Sunday, January 2, 2011

The Surprising Virtues of Bankruptcy

In this frigid economic climate, I meet a lot of people seeking advice on what to do with thousands of dollars of credit card debt, huge medical bills, or other financial headaches. For the most part, these people don't run into these problems because they are poor financial planners or because they are irresponsible; what typically happens is a person loses his or her job and they become dependent on their credit card to buy food or other necessities or they get injured and they have little to no medical insurance.

For people in these tough situations, it can seem like there is no way out and the only way you can cope is to throw the bills in the dustbin. But if you ignore a bill for too long, the company who you owe money to (called a 'creditor') will take the following actions: First, they will send your bill to a collection agency (whom will begin a nasty telephone assault against you at all hours and even at work); Second, they will file a lawsuit and obtain a judgment against you; Third, they will attempt to enforce their judgment against you by putting a lien on any valuable property you may own, freezing your bank account, or even garnishing your paycheck.

Usually, the best option to address large unpaid bills is to see if you can negotiate a settlement with the creditor to pay a smaller amount of what you owe. While most creditors will allow you to enter into a payment plan, even making monthly payments on a reduced debt will be tough for a lot of people having financial problems.

So if coming to a settlement with a creditor isn't an option, your only other (viable) option to deal with your bills is to file for bankruptcy. For those of you unfamiliar with bankruptcy, it is essentially a process where you petition the government to either eliminate your debts (called a "Chapter 7" bankruptcy) or have them consolidated in order to be paid off in monthly installments during a three or five period (called a "Chapter 13" bankruptcy).

So what's the catch to having your debts magically eliminated with a Chapter 7 bankruptcy? First and foremost, a bankruptcy will stay on your credit record for between seven and ten years. Secondly, the bankruptcy process will make certain private information about your financial affairs public.

But another reason people feel that bankruptcy isn't for them is that they feel that there is something morally wrong with walking away from legitimate debts. They feel that it is wrong to tell their creditors "listen, thanks for the money you lent me, but I don't feel like paying it back and here's the papers saying I don't have to." While this sentiment is certainly noble, I think two things should be considered in reflecting on the morality of bankruptcy:

1. Creditors Don't Care About You

This statement is pure hyperbole but it contains a lot of truth. Creditors won't hesitate to put a lien on your home, seize your car, or do other nasty things to get their money. Considerations such as whether you have kids to feed, or whether you just lost your job do not enter into the equation when a creditor is attempting to collect. If there is a way a creditor can get your money, they will do what they can to get it.

While not every creditor engages in strong-arm tactics, they are the exception and not the rule. Next time a collection company calls you, tell them about your kids and losing the job. Not only will this information not move them to the slightest, it will be immediately be forgotten the next dozen phone calls from a dozen different people you receive all trying to collect on the same debt.

2. Part of the Blame for Your Debt Belongs to the Creditors.

Bad deals happen. And if you will excuse the bluntness, when a credit card company allows you to run up a $5,000 debt that you can't pay back, they made a bad deal.

The allure of credit cards is easy to understand. You get a credit card and you can buy things you simply don't have the money for at that moment and you're able to make relatively small monthly payments. In exchange for this flexibility, the credit card companies slap on grossly high interest rates that average around 17 percent. Essentially, these creditors are betting that you will be able to pay them back at an interest rate that no sane person would accept in a normal lending situation.

But it's so easy to apply for and receive a credit card. We all receive junk mail on a weekly basis touting pre-approved cards, 0 percent introductory rates, cash-back promotions, that it is almost irresistible to not take up these offers. And after you get the card, the credit card company generously increases your credit limit as use the card (increasing their the amount of interest they earn on the card).

The combination of the ease of getting a credit card and the high interest rates associated with them make it make it extremely easy for you to get in over your head - and the credit card companies do little to warn you of this. By making it so easy, credit card companies must bear some of the blame when you rack up a huge credit card debt that you can't pay back. In many ways they set you up to fail.


A popular expression associated with bankruptcies is that it allows an individual a "fresh start" when they are swamped by debt. While it can certainly afford a person a great way to get out of a bad situation, it is a weapon that should be used sparingly as once you obtain a discharge through bankruptcy, you cannot file again for another seven years. But if you do decide to file, it is important to remember that there is nothing immoral or reprehensible about filing; it truly is one of the most powerful weapons a person can use to combat debt.

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