Financial writer Liz Weston (@LizWeston) writes that many people who could benefit from bankruptcy don’t file because of fear and misplaced optimism. See Fear of Bankrutpcy Holds Too Many People Back.
This is the second time that Liz Weston has suggested that more people consider filing bankruptcy (Do Debt Management Plans Work?), and this is notable since she is something of a financial guru with a long track record of encouraging Americans need to create spending budgets and advising many to seek assistance through credit counseling.
But something has changed in her approach. Maybe she is just seeing the futility of trying to dig out of debt when wages are stagnant, health insurance is non-existent or insufficient to cover ongoing medical bills, and it just seems like wasted effort to pay debts when new ones just spring up overnight.
About 14% of U.S. households — or roughly 17 million — owe more than they own, according to Federal Reserve Bank of New York estimates. Many of these households could benefit from having their debts wiped out, but fewer than 1% of U.S. households actually file for bankruptcy each year. Last year, there were 752,160 personal bankruptcy filings. Researchers refer to this gap as “missing bankruptcies” — the filings that could be happening, but aren’t.
THE FEAR FACTOR:
So what is holding Americans back from filing more cases? In a word, fear. Fear of living with bad credit. Fear of the judgment of future employers. But Weston says much of this fear is misplaced.
A bankruptcy filing remains on your credit reports for up to 10 years. But credit scores can start to recover soon after you file. It’s possible to get a VA or FHA mortgage two years after a bankruptcy. Most loans require you to wait at least four years.
People can start to rebuild credit a few months after their bankruptcy case is discharged by getting secured credit cards, which require a deposit, or credit-builder loans, available from some credit unions, community banks and online.
Yes, credit scores begin to recover as soon as the case is filed. Why is that?
There are two reasons bankruptcy enables the healing of credit scores. First, once a case is filed all negative reporting stops. Creditors no longer report late payments, collection accounts, judgments, and other negative information.
Second, filing bankruptcy improves the single biggest factor in your credit score–the Debt-to-Income Ratio. About one-third of your credit score is based on how much debt you owe compared to how much income you earn. The higher that ratio the lower your credit score. Filing bankruptcy eliminates the debt, so the debt-to-income ration is immediately improved.
Weston claims that too many people have an irrational belief that things will get better.
Misplaced optimism can also be a problem. The same hopefulness that causes people to take on too much debt also can lead them to put off the reckoning.
What Weston calls “misplaced optimism” is what I call Around-The-Corner Thinking. “As soon as I get this debt paid then I can start saving money.” The problem is, once you pay off that debt or solve that problem, a new set of problems pop up. So you adjust your plan and will start saving money after that problem is solved, but before you know it yet another problem arises.
The problem with around-the-corner thinking is that it fails to recognize that new problems ALWAYS continue to arise. That’s actually the norm. The concept that we can start to achieve financial goals AFTER today’s problems are solved is delusional. Today’s financial woes never end. Employers continue to lay off workers. Health insurance companies continues to not pay claims. Recessions continue to occur.
So instead of delaying making contributions to that retirement plan, instead of delaying saving for the house down payment, instead of delaying college until after the credit card debt is paid, start doing that today and consider filing bankruptcy to solve a debt problem that is not going away. Stop being overly optimistic and face the music of you debt problem. It’s not going away.
Am I taking Liz Weston’s advice too far? Gosh, this sounds so bleak! Well, by all means, we should find ways to pay back debt if possible. But do you really have a Plan to get out of debt, or is it just unrealistic optimism?
It’s time to stop fearing the debt problem and time to start addressing it realistically.