Should You Try to Pay Off Your Debt on Your Own, or Just Go Bankrupt?

Posted in Debt Help
Posted by J. Douglas Hoyes, CA, CPA, LIT, CIRP, CBV

I read an interesting article on the Boomer & Echo website by Robb Engen recently titled: A Lannister Always Pays His Debts (And So Should You).

I have no idea what a “Lannister” is (apparently it’s a reference to a character in The Game of Thrones), but his basic premise is that unless you are deep in debt, you should pay what you owe.

I agree with the basic premise of that statement.  The devil, of course, is in the details.  Just what does it mean to be “deep in debt”?

Mr. Engen starts with an example of someone who has total debts of $30,500, and he advises that you make your minimum monthly payment on all of your debts, and devote extra money to the highest interest rate debt.  In his example, “the minimum payments total $420 per month, and you’ve found $800 in your budget to commit to a debt repayment plan”.  With this plan, it only takes 45 months to be debt free.

This plan works great if:

  • You have “found $800 per month in your budget” for debt payments, and
  • You can keep at it for 45 months (which is almost four years).

If you have a high paying job and can afford $800 per month, and if you can avoid getting laid off or injured or otherwise becoming unemployed at any point in the next 45 months, this plan works.

Unfortunately many of the people I work with don’t have $800 per month.

In fact, while 81% of people who file a bankruptcy or consumer proposal have a job, their average net income is $2,366 per month.  Even worse, their average unsecured debt is over $61,000.

In simple terms, the average person who goes bankrupt has twice as much debt as in Mr. Engen’s example, so if we keep the math simple and assume they have $800 per month for debt repayment it would take 90 months (or seven and a half years) to get out of debt on their own.

But wait!  If the minimum payments were $420 per month for the person with $30,500 in debt, the person with over $61,000 in debt would have minimum payments of over $840 per month.

If they only have $800 per month for debt repayment, they have a problem.  They can’t even make their minimum payments, so they have no chance to actually start paying down debt in a meaningful way.

Of course I have also ignored the obvious: how can someone earning $2,366 per month pay $800 per month in debt payments?  That leaves $1,566 to pay rent, food, transportation and other living expenses, which would be very difficult.

Pay Debt or Go Bankrupt?

So here’s my suggested strategy:  I absolutely agree with Mr. Engen that you should make a budget and look for ways to cut expenses to free up cash for debt payments.  If you can free up enough cash to repay your debts in a reasonable time, that is absolutely the correct strategy.

What’s a reasonable time frame?  That depends on your age and financial stability.  If you are relatively young and work in a stable job, you may be able to devote three or four years to repaying debt.  However, if you are closer to retirement, or if your job is not secure, or if your income bounces up and down, a long term plan may not be possible.

If you don’t have the cash flow to repay your debts in a reasonable period of time the prudent approach is to consider other alternatives.  Other alternatives may include getting help from family, or considering bankruptcy or a consumer proposal.

You can deal with some problems yourself.  Some problems require professional assistance.

I can fill my car tires up with air.  I don’t attempt to fix my transmission.  For large problems I consult an expert.

The key, of course, is to know whether your debts are small enough that you can pay them on your own, or if they are large enough that the only way to secure your financial future, for you and your family, is to get professional help.