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How do I prevent financial errors that lead to bankruptcy?

Financial missteps before bankruptcy may prove costly

Robbing Peter to pay Paul is more than an old adage when it comes to people filing bankruptcy. It's also a major reason why people become so overwhelmed by debt that they need to seek relief from the U.S. Bankruptcy Court.

When confronted by a pile of bills, many debtors may be tempted to use whatever resources they have to stave off bankruptcy. However, some financial decisions could be more costly in the long run, warn legal experts.

Among the worst moves that people can make is to use the equity they have built up in their homes to pay off mounting debts. Consolidating bills by obtaining a home equity loan or taking out a second mortgage to pay off unsecured credit cards may result in having to pay higher interest rates for what amounts to a temporary fix.

Not only does it place the most important asset they own at risk, but a debtor's home equity is often protected from creditors in bankruptcy, according to the Jankins Law Firm in Iowa. Instead of preserving their equity with the court's protection, they have used it to pay off unsecured debts that the court will discharge when the case concludes.

Ignoring creditors

Attorney Kevin Chern, co-founder of TotalBankruptcy.com, advises debtors who are contemplating bankruptcy not to ignore lawsuits that have been filed against them by creditors.

"Until your bankruptcy case is filed, any pending legal action will continue to move forward. It's important that you protect your rights and your property from liens until a stay from the bankruptcy court takes over," he writes on Opposing Views.

Many debtors may be inclined to pay off loans to friends and family members instead of what they owe to institutional creditors because they don't want those closest to them to be hurt in a bankruptcy action. However, the courts take a dim view of preferential payments since creditors, personal and otherwise, are expected to be paid a proportional share by debtors.

If payments to close associates are made within the year before bankruptcy is filed, the court trustee overseeing the case is allowed to recover money already paid and divide it among all creditors.

Retirement funds

People in deep financial trouble also may turn to a retirement plan for a loan to pay off their debts. Like a home, it often is protected in bankruptcy. Once it is tapped for paying off debts from credit cards or medical bills, it is gone. Even when the loan is repaid, the debtor has lost interest earnings from the retirement fund that would have been generated if it had been left alone.

"The lost earnings that a person would experience from borrowing from their retirement to pay credit card debt will never be recouped," states the Jankins Law Firm.

Using cash advances and credit cards to pay off older debts is also ill-advised if those charges are run up right before filing bankruptcy. Recent debts - those occurring 90 or fewer days before a filing - are rarely discharged by the court.

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