Most people want to honor their debt. But many families have allowed their debt to spiral out of control, and they feel helpless, ashamed, and at a loss to know what to do. While bankruptcy isn’t anyone’s first choice, sometimes it is an important choice to consider.
As strange as it may sound, bankruptcy is one of the benefits of capitalism. In traditional cultures debt was passed from father to son. Without the ability of individuals to escape the slavery of debt, they could become slaves permanently. While bankruptcy is unpleasant, it does beat falling on your sword.
For those who are facing desperate financial circumstances, it is better to get professional advice regarding bankruptcy than to feel trapped into taking desperate measures, either illegal or violent. Bankruptcy, although certainly not pleasant, can provide a way out.
Bankruptcy laws make it possible for people to be forgiven and make a fresh start. I’m not trying to make bankruptcy attractive, just more attractive than the horrible alternatives. Those who have been through bankruptcy will not be trusted with credit for a decade, but this can benefit them as much as it protects those who might be extending them credit.
When consumer debt is insurmountable, here are some rules of thumb for bankruptcy to be the right option:
- Paying off the debt would cause a long-term hardship to the family.
- You have been unemployed or you are currently unemployed.
- You are retired, and living on a fixed income or a permanently reduced salary.
- You have become disabled, and the prospects of a quick recovery of your ability to work are in doubt.
- You have insurmountable medical debts.
Bankruptcy isn’t a decision you should make on your own. Unless you are intricately familiar with the credit laws you won’t be able to decide if you can seek hardship programs to have your payments reduced to a manageable interest rate, or file bankruptcy.
If you are feeling major financial pressures, a non profit firm that specializes in debt management may be able to help. The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 requires you to get credit counseling from a government approved organization before filing for bankruptcy and you must complete a debtor education course.
A credit counseling organization may be able to save you from the headache of bankruptcy if you seek their help early enough. But be cautious. Most provide valuable advice. Some are scam artists engaging in questionable activities that circumvent consumer protection laws. The Federal Trade Commission has a set of guidelines to help you pick a reputable credit counseling organization.
A debt management organization can negotiate and reduce your payments and interest rates. Usually your creditors will request 2%-3% of the balance as a monthly payment. A debt management organization can negotiate the terms of your repayment. Since they can negotiate the reduction of future fees, delaying seeking help increases the chance of bankruptcy. Failure to see help is part of the cause of spirally out of control debt.
A debt management organization can help you determine if you should seek hardship programs or client advocacy departments from your creditors. Many times they will have programs for those who qualify that will enable you to reduce your payments to a manageable interest rate such as 6%. And all of your creditor’s payments will be combined into one payment to the debt management agency that then pays your creditors.
A debt management organization can also determine if bankruptcy is the best way out of your spiraling debt. If you want a quick way to determine if you are heading for bankruptcy try this computation. Take your total debt and multiple it by 2%. That is the amount you will need to pay each month. Assuming you can get your debt lowered to a 6% rate of return, it will take 5 years to pay your debt off. You will need to live on a cash only basis during this time, and your finances will need to be carefully monitored.
Bankruptcy is designed as a last resort to getting out of debt. But it protects against involuntary servitude for the remainder of your life. If bankruptcy is inevitable, seek legal advice. Ask your friends and family of an attorney they would recommend, and then ask that attorney for a referral to a bankruptcy attorney.
There are two ways to file bankruptcy. Chapter 7 bankruptcy is for the liquidation of unsecured debt. This type of bankruptcy is used for large unsecured credit card debt. The second type of bankruptcy, Chapter 13, is used when payments on a mortgage or vehicle payment are past due. In this case a court order will determine what payments you will need to continue making in order to keep your house or car.
If there is a chance that you are getting into debt trouble, get help sooner than later. You may be heading toward bankruptcy and the point of no return if you cannot pay off your credit card each month, or if you avoid medical or dental visits because you can’t afford them.
Financial problems follow and find those who fail to save. We recommend saving 35% of your income: 10% for charity, 10% for retirement, 15% for short term expenses and emergencies. The 65% balance should be your standard of living.
The best way to avoid debt problems is to live well below your means and save and invest the difference. Compounded appreciation is financial heaven. Compounded debt is financial hell. And while bankruptcy isn’t financial salvation, it can at least release you from eternal servitude.
David John Marotta works at Marotta Asset Management, Inc. of Charlottesville which provides fee-only financial planning and asset management.