 trustee (and the trustee distributes those payments pro-rata to your creditors) and only after 5 years do you get a discharge on whatever amount of debt is still owing at that time.

In Texas, there is no wage garnishment (i.e. no deductions from your paycheck by creditors) and the list of exemptions (i.e. the list of stuff that is exempt from levy by creditors- and thus may be kept by you) is very generous. So, the third option (in addition to 7 and 13) of not filing any form of bankruptcy and doing nothing to respond to creditors attempts to collect from you is not such a bad option. This “do nothing option” is sometimes referred to as “informal bankruptcy.”

There are only two situations in which I commonly recommend that a debtor file a Chapter 13 bankruptcy in Texas (or probably any other state that does not allow wage garnishment):

1. Where the debtor is behind on his house and wants to force the mortgage lender to allow him to catch up on his late payments over time.  However, I rarely think this is a good idea because usually if someone has fallen behind on their mortgage payments, they are going to have a tough time getting caught up and staying caught up.

2. The situation in which the debtor makes too much money to qualify for a Chapter 7 but is not comfortable with the informal bankruptcy option, usually because he or she is a person of delicate temperament and is very bothered by the telephone calls from creditors. (NOTE: see my other post on How Creditors Can Attempt To Collect.)

Note: If you live in a state that allows wage garnishment and you don’t qualify for Chapter 7 (usually because you make too much money), then a Chapter 13 might make sense. A Chapter 13 is going to result in a deduction from your paycheck each month for 5 years (i.e. 60 months). The amount of the deduction is roughly the amount of your income in excess of the means test limit (which is more or less equal to the median income amount in your region). So, you have to do some math. Option A is you just allow the garnishment to occur until the debt is paid off. Let’s say your state allows 25% of your paycheck to be garnished, and let’s say you make $4,000 per month. In that case, the creditor is going to be paid $1,000 per month, if you don’t file a Chapter 13, until they are paid in full. Option B is you file Chapter 13 and the deduction from your paycheck will be the amount of income you earn in excess of the means test amount, but it will only last for 60 months and then the rest of the debt will be discharged.

In order to determine whether Option A or Option B is better, you just have to run the numbers. Try to find a bankruptcy attorney who will give you a free or low cost consultation and walk through the numbers with you.

Reaffirmation Agreements – Do They Make Sense?

Is “Ride-Through” still an option for Chapter 7 Debtors?

Prior to the bankruptcy law change in 2005, there was a circuit split (i.e. the courts were divided) as to whether debtors had the right to retain their vehicle and continue making regular monthly payments without signing a reaffirmation agreement in places that allowed “retain and pay.” The debtor’s personal obligation on the note was discharged, and the automatic stay prevented repossession of the collateral. If the debtor defaulted after the bankruptcy, he would not be on the hook for any deficiency after repossession.

Now that BAPCPA has made clear the elimination of the option of “retain and pay,” creditors have the ability to repossess a vehicle even if the payments are current, simply by virtue of the debtor filing a bankruptcy and not reaffirming the debt.

But, do creditors actually take advantage of this option?

The short answer seems to be “no.”

According to the American Bankruptcy Institute’s Reaffirmation Agreements in Consumer Bankruptcy Cases by Daniel Austin and Donald Lassman, “the likelihood of a creditor repossessing the collateral of a debtor who is current simply because a bankruptcy has been filed is very remote” (see pg. 31).

Creditors are almost always better off continuing to accept payments from a bankrupt debtor who refuses to reaffirm, as opposed to repossessing the collateral. Repossessed vehicles only net a small percentage of the loan balance after considering attorney fees, repo fees, storage fees, auction fees, and low market value of a vehicle at auction. So, creditors have very little incentive to expend the time and money necessary to compel reaffirmation. And even if the lender is successful in getting the debtor to reaffirm, there is no guarantee they will be able to collect from a judgment-proof debtor who later stops paying.

Nationwide, only 23% of cases ever have reaffirmation agreements filed in them. In Texas, the percentage is higher. At 37%, Texas ranks in the top four states, along with Mississippi, Alabama, and Maine (see Austin and Lassman pg. 61 & 62). It is hard to believe that so many Texas debtors make a fully informed decision to reaffirm. Reaffirmation agreements disproportionately benefit the creditor. The only up-sides to the debtor are (a) an ability to have timely payments reported on the debtor’s credit report, (b) maintaining a positive relationship with the creditor, and (c) eliminating the very small chance of repossession. Thus, the benefit of discharging your personal obligation to pay an entire auto loan usually greatly outweighs the limited benefits of reaffirmation.

From attorney to attorney, there seems to be a large disparity in percentage of reaffirmation agreements filed for clients. Some bankruptcy attorneys file many more reaffirmation agreements on their clients’ behalf than other attorneys. This is further evidence that something is amiss. Clearly, a large number of debtors are reaffirming debts that they do not really have to reaffirm. If you do not reaffirm, and the lender fails to repo while your bankruptcy case is still open, it is arguably too late for them to repossess on the basis of your bankruptcy. In other words, you can argue that they have waived the default you committed by filing bankruptcy, and thus can not lawfully repo the vehicle unless you create a new default by missing a payment or failing to maintain insurance, etc.

Granted, a small calculated risk must be accepted by the debtor when he chooses not to reaffirm. However small the chance may be, there is a possibility that the debtor’s vehicle will be repossessed even if he is current on the payments. Debtors should be cautious in choosing an attorney who will look out for their best interest when dealing with reaffirmation. Debtors should be wary of anyone who is too eager to have them reaffirm.

Making a sound financial decision should take priority over a personal attachment to a car, or a debtor’s strong desire to have their payments reported to the credit bureaus. In practice, the “ride-through” option has not been completely eliminated, and should be fully explained by the debtor’s attorney before a reaffirmation agreement is hastily signed.

Qualifying for a Chapter 7

When we evaluate a bankruptcy case to determine whether it qualifies for a Chapter 7, we first look at three major questions. We practice in Texas, but all three of the considerations below apply in every state. The only difference outside of Texas is that different exemptions apply, and that may change the answer to #2 a bit.

1. How much unsecured debt (credit card, medical, signature loans, personal lines of credit, etc.) does the debtor have?
It costs over $2,000 to file bankruptcy when you include all of the attorneys fees, filing fees, required classes, credit reports, etc. So, unless a debtor can discharge $10,000 or more, we generally don’t recommend filing bankruptcy.

2. Does the debtor have any non exempt property?
Exempt property is property that is exempt from levy by creditors. In other words, exempt property is property that can not be touched by creditors. Non- exempt property is anything you own that is NOT exempt. Thus, “non-exempt property” is the property that creditors CAN TAKE. If a debtor has a large amount of non exempt property, which will be taken if he files bankruptcy, then it is usually not advisable to file bankruptcy.

The determination of what is exempt and not exempt is complex. The first complexity is that some states are “choice states” and others are not.  Texas, where we practice,  is a choice state that allows you to choose between the state list and the federal list of exemptions.  Some states require you to use the state list, and other states require you to use the federal list.

Let me explain this “choice state” thing a bit further, using Texas as an example.  There is a list of exemptions in the Texas Property Code. And there is another list of exemptions in the Federal Bankruptcy Code. If they get sued in the ordinary course of life, outside of a bankruptcy context, Texans can only exempt the types of property listed in the Texas Property Code exemption list. However, a Texas resident who files bankruptcy gets to choose the Texas list or the Federal list.

Generally speaking, the Texas list is more generous (ex. unlimited homestead protection), but it contains no exemption for cash (which means the debtor has to have empty bank accounts on the filing date or lose his cash to the trustee) and the Texas exemptions also contain no “wild card exemption” (i.e. a kind of exemption that can be applied to anything up to a certain value limit).

The federal list is generally less generous than the Texas list, but contains approximately $10,000 per person of “wild card exemption” which can be applied to any kind of property, including cash.

So, choosing between the Texas list and the federal list is going to depend upon what assets the debtor has.  If he has a big house that is paid off (and thus he has a lot of equity in the house), he has to use Texas exemptions to protect his house.  If he has very little in the way of assets, he will probably use the federal list so that he can use wild card exemption on the cash in his bank account and avoid the hassle of having to schedule his bankruptcy filing for a certain date when he is out of money and before his next paycheck arrives.

3. What is your income level?
In order to file bankruptcy, a debtor must pass the Means Test. Generally speaking, your income can be at most 5-10% or so above the median income for your county and your household size. To give you an idea of what that means, the current Travis County, Texas (where Austin is located) median income for a household size of 1 is about $38,545, for a household size of 2 it is $54,908, for 3 it is $57,053, and for 4 it is $66,400. Keep in mind that if you are married and you and your spouse both work, then both of your incomes must be counted against this household median income level. As with everything to do with bankruptcy, the calculation of the Means Test is complex (certain deductions apply, and certain kinds of income such as Social Security are not counted). It is absolutely essential that you consult with an attorney before making any decisions.

The determination of whether someone qualifies for a Chapter 7 is a complex one and the above three factors are only the first level of analysis that we do.

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