Financial Options When You Are Circling the Drain

The downfall in housing values, the resetting of adjustable rate mortgages to market rates, and rising unemployment have ratcheted the debt level of many American families to astronomical levels. Many families feel overwhelmed by their situation, stuck and wishing for a fresh start. Some may be wondering if bankruptcy is a good option. Today’s post talks about the difficult choices facing those in financial hardship.

First off, bankruptcy law is a very complex area that varies by state and if you are seriously considering bankruptcy, a consultation with an experienced bankruptcy lawyer in your state is well-worth your precious dollars. One good way to find a lawyer is through the lawyer referral services offered by most state bar associations. For those in the DC area,

• Bar Association of the District of Columbia – Lawyer Referral Service
• Maryland State Bar – Lawyer Referral Services
• Virginia State Bar – Lawyer Referral Service

If we return to our fictional family, The Medians, let’s assume their finances are in severe distress. The $150,000 mortgage on their home was a 5-year interest-only mortgage. Initially, they were paying $500 a month but their loan has recently reset to just over $1,000 per month. The Medians are struggling to afford this new payment and cannot refinance because their mortgage debt is now more than the value of their home. We will assume they do not qualify for new government programs such as Making Home Affordable.

The Medians have no savings to speak of really so the extra mortgage burden has no place to go except to their credit card balances. Their credit card balances have ballooned, the Medians are getting further and further behind in their payments and the interest rates on their credit cards are soaring. The financial strain is taking a toll on their marriage as well and Mr. Median in particular feels depressed. What are their options?

Is bankruptcy the only option? Two of the most popular financial advice columnists, Suze Orman and Dave Ramsey, say no. Suze Orman describes bankruptcy as the “absolute last choice.” Dave Ramsey goes further, “Bankruptcy is not something I recommend any more than I would recommend divorce. . . . . Bankruptcy is a gut-wrenching, life-changing event that causes lifelong damage.”

If the Medians decide not to file bankruptcy, how are they going to get out of the mess they are in? It will be painful and the options basically fall into two categories: make more money or cut expenses. Some possibilities:

1. One or both of Mr. and Mrs. Median could seek a higher paying job or a raise. They might also take on a second job to earn more money. (With high unemployment right now, this could be easier said than done and the cost of child care needed would have to be factored in.)
2. Mr. and Mrs. Median could take in a renter to help pay the mortgage or perhaps provide child care in exchange for room and board.
3. Mr. and Mrs. Median could sell off collectibles or other items of value.
4. Mr. and Mrs. Median can cut expenses absolutely to the bone, spending nothing other than what is essential to pay the mortgage, eat and work. They might ask for food or clothing assistance from their church or a local charitable group if necessary. They might adjust their thermostat to a temperature either hotter or colder than they would prefer to save on utilities costs.

What about the mortgage problem? Initially, the Medians would have to find another $500 in their budget to pay the adjusted rate. Over years, they could save up to pay down the mortgage to a level where they could refinance into something more affordable. While the Medians are making all these sacrifices and paying down their debts, they are likely to be hounded by creditors and living a somewhat miserable existence.

Would bankruptcy be that much better? One of the benefits of the bankruptcy process is that creditors have to stop calling you while the bankruptcy is pending. This gives some mental relief. There are many options for how the bankruptcy can be structured and resolved but if the Medians chose Chapter 7 bankruptcy (the most common type of bankruptcy), they would most likely lose most of their assets in exchange for debt forgiveness. And some debts, like tax debts and student loans, never go away. After the bankruptcy, the Medians might not have the burden of an underwater mortgage, but they also won’t have a home. They might have trouble finding a place to rent and might need to move in with a friend or family member temporarily. If they are able to qualify for credit, it will be secured or at a very high interest rate. It will take many years for them to re-establish a good credit history. Also, sometimes bankruptcy will disqualify you for certain jobs.

Of course, sometimes there is no other option other than bankruptcy. If your debt levels get too high you might never be able to repay despite your best efforts. The only way out might be bankruptcy. If this is your situation, know that you are not alone. Almost 1.5 million bankruptcy cases were filed in 2009, increasing nearly 32% from 2008. Almost all of these filings were individuals filing Chapter 7 bankruptcy, with businesses filing almost 61,000 cases.  There are so many bankruptcy cases being filed that the Justice Department has asked for increased funding to cope with the load.

If I was in the Median’s situation, I don’t know which option I would choose. Likely, I would at least try the non-bankruptcy option first. Neither one is all that great a choice. In the non-bankruptcy option, you would have a lot of pain immediately, having to acknowledge to friends and family that you are struggling and making dramatic lifestyle changes. In the bankruptcy option, pretty much the same thing happens except you can delay the changes until after the bankruptcy is finalized.

The Hardest Year.com profiled families across the United States struggling with the recession. Bob and Callae bravely shared their experience of bankruptcy.

One of the most disturbing aspects of this recession is the deep emotional pain it exposes in hard-hit individuals. Starting over and acknowledging to friends and family that we made mistakes is incredibly hard. For some, the pain is so great that they would prefer suicide over the humiliation of bankruptcy or foreclosure. Horrifying stories of fathers taking their own lives as well as those of their entire families have surfaced, including a family in Los Angeles and one closer to home in Frederick County, Maryland.

I sincerely hope that none of my readers will ever find themselves contemplating suicide over financial troubles. Truly, money and status is not that important. Anyone who will no longer speak to you because of your financial status is not someone to be concerned with anyway. Your life can be different and still very much worth living. Being able to admit a mistake and move forward is a very valuable lesson for all of us. We will all be impacted by the emotional carnage of the recession in some way, whether personally, through friends or family, or in our workplaces. Here’s hoping we can all remember to value people above possessions, learn to forgive and allow people a true fresh start to their lives.

What do you think the worst impacts of the recession will be? Is society ready to accept bankruptcy with less stigma? Please share in the comments.