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