Last month, I wrote a blog post entitled Are You Exposed on this blog where I suggest that most bankruptcies occur when a debtor allows himself to be excessively exposed to external forces. By recognizing and controlling these points of exposure, you reduce the risk that you will need to file for bankruptcy, and, if you do file, you will be better positioned to avoid falling into the same traps in the future.
Recovering from bankruptcy means more than re-establishing credit. True recovery means that you need to change the way you think about credit and money. If you make the same financial choices post bankruptcy discharge with your new credit cards, you will inevitably find yourself back in your bankruptcy lawyer’s office at some point in the future.
After 25+ years of representing bankruptcy filers, I can point to a number of poor financial decisions that have led my clients into bankruptcy. Avoid mistakes like these and your bankruptcy will become a distant memory.
Running a monthly balance on your credit cards. Credit card companies charge between 15% and 28% interest on monthly balances. By contrast, mortgage loan rates are around 4% and car loans are around 2% to 6%. Banks pay depositors just over 1%. Interest rates at 15% plus will cost you hundreds or thousands of dollars. 14% or higher is loanshark territory.
Look at the credit card interest calculator here and plug in whatever numbers you wish. I plugged in 25,000 at 14% interest and a minimum payment of 2% of the balance each month. In this scenario it would take over 31 years to pay off the $25,000.
Credit card debt is a major component of most bankruptcies. If you can’t pay off your balance each month, you are spending more than you can afford and this problem will not magically disappear. It will lead you back into bankruptcy.
As a practical matter, once your running balance reaches $8,000 to $10,000 you will most likely never pay it off.
Instead of using a credit card, use a debit card that withdraws funds from your checking account immediately. Debit cards have a way of minimizing impulse purchases.
Not recognizing the total cost of a purchase. I see this a lot in my client’s auto loans. The auto loan may be $325 per month but the total cost of ownership may be $650 or more when you factor in fuel, insurance, tires, service, repairs and other associated costs. Further, an accident (unexpected) may cause insurance costs to rise and may give rise to repair or rental car expenses.
Real estate purchases also result in extra expenses. Property ownership always results in unexpected expenses, in addition to normal expenses that you would not see as a renter. When you budget for a home purchase, assume that you need to budget several hundred dollars each month to repairs and maintenance.
Not using a budget. My bankruptcy questionnaire asks my potential clients to prepare a budget. More often than not, my questionnaire budget represents the first time that my potential client has looked at his family’s income and expenses in black and white.
Budgets help you understand where you are spending money and often where you can cut back. Business owners know that you can’t change what you don’t measure and the same holds true for individuals. You should aim for a budget that results in some level of disposable income (which you can allocate to a savings account or retirement plan).
Not preparing for retirement. In addition to my bankruptcy practice, I also represent clients in Social Security disability claims, so I interact a good bit with the Social Security Administration. If you are relying on Social Security to fund your retirement years, you are asking for trouble.
In most cases, Social Security retirement will pay you enough to live at the “Poverty +” level. Everyone should be putting money away – even $100 per month. Most retirement plans have favorable tax consequences so every dollar you put away will benefit you.
Squeezing $100 or more from your budget may be painful but you should see this type of contribution as a necessary investment – just as necessary as paying for electricity or car insurance.
Cashing out a retirement plan to pay credit card or other debts. Most retirement money is protected from claims by creditors. With very, very limited exception you should never tap into retirement money because these funds will almost never be at risk.
If you are tempted to encroach upon retirement money, talk to a lawyer first so she can talk you out of this bad idea.
Failing to buy insurance. No one likes to spend money on insurance because you are buying protection against events that may never happen. No one expects to be diagnosed with a debilitating disease or injured in an accident but every year people end up facing the unexpected.
Insurance is another necessity that should come before “wants” like that new TV or cosmetic improvements to your house.
Not looking for opportunities to earn extra money. In today’s connected economy there are dozens of legitimate opportunities to earn extra money. Become an Uber driver. Sell your time and expertise in an online marketplace like Fiverr or Upwork. Find a part time job.
TV watching, by the way, is not a “hobby” – more than an hour a day is too much if you hope to get ahead.
Neglecting your health. Your physical health will have a direct bearing on your financial health. Smoking, consuming sodas, eating processed foods and overeating generally will make you lethargic and not motivated. Little changes can yield big results. Several years ago, for example, I gave up soft drinks in favor of carbonated water with a little lemon or lime juice. I dropped 15 pounds in about 4 months without doing anything else. I also became more productive at work because I eliminated the yo yo effect of metabolizing huge amounts of sugar pouring into my system.
All of these mistakes or “exposure points” may seem like common sense, but most of these problems are very common among bankruptcy filers.
You can look at this another way – intentionally do the things I call mistakes and you will almost certainly end up in or close to bankruptcy. The good news is that these types of mistakes to avoid are not moral failings; they represent poor planning and a lack of basic financial literacy.
There are dozens of books out there and plenty of free online resources. Google “basic household budgeting” and you will see dozens of entries. Spend a little time improving your financial literacy and your quality of life will improve.
Now that you better understand why bankruptcy happens and how to change your mindset to ensure that it happens only once, what can bankruptcy do for you. That is the subject of next month’s installment.
Written by Jonathan Ginsberg, Bankruptcy Law Network