7 Tough Questions About Debt, Answered

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We've all heard the tales of financial woe that befall people who fail to pay their debt, die without a will, or go through a nasty divorce. But what is the truth? Is there a such thing as credit jail? Can filing bankruptcy give you a clean financial slate? Are you responsible for an ex spouse's debts?

We're answering some of your most pressing debt questions. As always, it's important that you do your own research — each situation is different and laws and regulations change on a case-by-case basis. This is your jumping off point. Now, let's get started.

1. Is failing to pay debts ever a jailable offense?

The quick answer to this question is no. And to take it one step further, according to the Federal Trade Commission (FTC), it is against the law for debt collectors to threaten you with incarceration.

You can be sued for the debt, your wages can be garnished, your bank accounts frozen, your assets seized, and a whole slew of other nasty things can befall you for failing to pay, but going to jail isn't among the list of possible consequences.

The caveat and exception to this rule is if you owe child support or taxes. The IRS usually doesn't impose jail time for nonpayment. Incarceration is reserved for those who lie, cheat, and try to defraud the system. In both cases — tax evasion and failure to pay child support (technically contempt of court) — you have options. You can, in most cases, maintain your freedom while you catch up — but you have to be proactive and compliant. (See also: Here's What Happens If You Don't Pay Your Taxes)

2. Should I borrow from retirement to pay off debt?

This is a tricky question and the answer can vary based on your situation. In most cases, the answer is no.

Most financial advisers will tell you there are a plethora of options you should explore before tapping your retirement accounts. You should seek to exhaust these options before borrowing against your 401(k) or raiding your IRA. You may be hit with early withdrawal fees and you could seriously derail your future earnings.

Borrowing from your retirement is usually a quick solution to a deeper issue. You will treat the symptom, but fail to fix the problem. And, if you do it once, chances are you'll do it again. Don't use tomorrow's resources to pay for today's mistakes. Find another way. If you feel that this is the only option, please consult a financial adviser before you do. (See also: 6 Foolish Ways to Pay Down Debt)

3. If I divorce my spouse, am I responsible for their bills?

The answer to this question is a firm, "It depends." Here's where you have to do some research and may need to seek legal advice.

Your level of responsibility as it pertains to an ex-spouse's debt depends on a few key factors. Your state's laws and whether or not you signed the credit contract are the top two issues. In most cases, if your John Hancock is on the contract, you are liable.

During the divorce process, couples should agree on who owes what and who will pay, and have it outlined in their divorce decree. The important thing to note here is that the decree establishes who should pay — however, from a legal standpoint, if you signed a credit contract, you are liable if your ex-partner fails to make payments. (See also: How to Protect Yourself Financially During a Divorce or Separation)

4. Is there a statute of limitation on debt?

Every state establishes its own statute of limitations for debt. Each type of debt has its own time-frame. It can be as few as three years, or as many as six. You need to research the laws for your state and for your particular debt to determine the expiration period.

That said, the fact that time has expired doesn't erase the debt. The statute of limitation limits the creditor's ability to sue you and to gain a court order for repayment. The creditor can still pursue repayment of the debt past its expiration as long as it adheres to the Fair Debt Collection Practices Act. The only way to eliminate or erase a debt is to pay it, have it canceled by the lender, or have it discharged in bankruptcy. (See also: What to Do When a Creditor Sues)

5. I have defaulted on a payday loan. What happens now?

You already know this, but I must state it for the record: Payday loans are bad news. They are expensive, and defaulting is going to cause you massive amounts of financial heartache.

Payday lenders aggressively go after borrowers who don't pay. And if you are sued, it's not just the debt you are on the hook for — you can also be held responsible for the legal fees and additional interest that accrues during the process. It's a web that could take you a lifetime to untangle.

If you do have a payday loan, you've got to attack it. You should prioritize it over all your other debt. Time is your enemy, so you must rush to get rid of it as quickly as possible. Work with the lender to keep the debt in good standing. Get a second job, cut all unnecessary spending, and save every single dollar to pay it off. (See also: How to Protect Yourself From Predatory Lending)

6. Does filing for bankruptcy absolve all debt?

No. There are two common types of bankruptcies most people file:

  • A chapter 7 bankruptcy liquidates all of your nonexempt assets to pay off creditors. It's the advisable option if you have massive amounts of unsecured debt, such as credit cards and medical bills, and very little or no income.

  • A chapter 13 bankruptcy adjusts your debt using a repayment plan. This option is advisable if you have stable income and secured debt such as a home or car loan, but are so far behind on payments that you are facing legal action (foreclosure or repossession of valuable items).

Making your debt magically disappear may seem like a great idea, but bankruptcy has a dark side. It doesn't (except in rare cases) get rid of mortgages, student loans, taxes, alimony, or child support. And the court could order that some of your property be sold to help pay off the debt. Declaring bankruptcy also wreaks havoc on you credit score for years to come. Once you file, chapter 7 remains on your credit report for 10 years and chapter 13 stays for seven.

Before plunging into bankruptcy, you should consult a CPA or other certified financial fiduciary, and an attorney. Ensure you fully understand and consider the long-term impact bankruptcy will have on your financial life. (See also: 11 Steps to Take When Bankruptcy Is Your Only Option)

7. If a family member dies, am I responsible for their debt?

The short answer is no. According to the FTC, family members of the deceased are not obligated to pay the debts of a deceased relative. The deceased's estate owes the debt, not you. This means before the estate is liquidated and divvied up according to your relative's will, all debts must be paid.

If the estate isn't sufficient to cover the debts, the debts go unpaid. Family members are not obligated to pay. However, for every rule, there is an exception. You could have to pay the debt if you co-signed the debt, live in a community property state such as California, or were married to the deceased. It should also be noted that if you are the executor of the estate, you must make sure all of your loved one's debts are satisfied before you liquidate it. If not, you could be held responsible for the debt. (See also: Who Pays When Loved Ones Leave Debt Behind?)

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