Bankruptcy and Divorce in Colorado

Summary:  Consider options such as bankruptcy or the sale of assets such as real estate in order to pay off debt. Debt is often one of the major reasons for divorce. Plan to eliminate or reduce it before the decree is final. You must consider the bankruptcy option early, since it may be too late to discharge some debt if you wait until after the divorce decree is final. In most cases, the 2005 change in the law requires that a Chapter 7 bankruptcy be filed before a divorce is final to discharge the maximum amount of debt. Be extremely care of credit counseling agencies.

Divorce and Debt

For many Colorado divorcing couples, their debt is a primary reason for the divorce. Particularly medical debt, home mortgage, credit card debt, vehicle purchase, vehicle lease and purchase loans, other unsecured purchases, and income taxes.

When the separation from one household to two separate households is considered, there is generally a significant shortage of income to pay the increased housing as well as the existing marital debt. And sometimes additional health insurance and day care expenses are incurred.

Debt for Divorcing Couples Can Be Reduced By:

1. Selling assets to raise cash to pay the debt;

-  Assets can be sold, but income tax must be paid on any gain on the sale

2. Liquidating retirement assets, such as an IRA or 401(k) account to raise cash;

-  Although this should be considered, your retirement assets can be kept if debts are discharged in a bankruptcy filing.

-  However, avoid liquidating retirement assets if possible.

3. Negotiating with creditors to reduce the debt;

-  Generally creditors will not all negotiate, and a later default will result in a much higher interest rate, and a potential inability to later take bankruptcy.

-  Because of the 2005 change in bankruptcy law, creditors now are less likely to agree to lower interest rates.

-  For most people, this is not a viable alternative (even though the consumer counseling advertisers say differently).

4. Bankruptcy.

-  Under the new 2005 law, any bankruptcy which discharges marital debts which are allocated in a divorce decree cannot be later discharged in a Chapter 7 bankruptcy.

-  In other words, bankruptcy should be done to eliminate the debt before the divorce decree is final. If you wait, you can lose.

Tip: Credit counseling organizations mislead the public and often damage your finances and credit rating. Some advertise that they are nonprofit agencies created to help consumers. The truth is, they are agencies for credit card companies which are encouraging you to avoid filing bankruptcy. My experience is that they are a rip-off. The Federal Trade Commission agrees.

See another page on this site for more on credit counseling agencies. If the debt cannot be paid, then a creditor will eventually take a court judgment and garnish your wages.

If real estate loans are in default, the lenders will foreclose and sell the property. They then will obtain a judgment against you for any remaining loan balance due after the foreclosure. Just like any other unpaid debt, they can garnish your wages.

For many couples, bankruptcy may be the only viable option to financial survival. In many cases, bankruptcy allows you to retain all your personal property, even though all of your unsecured debt is eliminated.

The Benefits of a Bankruptcy For a Divorcing Couple Include:

1. The elimination of unsecured marital debt (such as credit card and medical) and any deficiency of a secured debt. For many couples, there is no other way to survive.

2. The elimination of vehicle leases and/or reduction of car purchase loans;

3. The elimination of court judgments;

4. The protection of your wages from garnishment;

5. The elimination of back income taxes (generally those more than 3 years old);

6. The re-establishment of credit, sometimes rather quickly; and

7. After 2 years has elapsed since a bankruptcy discharge, you can qualify for a federally-insured home mortgage and be back on your feet.

In other words, do some financial planning in order to reduce or eliminate your debt. Don’t wait until after your divorce to consider bankruptcy, since marital debt allocated in a divorce decree is now (as of October 2005) nondischargeable in bankruptcy.

Also, be aware that any forgiveness of debt is taxable income to you, even though you never receive any money. Unless the forgiveness of debt occurs in bankruptcy or you can prove that you are insolvent at the time of the forgiveness. Accordingly, the IRS requires that a creditor issue a Form 1099 to you so that the forgiveness of debt is reported as income. Credit card debt reduction and a mortgage deficiency write-off (such as giving a deed in lieu of foreclosure) are prime examples where you may have to pay income tax on the amount of debt forgiveness.