Dear Penny: Can I Get Debt Forgiveness if I Owe $50K From Bailing Out Family?

Dear K.,

When you don’t have much hope of paying off debt, bankruptcy is often the best route. I think that may be the case here, given that you have $50,000 debt and not much income.

You could try credit counseling first with the goal of making your debt more manageable. (If you’d decide to pursue bankruptcy, a credit counseling course will also be required.)

A credit counselor won’t get your debt forgiven, but they may be able to help you by rolling all your debts into a single monthly payment. Or they might negotiate with your creditors to allow you to pay off your balances over a longer timeframe. The websites of the Financial Counseling Organization of America and the National Foundation for Credit Counseling (NFCC) are two good resources for finding a reputable credit counseling service.

But if you can’t afford your debt payments, bankruptcy is probably the most viable option. Chapter 7 bankruptcy, also referred to as liquidation bankruptcy, allows people with limited incomes to discharge much of their unsecured debt, like credit cards and personal loans. This isn’t a decision to enter into lightly, but it sounds like you’ve done your homework. The point of bankruptcy is to allow people a clean slate when their debt has become unmanageable.

You’re typically considered a good candidate for Chapter 7 if your unsecured debt adds up to more than half of your income, or if it would take you more than five years to repay your debt.

One of the biggest downsides to bankruptcy is the impact on your credit. But often by the time someone files bankruptcy, their credit has already tanked.

A Chapter 7 filing stays on your credit reports for up to 10 years, but the impact on your credit score will start to fade after the first two years. You could start rebuilding your credit immediately after the bankruptcy is discharged by getting a secured credit card, where you put down a deposit that becomes your line of credit.

If you decide bankruptcy makes sense, be sure to consult with an attorney ASAP. This is especially important since you’re in the middle of a divorce, which could complicate things. Some offer a free consultation or will offer one for a reasonable fee. If you have assets like a home or a car, make sure to ask about whether you’d be able to keep them — which is often possible in Chapter 7.

Two points of caution here: First, you may see companies that advertise “debt relief” or “debt forgiveness.” Stay away.

What these companies often provide is called debt settlement. Essentially, you stop making payments to your creditors and pay the debt settlement company instead. Once you’ve stopped making payments (and killed your credit score in the process) the company swoops in and negotiates a settlement on your behalf. At this point, since your creditors aren’t getting paid, they’re often willing to accept a lower amount because getting something is better than nothing.

You’ll pay the company a fee, usually a percentage of the balance they got forgiven. Plus you owe ordinary income taxes on any amount that is forgiven.

My other big concern is that you could wind up in this situation again. It sounds like you have trouble saying “no” to family members. That’s a habit you’ve got to break if you’re going to rebuild your finances. Make it a policy that you don’t lend money to anyone moving forward. That may seem harsh, but it’s the only way to avoid a repeat of this situation.

Many people find that rebuilding their finances post-bankruptcy is quite doable. With patience and firmness on your part, I think you can find the fresh start you need.

Robin Hartill is a certified financial planner and a senior writer at The Penny Hoarder. Send your tricky money questions to [email protected].