Over the past four weeks, I’ve written about the legal consequences of filing bankruptcy. As I wrote when I started looking at the legal outcomes of filing bankruptcy, while the legal consequences of filing are certainly critical for my clients to understand, legal consequences are not the only factors in a client making a decision as to whether to file a bankruptcy case. For my clients, it is just as, if not more important for them to be clear about the financial consequences of filing a bankruptcy case. The effect of filing a bankruptcy financially is what we will look at this week. And I will concentrate on what happens to the consumer debtor (as opposed to the business debtor) when I write about the financial impact of filing bankruptcy.
Monthly Budget
The immediate, and welcome, consequence of Filing Bankruptcy for almost all of the consumer debtors I represent is that the debtors can discontinue making payments on credit cards, doctors’ bills and other unsecured debt that have accumulated over the course of time. For many Chapter 7 consumer debtors, the accrual of interest on these accounts acts to suffocate the debtor financially. The debtor finds himself with multiple accounts, all requiring minimum payments. Unfortunately, due to lack of income or high balances, many of my clients have found themselves unable to pay much, if anything over the minimum payments on their accounts. And that financial inability to make large payments on credit accounts, while very profitable for a creditor, leads to overwhelming problems for the debtor.
An example will illustrate the problem: people who carry balances on credit cards receive monthly billing statements from the card issuer showing the previous balance on the account, the payment, if any, that was received the month prior and the current balance. The issuer will also identify the “minimum” payment due on the card - the absolute smallest amount of money that the debtor must pay to remain in good standing. Typically, that payment is between one and three per cent of the balance. The minimum payment might be attractively small, but it’s a little ticking time bomb, financially. Take a credit card with a $5000 balance. Assume a minimum payment of 3% of the balance - that’s right at the top end of the industry standard. Under this scenario, if the debtor pays only the minimum payment, the monthly payment will be $150 - not an overwhelming amount to pay each month. But it will take 17 years and 4 months to pay the account in full, and the total paid on a $5000 balance will be $10,188 - more than twice as much as the original balance. And that’s assuming that no charges are made on the account while the debtor is spending $150 a month to pay down the balance, something that is pretty unlikely in the real world. A way of understanding the long-term nature of making only minimum payments is this: if our hypothetical debtor started paying down the $5000 balance on the day her child started kindergarten, she would be done paying off the balance four months after this child graduated from college!
The person who files a bankruptcy case who would otherwise be looking at payments like these will save over $5000 over the course of time. It’s that interest saving that people who are thinking of filing bankruptcy need to concentrate on - almost all of my clients have “legitimate” charges on their credit cards - expenses for food, clothing, medical and dental bills. Those expenses won’t go away. But the interest charged certainly will go away with a bankruptcy filing.
This savings is the benefit of filing a bankruptcy
When unexpected things happen to personal budgets - either an increase in expenses, or an unanticipated decrease in income, people are forced to either liquidate assets they own or borrow money to make up the unforeseen shortfall. My clients find themselves in a hole, and because of the interest rates charged for revolving credit card balances, or bank-issued lines of credit or online loans, my clients can’t get out of that hole, easily.
In this situation, debt service (paying interest on credit balances) eats up more and more of the personal budget, which decreases discretionary spending and eliminates the ability of my clients to get ahead financially. Some people can “ride out the storm” by strictly budgeting their expenses, maximizing income through increased overtime or second jobs, or both. These people follow a strict budget, and then slowly but surely eliminate debt so that they can breathe again financially.
But the problem for people in this scenario is that while they are following a strict budget there can’t be a spike in expenses or a downturn of income. And for so many of my clients, that is exactly what happens: they are working hard to retire debt, then another expense pops up or job hours are reduced, overtime is cut down, or the job itself disappears. In these cases following a strict budget just isn’t going to work. In this circumstance, people aren’t able to provide for their necessary expenses - there just isn’t enough money to pay for food, clothing and housing.
It is for these situations that the bankruptcy law exists
By filing a bankruptcy case and receiving a discharge, the debt that is overwhelming a person’s budget is eliminated. Now this person, who has struggled to pay debt and keep current on monthly expenses can have extra money available each month, since there is no debt service being paid. Instead, this individual has the ability to meet monthly expenses without the need to add overtime hours or a part-time job in addition to full-time employment. And in many cases, the person who has filed a bankruptcy case and received a discharge is able to not only pay monthly living expenses comfortably, but also save money every month. That way, when the unexpected happens (and it inevitably does) with expenses and/or income, this person has savings with which to meet the unexpected financial situation, rather than having to borrow money to try to cope with the unexpected.
One of the secrets of moving ahead financially is to have someone or something pay you interest on your money, rather than the other way around.
That’s one part of the financial consequence of filing bankruptcy. Next week we will look at access to credit after a bankruptcy case is filed.
