03 Feb Causes Of Bankruptcy: Snowballing Debt And Interest Charges
Many people file for bankruptcy to discharge credit cards and other loans they took to buy a few things “on time” that have snowballed to a point that it can no longer be paid off. Buying on time is something that hurts consumers in the long run. It traps them until something is paid in full; increases the amount needed to cover monthly bills, and raises the cost of every item bought through financing. Payments made on revolving debt use up income that people should be saving for car repairs, new clothing, and other items that they will end up charging because that is the only way to get what they need.
Once people start using financing, it is very difficult to stop. People often refer to this situation as a snowball, where the debt keeps getting bigger and bigger as time goes on. If you are paying more for everything you buy, you will buy less over your lifetime, and probably have little in savings. If you are paying off something you bought several years ago, there is no money left to save, let alone to pay cash for new things. Once the snowball gets big enough, new credit card debt is used to help cover old credit card payments once monthly income isn’t enough to cover both living expenses and debt payments. This is commonly referred to as “robbing Peter to pay Paul.”
Think of interest as an expensive purchase. If someone wants to buy something that costs $1,000.00 but finances it at 18% for five years, they are going to pay about $1,525.00 for an item worth $1,000.00. The extra $525.00 paid in interest is money that could have been used for another $500.00+ in goods, a vacation, charity, savings or retirement. If most purchases are financed at those rates, buyers will pay 50% more for everything they buy, and have that much less money to use for other purposes. That assumes that the payments are set up for 18% AND payment over five years. Many credit card payments are set up to pay less each month but won’t be paid for many more years, some as long as 20 or more years! The interest paid on those loans can greatly exceed 50% of the original purchase.
Paying interest on every purchase made over a lifetime makes little sense for the benefit of the buyer. There has to be a way to get out of debt if someone really wants to get on solid financial ground. Debt management programs may be a solution but it is important that the plan is realistic that allows the debtor to cover all necessary living expenses. Many programs don’t leave enough for a debtor to live on, let alone save for necessary expected expenses such as car repairs or medical bills.
If the debtor can’t figure out a reasonable payment plan to get out of debt, Chapter 7 bankruptcy and Chapter 13 bankruptcy may offer a solution to help. Chapter 7 can discharge debts and give people a chance to start over. Chapter 13 may allow someone to restructure their debts into an affordable repayment plan over a three to five year period.
The only way to know if bankruptcy is right is to consult an experienced bankruptcy attorney who will review your situation and explain how bankruptcy works.
See also: Credit Financing: Buy Now Pay Later (Superbowl Edition) by Susanne Robicsek, CreditLawNetwork February 3, 2008
For Budgeting and financial tools: Hummingbird Credit Counseling Financial Learning Center
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