Debtor and Creditor

Debt and Credit FAQs

By Tom Pedreira, Attorney

Q: Can I change my mind after I sign the paperwork on a loan?

  • A: There are consumer protection statutes that sometimes give borrowers a cooling off period where they can change their minds. The Truth in Lending Act, for example, gives a consumer the right to cancel certain real estate loans within three business days without penalty. But these protections will usually apply only to limited consumer transactions. The chances are that they won't apply to a business or commercial loan.

Q: Does it make any difference if I'm dealing with business debt?

  • A: While the concepts are largely the same, it can make a huge difference, depending upon how your business is organized. One of the reasons people incorporate, for example, is to separate business debts and obligations from their personal financial situations. Business debts of the corporation are not necessarily personal debts. If you have no personal responsibility for the debts of your business, you may elect to deal with them in a manner entirely different than would be the case if creditors could come after you directly and seek to be repaid out of your personal assets.

    The reality of the situation for many small businesses is that they're being operated as sole proprietorships, which means that the owners can be held personally liable for the debts and obligations of their businesses. Even if they're incorporated, creditors may insist on personal guarantees, which is a method to make sure that the owners are on the hook personally for any credit extended to the business. But incorporating may still make a lot of sense, because the corporate entity can still serve as a very effective shield against such things as negligence claims or other wrongful acts of employees, and other types of debts or obligations where there are no personal guarantees in place.

Q: Does it may any difference what kind of property is put up for collateral?

  • A: Yes. There are big differences in the rules that apply to personal property versus real estate. While the distinctions sometimes get blurred, the term "personal property" refers to equipment, household goods, vehicles and most anything that is not a land or a building. Land and buildings are real property.

    On a loan secured by real property, the lender will want a mortgage from you. In some states, this is called a deed of trust. Whatever the document is called in your state, it gives the lender the right to foreclose on the property if you default.

Q: How do I go about trying to restructure or consolidate my debts?

  • A: Most people don't have the expertise or practical knowledge needed to negotiate with creditors on a debt restructuring or consolidation. So creditors are less likely to work with you, and you probably aren't going to get very far on a debt consolidation or restructuring without hiring a professional to help you out. There are debt-counseling services that may be able to help you come up with a plan that your creditors as a group will accept. Creditors would rather that you not file bankruptcy, since they may then get nothing. However, creditors are usually of the mindset that no one of them is going to accept a compromise on a debt unless they all do. The threat of filing bankruptcy and having a debt counselor who knows the ropes may just be the leverage you need.

Q: How much interest can a bank charge?

  • A: The lending industry is heavily regulated on what can be charged for interest rates. Each state has maximum limits that can be charged. The limits are usually established on the basis of annual percentage rates applied to the outstanding principal balance on a loan. Banks and other financial institutions are usually allowed to charge higher rates, but they must go through a rigorous licensing process before they're allowed to do so.

    The charging of excess interest is call "usury." If you're charged too much interest, the penalty is sometimes that all interest is waived. This is most likely to happen with a loan between private individuals. Banks and other financial institutions are generally sophisticated in their lending practices not to step over the line on assessing interest.

    There are also lots of ways to assess loan charges that technically may not be considered "interest." Common examples would include late charges, charges for exceeding your credit limit, charges for excessive use of leased property.

Q: How the heck do I afford a lawyer when I'm already strapped for cash?

  • A: In the grand scheme of things, financial advisors have ways of working out payment arrangements for people like yourself and whatever you pay them may be money well spent. This usually involves paying your advisors with money that might otherwise have gone to pay your unsecured creditors. The logic is that it is better to reallocate the resources to pay for good representation, rather than continue to pay on an unsecured debt that you're going to try to restructure, consolidate or otherwise discharge in bankruptcy.

    Using this logic, for example, a bankruptcy lawyer is going to require being paid up front. If you know you're going to file bankruptcy, you can plan ahead to pay your lawyer rather than someone else. (If you pay your lawyer up front before you owe anything, the lawyer is not one of your creditors!)

Q: Is borrowing money from friends or relatives a good idea?

  • A: Pride alone should not keep you from asking friends or relatives to co-sign for you or loan you money. However, you should approach the matter with the assumption that your relationship with anyone who steps to the plate will be ruined forever if you're unable to pay back the loan. So you may want to think twice if the loan would only be a quick fix to your credit problems and you may end up in bankruptcy anyway. Even if the loan would solve your immediate credit problems, you should also have a job and a steady income that would allow you to pay the loan back.

Q: Is it a good idea to contact my creditors if I'm having financial problems?

  • A: Absolutely. If you aren't straight with your creditors, it's only going to make matters worse. Believe it or not, your creditors don't want you to file bankruptcy, and would rather try to work with you rather than against you.

    One mistake to avoid, though, is calling up a creditor and not knowing what you're going to say. Write out a summary of what you want to discuss. Let a creditor know what is going on and try to suggest solutions. Examples would include:

    • A temporary reduction in payments
    • Skipping a few payments and adding them on at the end of a loan
    • Skipping a few payments and paying them off over a few months
    • Writing off late fees and other charges
    • Restructuring the loan completely

    Again, get help before trying to tackle this alone.

Q: On what basis can a bank turn me down for a loan?

  • A: Banking is regulated by many federal and state laws and regulations, including laws prohibiting discrimination in lending practices. These laws are designed to help protect consumers from shady leaning practices. But there are so many valid reasons a bank could turn you down for a loan that it would be a rare case where you could prove it was for an illegal reason. One of the most common reasons is that you don't meet one of their conditions for extending credit. Prior credit history (or lack thereof), too much existing debt, or not enough collateral are often reasons given.

Q: Should I file bankruptcy?

  • A: It is relatively easy to file bankruptcy and it will give you some immediate relief. However, the long-term consequences can be much more difficult.

This is not an easy decision, and you should first exhaust all other options. There are also different types of bankruptcy proceedings, so the decision may not be as simple as you think. Furthermore, the decision is also one that you shouldn't make without first getting financial and legal advice.

A primary purpose of the bankruptcy laws is to give relief to people whose financial problems have become so severe that they cannot deal with them any more. You may want to file bankruptcy if there's a black cloud of credit problems hanging over your head that just won't go away. In these situations, the relief of filing bankruptcy will usually outweigh the inevitable drawbacks (for example, hurting your credit history and being embarrassed).

If you're even thinking that you may be at the point of filing bankruptcy, you should absolutely go to see a bankruptcy attorney and do as much pre-planning as possible. It would also be very helpful to read up on FAQ's and other information geared specifically to the bankruptcy laws.

Q: So how do I prepare for meeting with someone to talk about my credit problems?

  • A: It can be a big waste of time to meet with someone and not be prepared. If your legal or financial advisor is charging by the hour, which many of them do, being unprepared may also end up costing you money, because they'll have to spend more time getting up to speed on your matter. With this in mind, here are some things to pull together as part of your financial summary:

    • All of your contact information
    • Your personal and business background, and a description of your business and how is it organized, if applicable.
    • A list of all present income sources and any expected changes in the future. A copy of recent W-2 wage and tax statements would be helpful.
    • A list of all your debts and obligations
    • If you're going into bankruptcy, it will be necessary to file detailed schedules with the bankruptcy court. If you are meeting with a lawyer, for example, you may be asked you to try to fill out the schedules before your meeting Sometimes, you may also be asked to fill out a questionnaire before meeting with someone. If this happens, be sure to fill out the questionnaire and send it in before your meeting. Also send along copies of any available documents that may be requested in the schedules or the questionnaire.
    • Written documentation of your debts and liabilities is especially important. Thus, even if a lawyer doesn't ask for documentation beforehand, it is still a good idea to bring a copy of all documents relevant to your situation to the meeting. Spend some time thinking about what you may have on hand. Try to organize the documents in a logical manner before your meeting. Put together the originals and a copy of any and all loan or financing documents that you have in your possession. In the case of a loan, these documents may include a loan agreement, title policies, insurance policies, a promissory note, a security agreement, guaranties, "UCC" filings, deeds of trust, mortgages, and notices of default.
    • If you are a party to a lease, bring the lease itself
    • A copy of your recent tax returns would also be helpful
    • Bring any information you have to show payments you made (for example, bank statements, canceled checks, money order receipts)
    • If you are involved in a foreclosure proceeding, bring a copy of all foreclosure documents that you have received
    • Bring the originals and a copy of all correspondence that you may have sent to or received from your creditors
    • Dates can be critical. Get a calendar and mark down dates of when things happen and when you receive any notices or other documents. Bring the calendar to your meeting to use as a reference.
    • If anybody guaranteed a loan or a lease for you, your advisor will want to know who the guarantor is. You should have this information available, as well as a copy of any guaranty documentation.
    • Your advisor may also want to know who you talked with, including the names of any representatives at the financial institution. You should have names, addresses, and telephone numbers available.

Q: What can a bank do to collect a past due debt?

  • A: A creditor can try to collect the debt directly. The collection process usually starts by telephone calls, followed up with letters. Ultimately, most creditors will end up turning the obligation over to a collection agency. The collection agency will usually be paid a percentage of up to 50% of whatever they collect on a debt.

    The Fair Debt Collection Practices Act requires that debt collectors treat you fairly and prohibits certain methods of debt collection. Of course, the law doesn't erase any legitimate debt you owe. Personal, family, and household debts are covered under the Act. This includes money owed for the purchase of an automobile, for medical care or for charge accounts. However, a business or commercial loan may not be covered by the Act.

    The Act specifically applies to any debt collector, who is defined as a person who regularly collects debts owed to others. This includes attorneys who collect debts on a regular basis.
    A collector can contact you in person, by mail, telephone, telegram or fax. However, a debt collector may not contact you at inconvenient times or places, such as before 8 a.m. or after 9 p.m., unless you agree. A debt collector also may not contact you at work, if the collector knows that your employer disapproves of such contacts.

    There are ways to stop the collection process. You can stop a debt collector from contacting you by writing a letter to the collector telling them to stop. Once the collector receives your letter, they may not contact you again except to say there will be no further contact, or to notify you that the debt collector or the creditor intends to take some specific action. However, sending such a letter to a collector does not make the debt go away if you actually owe it. You could still be sued by the debt collector or your original creditor.

    Debt collectors can't:

    • Harass
    • Oppress
    • Abusing you or any third parties they contact
    • Use any false or misleading statements when collecting a debt

    You have the right to take your own legal action by suing a debt collector in a state or federal court within one year from the date the law was violated. Court costs and attorney's fees can also be recovered. But you would probably have to have a really strong case before a lawyer would be willing to represent you on a contingency fee basis. If you have problems with a debt collector, though, another option would be to report the matter to your state Attorney General's office and the Federal Trade Commission. Many states have their own debt collection laws, and your attorney general's office can help you determine your rights.

Q: What is a lender required to tell me up front about the terms of a loan?

  • A: Lenders are required to tell you certain things before you sign on the dotted line. The Truth in Lending Act, for example, requires disclosure of the essential terms and costs of a loan, including:

    • The annual percentage rate, points and fees
    • The total of the principal amount being financed
    • The payment due date and terms, including any balloon payment where applicable and late payment fees
    • If there are variable interest rates involved, the Act requires that you be told the highest rate the lender would charge, how it would be calculated and the resulting monthly payment
    • The total finance charges
    • Whether the loan is assumable
    • The amount of any application fee
    • Any annual or one-time service fees
    • Pre-payment penalties
    • If you are taking out a loan secured by collateral, the lender may also be required to confirm for you the address of the property securing the loan

Q: What is the worst thing that can happen to me on an unpaid debt?

  • A: There are laws that make it a crime to intentionally provide false information to a lender when obtaining a bank loan. Assuming you don't have any concerns about criminal fraud or other intentionally wrongful acts, the worst case scenario is usually that the lender or a collection agency can foreclose on collateral, if any, and sue you (and any guarantor) to recover amounts owed on the debt. This may force you into bankruptcy, where you may be able to discharge the debt.

Q: What kind of loan documents will I need to sign if I want to borrow money?

  • A: Typically, you'll be asked to fill out a loan application with credit information about you the lender will rely on in deciding whether to make you a loan. If you're judged "credit worthy," the lender will prepare a loan agreement that sets forth the general understanding and agreement of the parties. It will also contain provisions requiring you to guarantee that the information you've provided is true and accurate.

In addition, a promissory note is usually the most important document that you'll be asked to sign. It will set out the critical terms of your loan, such as the principal amount borrowed and the interest rate. Most fundamentally, the promissory note will also set forth what is usually an unconditional promise on your part to pay back money in accordance with the terms of the loan.

If you're being given an unsecured loan, there may not be a lot of other documentation that you'll be asked to sign. If the lender is giving you a secured loan, you'll be required to sign additional documentation to given the lender a security interest in property that will be collateral for the loan. This will give the lender a lien on the property, with the right to repossess or foreclose on the property if you default on the loan.

Q: What makes me legally obligated to pay back a debt, and what is the extent of my liability?

  • A: If push comes to shove, the reason you can be forced to pay back a loan is because it is a legally enforceable contract. Courts enthusiastically enforce contracts in order to protect the expectations of the contracting parties.

A loan can be enforced in court even if it's based only on an oral understanding, such as might be the case of someone helping out a friend in a pinch. However, banks and other financial institutions are in the business of loaning money, so they will always reduce the terms of their loans to writing in order to make sure that there is no misunderstanding as to how they are supposed to be repaid.

The extent of your liability can vary significantly, depending on the obligation. If it's a business debt and your business is incorporated, you may have no personal responsibility for the obligation unless you personally guaranteed it. On a secured loan, the question of your personal responsibility for repaying it depends on whether it is recourse or non-recourse. With non-recourse, it generally means that the lender can only foreclose on the collateral for repayment in the event of a default. In some jurisdictions, it is also the case that a lender on a mortgage taken out to buy a home may not be able to come after you personally, but can only foreclose on your home.

Sometimes, there's more than one person obligated on a loan. If it's a joint and several obligation, the creditor could come after one of the debtors, some of the debtors or all of the debtors. If an obligation is guaranteed, the terms of the guarantee may require the creditor to go against the primary debtor or foreclose on collateral first before coming after you if you happen to be the guarantor. Chances are, though, that you signed a guarantee that allows the creditor to come after you at any point in time.

Debt collection rules are very complicated and you are a sitting duck in a creditor's eyes if you try to resolve them on your own. It really pays to seek professional advice to see just what your options are.

Q: What options do I have to try to fix my credit problems?

  • A: The options available to you will very much depend upon the type of debt you have and what your debt burden is relative to your ability to pay your obligations. The options that are generally going to be available to you, short of sticking your head in the sand, will boil down to the following:

    • Debt restructuring or consolidation
    • Borrowing more money, possibly from friends or relatives
    • Selling assets to pay off debt
    • Surrendering collateral or assigning it for the benefit of your lenders
    • Negotiating compromises with lenders
    • Filing bankruptcy

Q: What questions should I ask when I meet with someone about my credit problems?

  • A: Prepare a list of questions to take with you to your first meeting. You have to feel comfortable with the lawyer or whoever else is helping you. Remember that they are working for you. You want someone who is skilled, but you also have to get along with your advisor. Don't feel that any question is too silly to ask. Questions to ask a lawyer, for example, would include:

    • Should you fight the creditor or is it a lost cause?
    • Should you consider filing bankruptcy?
    • What might your other options be?
    • How many similar cases has he or she handled?
    • What percent of his or her practice is in the area of expertise that you need?
    • Does he or she usually represent debtors or creditors?
    • What problems do they foresee with your situation?
    • How would they handle your situation? What is the process?
    • How long will it take to bring the matter to a conclusion?
    • How do they charge for his or her services?

    Q: What should I do if I'm over my head in debt?

    • A: A financial crisis isn't the end of the world. There are no longer debtor prisons in civilized societies, and laws give you ways to deal with financial problems. In the worst-case scenario, a person buried with debt can obtain immediate relief by filing bankruptcy. Short of taking this route, there are many options available to people who are over their heads in debt.

      There are many reasons a person can end up being mired in debt. Sometimes the reasons are beyond your control, such as when unexpected medical expenses arise. In other situations, a business may have failed, you may be going through a divorce, or you may be affected by a substance abuse problem. Or you may simply be one of millions of people who simply over-spend. Regardless of the reason, the law gives you a remedy if you're willing to make the necessary sacrifices and do the work to resolve your financial problems.

      Before even worrying about the legal consequences of not being able to pay back all your debts, the first thing you have to do is shut down your spending. Cut up your credit cards and pay for everything in cash. Draw up a household budget and stick to it. Eat at home. Develop an austerity program. Control your spending.

      Next, you have to come up with a game plan on how you're going to deal with your debt. You can begin by gathering up all your financial records and organizing them. Next, you want to prepare a financial summary by putting it all down on paper. Start out by listing all your present sources of income and any anticipated changes in the future, good and bad. Then list information about all of your debts, including the creditor, the type of debt, the amount owed, interest rates, repayment terms, collateral, and who is responsible for repaying the debt. Don't forget about taxes you may owe.

      Having this information at your fingertips will hopefully bring things into focus for you in terms of how to deal with your debt. Perhaps more importantly, though, it gives you a concise financial picture that you can use to get advice from others on how to deal with your problems.

      There are many paths you can take and the decisions won't be easy. So don't try to resolve all your problems by yourself without first seeking advice from people you can trust. For practical advice and moral support, you'll probably first want to talk to your parents, siblings or even close friends. Keep in mind, though, that they may find it difficult to give you objective advice.

      Before you get too far down the road, you'll want advice from professionals who deal with these types of problems on a day-to-day basis. These people would include:

      • Lawyers
      • Accountants
      • Debt counselors
      • Financial planners
      • Intervention counselors
      • Financial planners
      • Financial mediators
      • Insurance agents
      • Bankers or mortgage loan brokers

      If they are given concise and accurate financial information, financial advisors may be able to quickly diagnose the situation and lay out your options. You may even be able to get some preliminary help for free. But you should have the expectation of having to pay these advisors at some point if you're truly going to benefit from their services. In the grand scheme of things, financial advisors have ways of working out payment arrangements for people like yourself and whatever you pay them may be money well spent.

    Q: What types of debt are there and why does it may any difference?

    • A: Everyone knows that having a debt means that you owe money to someone who is called a "creditor." But there are many ways a debt can arise, and not all debts are the same in terms of your legal obligation to pay the debt. The options available to a creditor to try to collect the debt will also depend upon what kind of debt it is.

    Most of your debts probably arose because you agreed to them. You may have financed a car, which means that a creditor loaned you money to buy it. You may have signed up for a credit card, which means that the creditor extended credit to you on purchases using the card, with your agreement to repay the creditor under the terms of the credit agreement you signed. Sometimes, a debt arises more indirectly, such as when you co-sign on a loan as a guarantor.

    A debt can arise even if it is based on an oral understanding, such as paying someone to mow your law or clean your house. It could even be an implied understanding, such are when someone gives you something or renders services on your behalf in expectation of being paid. An example would be medical services in an emergency.

    In other instances, the law may impose a debt obligation on you without any agreement. The best example of how this might happen would be under tort law, such as when you are at fault in an accident. In such a situation, you could be found negligent and held liable for injuries you caused. This liability becomes a debt that you owe.

    Debts break down further into "secured" and "unsecured" obligations. A "secured" obligation means that you have agreed to give a creditor a lien on some of your property. This makes the property "collateral" that a creditor can take if you default on your obligation. Sometimes, you can offer the same collateral to more that one creditor, such as when you take out a second mortgage on your house. It then becomes a priority issue between the creditors to decide which one would be able to foreclose first in the event of a default.

    One benefit of a secured creditor is being able to foreclose on its collateral to the exclusion of unsecured creditors. Furthermore, an unsecured creditor's right to foreclose on collateral generally survives even if the debtor files bankruptcy. On the other hand, unsecured debts can be written off and "discharged" (gotten rid of) in a bankruptcy. So a debtor in financial trouble may be more inclined to pay secured creditors than unsecured creditors.

    Q: What types of loans do creditors use to extend credit?

    • A: The simplest way a creditor can loan you money is with a demand loan. This means that the loan is payale any time the lender gives you proper notice demanding payment Given that there's a significant degree of risk involved in running any business demand loans are quite common in business settings where lenders want the security that they can "call" their loans at any time.

    Another common type of financing is a term loan where you borrow a specific amount of money and promise to pay it back over a period of time. The amount you borrow is called the principal. A term loan is usually repaid in installments each of which is first applied to accrued interest with the balance being applied to reduce the outstanding principal balance. The timing of installment payments over the term of the loan is called the amortization schedule.

    A line of credit is a non-binding commitment by a lender to lend up to a specific amount from time to time. Lines of credit usually don't exceed one year but may be renewed yearly if the lender wants to.

    A revolving credit loan is similar to a line of credit and is what you have on your credit cards. The lender commits to loan up to a specific amount from time to time as required by the borrower. Unlike a line of credit agreement the bank is obligated to lend the amount requested by the borrower as long as the borrower is in compliance with all the terms and conditions of the loan agreement. Amounts borrowed and prepaid may be re-borrowed during the term of the agreement so long as the total amount of borrowed funds at any one time isn't more than a preset maximum amount. Revolving credit loans often have other requirements regarding renewing the loan or requiring repayment of the entire amount of the loan.

    If you put up collateral for a loan it is called a secured debt . If there is no collateral it is called an unsecured debt. Although both types of debt are enforceable a secured creditor has the leverage of collateral to fall back on if there is a default. On the other hand unsecured creditors oftentimes find themselves at the end of the line when financial problems arise.

    Q: What's the difference between debt restructuring and debt consolidation?

    • A: A debt restructuring usually entails working with a creditor to change the terms of a loan. This may involve:

      • Reduced payments over a longer period of time
      • Skipping payments for a few months and tacking them onto the end of the loan
      • Compromising the debt by writing off certain charges such as late fees of interest

      While creditors are very hesitant to write off the principal amounts on their loans they may do so if it looks like the best way to get paid something back on a debt that may otherwise be discharged completely in a bankruptcy.

      A debt consolidation usually entails lumping debts together into a new loan. The goal is to secure more favorable terms of repayment. A common approach for example is to take out a term loan at a lower interest rate to pay off credit card debt and other obligations where interest rates are high and terms of repayment are unfavorable.

      But you must be able to offer the consolidation lender some type of assurance that the new loan is going to be repaid. This assurance usually comes in the way of being able to offer up collateral to the lender in the form of a lien on your property in order to secure the loan.

      In addition the lender will usually insist on having a lien with the highest priority which would give the lender the right to foreclose on the property before anyone else if you default on the loan. This goal can sometimes be accomplished by paying off other secured lenders and by taking over their collateral position. If this can't be done though another option would be to get someone like a family member to guarantee the loan.

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