The decision on whether to file for bankruptcy is as much about time as money.
Specifically, how much time will it take to pay off unsecured debts? If the answer is more than three years, filing for bankruptcy now might be a more efficient solution to your financial problems.
That’s because debt management programs and Chapter 13 bankruptcy, two of the most popular choices for relief, both require individuals to pay off debts in a 3-to-5 year window.
“And if it’s going to take you that long to pay off debts, you might as well get the relief bankruptcy laws allow anyway,” Jeff Badgley, a bankruptcy lawyer in Central Florida, said.
The relief bankruptcy provides is to discharge most forms of unsecured debt, meaning credit cards, medical bills and payday loans. It can provide relief from car loans and mortgages, but only if you surrender the property.
Bankruptcy does not remove debts like alimony, child support, taxes and student loans.
Many candidates for bankruptcy fit into two distinct financial categories: Middle class and low-end wage earners. Most are trying to deal with the same two problems: Major medical debt or job loss.
“These are good, honest, hard-working people looking to bridge a gap they see as temporary,” Badgley said. “Some kind of catastrophic event has put them in this situation and unfortunately, they live with the consequences of that event for a long time before realizing they need bankruptcy. It’s a shame.”
Badgley said many middle-class wage earners who lose their jobs resort to using credit cards to tide them over. It doesn’t take long before they max out four or five cards and owe $20,000-$30,000 or more in credit card debt.
They limp along making minimum payments, but the interest on their debt eats them up. Even consolidating credit card debt, which could drop the interest rate from 25-29 percent down to a seemingly manageable 7-10 percent, often isn’t enough.
“The question people should ask themselves is: How long should I reasonably make sacrifices in my financial life to resolve a debt?” Badgley said. “Even if you find another job, you could be trying to play a catch-up game that you can’t win.
“And if you haven’t found another job … well, things just keep getting worse.”
Low-wage earners may have limited access to credit cards so when a financial emergency arises, they often end up at a predatory lending business. Commonly referred to as “payday loans,” these companies charge interest rates even more exploitive than credit cards. Payday loans typically run for two weeks, charging $15-$20 for every $100 borrowed, which comes out to about 400 percent interest.
When people with limited or no income can’t repay the principal and interest, the lender extends the loan for another two weeks with similar fees. The cycle can continue for months, costing the borrower thousands of dollars in interest alone.
“Once they get in the clutches of a predatory lender, the situation becomes hopeless,” Badgley said. “They fear for their safety and security and don’t even realize that bankruptcy is a legal way to extract themselves from it.”
Badgley said that the stigma of filing for bankruptcy, or seeking any kind of help when debt becomes unmanageable, is a big hurdle for people to overcome.
“If people come in soon enough and it looks like they could pay off their debts in 2-3 years, I advise them to do that through credit counseling and a debt management program,” Badgley said. “Unfortunately, most of the people I see are well beyond that and they have no choice, but to file for bankruptcy.
“The law exists to give them a fresh start, but sometimes they wait too long for it to be effective.”