Old debt has a way of sucking the air out of today’s budget.

You can’t make repairs to your car or see to needed health care or accumulate an emergency cushion because you’re still paying for stuff you bought long ago.

Worse, old debt blights your old age.

Few of us have sufficient income to both pay off the old debts and set aside money for our old age.

It comes down to a choice, for many of my clients facing a budget that doesn’t work: pay the old debt over a long time or get a fresh start that enables saving for retirement.

Ditching the debt

As a culture, we are committed to keeping our personal promises to pay. Promises matter.

Clients find the thought of bankruptcy painful; they have usually worked very hard to make the minimum payments and feel profound responsible for repaying their debt.

“It’s my debt and I want to repay it,” is a frequent refrain.

My retort is: how much do you have saved for retirement?

All too often, the answer is “Nothing”.

I think the conclusion from that question and answer is obvious, and becomes more obvious the larger the debts and the older the speaker.

Time is short, life is uncertain, and old age is costly.

The choice comes down to:  pay off debt as you promised, or provide for your old age.

How your choices add up

Assume that your credit card debt is $20,000, the interest rate on the card is 18%, and the minimum payment is 2.5%.  (For most people meeting with a bankruptcy lawyer, both the total debt and the interest rate I’ve used here are low, but they’ll do for this exercise.)

Paying the minimum payment and adding nothing to the balance in the way of new purchases or penalty fees, it will take 37.5 years to pay the balance down to zero.

Interest over the life of the repayment period would be nearly $30,000 .

What you have at the end of 37 years is a warm glow of self satisfaction and a paid-off debt.

Fund your old age

If, instead, you made the same payments required to pay off that credit card (approximately $50,000) into retirement savings at 6% for 37 years, you would have $315,874 in cash to fund retirement.

So which would you rather have after 37 years of paying: nothing or $315,874?

I honor the instincts of the client who wants to repay their debts; I simply challenge the wisdom and feasibility of doing so.

Not all of my clients have 37 more years of working life. Few of them can expect a future free of job loss, ill health, divorce, or other bumps in their financial lives that may interrupt their ability to make the payment every month.

When bankruptcy law was changed in  2005 to make it more complicated and more expensive for consumers, there was lots of pontificating about average folks taking “personal responsibility” for their debts.

I suggest that perhaps taking “personal responsibility” means saving to be financially self sustaining at the end of one’s working life.

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Image courtesy of Sally and Flickr under a Creative Commons license.

 

Facing financial trouble, there are only three times when it makes sense to file bankruptcy.

None of them is labeled “last resort”.

Yet financial-advice gurus keep saying, bankruptcy should be your last resort.

That kind of thinking keeps people suffering too long, risking worse than financial embarrassment, and wasting money when repayment is a lost cause.

Putting emotions to the side, let’s walk through those three situations when filing bankruptcy is the right choice.

1.  You have a crisis

Foreclosure, repossession, or wage garnishment threaten the foundation of your finances.  Without a house, a car, and a paycheck, not much about day-to-day life is manageable.

Bankruptcy is may allow you to keep something that you would otherwise lose to creditors without bankruptcy.

Bankruptcy provides the “time-out” that stops all collection action.

The automatic stay triggered by filing bankruptcy has the force of law to make everyone stop in their tracks and move the action to bankruptcy court.

Sometimes, just getting served with a collection lawsuit seems like a crisis.

A lawsuit, after all,  is the precursor to a judgment that leads to garnishment, liens, or levies on your assets.

Service of the complaint isn’t really a crisis, but it’s a wake-up call that trouble looms ahead.

Usually, actually getting sued is often just a symptom of a much larger problem:  it’s not just the creditor who filed this suit, but the bunch of  other creditors who aren’t getting paid either.

Bankruptcy gets you a moment to consider the big picture, and provides the legal forgiveness of most unsecured debts.  It’s the long term effect of the discharge that is precious.

2.  You see the big picture

It doesn’t require a crisis to look at your balance sheet and realize you can’t dig your way out of a financial hole.

A lifetime of minimum payments on suffocating debt is no life.  Keep making minimum payments and the debt doesn’t even die of old age, because payments extend the statute of limitations.

Healthy finances include a reserve for emergencies and serious savings for your old age.  Keep feeding VISA and AMEX and you’ll be eating cat food at 70.

Bankruptcy exists because lawmakers understood that the economy is better off when people aren’t driven into the economic underground, and when families have the chance to be self sufficient.

It doesn’t matter how got you into debt: most bankruptcies result from events the individual didn’t control, like job loss, illness, or divorce.

Whether you’re in financial trouble because of bad luck or bad judgment, a fresh financial start is energizing.

3.  You’re worrying yourself sick

How we feel about owing money has a huge impact on physical and mental health.

It’s unfortunate in a way that our societal tendency to lionize those who doggedly pay off their debts:  the heroic story of slaying debts blinds us to the fact that stress kills.

And stress makes us stupid:  actually, measurably less likely to make good decisions going forward.  Collection pressures force too many folks make foolish choices about which creditor to pay.

So, when money worries interfere with sleep, digestion, work or relationships, it’s worth considering whether a bankruptcy discharge would improve the situation.

Even elders and the disabled, who are often legally protected from collection by non bankruptcy laws, decide to discharge debts so the bills are gone legally, for all time. And they enjoy peace at home.

Reasons to file overlap

These three reasons for filing bankruptcy aren’t mutually exclusive:  you can have a crisis and see the big picture.

But the idea that bankruptcy is only a last resort, when you’ve exhausted all other avenues, is just flat wrong.

Bankruptcy should not be taken lightly, but neither should it be the last option.

The sooner you look at the big picture provided by bankruptcy, the less likely you are to waste money trying to pay impossible debts or make catastrophic decisions like invading retirement or borrowing against your house to pay dischargeable debts.

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