For as long as debt has existed, society has judged people for failing to pay back their debts. Over the years I’ve heard hundreds of honest, but unfortunate debtors tell me they are stressed out because they believe they have morally failed for being unable to repay their debts. But why is it that we attach a moral dimension to bankruptcy at all? Is bankruptcy morally and ethically wrong or is it more accurate to just consider filing bankruptcy to be a math decision?
When you face financial hardship like an illness or job loss, and can no longer afford to make your debt payments, it’s a math problem, not a moral dilemma. On today’s show, I give you 5 reasons why bankruptcy is not morally wrong, despite what mainstream society would have you believe.
1. Your lender collects interest.
When you borrow from a bank, they recognize that there is a chance you won’t repay the loan. Therefore, they charge you interest on top of what you borrowed. When it’s an unsecured loan, interest is very high. For example, a credit card often charges 18-20% interest. When it’s a secured loan like a mortgage, interest is generally lower, but then your lender also has the option of repossessing your home and selling it to recover their loss should you default on payments.
Payday loan lenders are even worse. Their average interest rate is 390% in Ontario. For most of my clients, even when they try their best to pay back their debt, the interest alone won’t let them succeed. With this in mind, should you feel morally bad for being unable to repay debt, despite every effort? Probably not. Of course, there are ways you can reduce your risk of default, like limiting how much credit you borrow and searching for the lowest interest loan, but that’s not always possible.
2. Your lender is prepared for risk.
As mentioned, your lender already recognizes the risk of you defaulting on a loan. That’s why, when you borrow, terms and conditions are outlined. There are no surprises. The bank is aware that if you cannot make your payments, they can repossess the asset you used to secure a loan, or garnishee your wages, or seize your bank account. They also charge you interest. If both parties have considered the risk of default and both parties agree on the penalties in the event of a default, then bankruptcy is no longer a moral issue.
3. Debtors don’t want to default on their debt. Life happens.
My clients don’t choose to default on their debt. In most cases, it simply can’t be helped. They lost their job or got injured at work or got sick or got divorced. There was no decision made; they simply couldn’t pay. So, they default. But as already mentioned, any loan with a lender involves a contract, in which an agreement is reached on what happens if you don’t live up to your end of the deal. Ultimately, debt isn’t about right or wrong. It’s a contract.
No one sits down and says “I think I will stop paying my debts.” That’s not how it happens.
4. You have to do what’s best for you financially.
What causes us to feel bad about not paying our debts? I often ask my clients this question and they tell me it’s because they’ve been with the same bank for many years. They like their bank and they don’t want the relationship to end. Yes, the bank was probably good to you when things were going well and when you had a job, they were happy to loan you money. But, when you got laid off or faced a financial speed bump in your life, you are now considered a bigger risk and pay higher interest or simply don’t qualify for more money.
It’s understandable. They’re a business and they have to do what’s best for them. But so can you. You’ve made a business transaction and since now you can’t pay, they will take the necessary steps to collect their money and you will take the necessary steps to protect yourself – whether that’s through a bankruptcy or a consumer proposal.
Your bank pays you zero interest on your savings account, charges you a monthly fee, and now they are charging you 19% interest on your credit card. And you feel bad that you can’t repay your credit card?
5. Bankruptcy is a necessary social safety net.
Just like you would collect unemployment insurance when you get laid off or disability insurance if you are injured, bankruptcy is a safety valve for those burdened with more debt than they can ever repay. If you have only have enough cash this month to pay rent and buy groceries, what should you do? You should support yourself and your family. That is the morally correct decision. If you can pay your debts, then by all means, do it. However, if you can’t, you have to do what is right for you.
I’m not saying you should default on your payments. You have to be responsible and only take on as much credit as you can afford to repay. But when you’re faced with a life emergency or high interest holds you back from paying off your debts, you have a moral obligation to take care of yourself and that might involve filing for bankruptcy or repaying debt with a consumer proposal.
For more detail on why bankruptcy is not morally wrong, tune in to today’s podcast or read the complete transcription below.
FULL TRANSCRIPT – SHOW 200 5 Reasons Why Bankruptcy is Not Morally Wrong
Doug Hoyes: This is episode number 200 of Debt Free in 30. Over the past 3 ½ years we’ve covered a lot of topics about money and debt. I started this podcast to provide practical information from experts about how to become debt free.
Since our first episode aired on September 6, 2014 a lot has changed.
- Total Canadian household credit was roughly $1.8 trillion in September 2014. As of April 2018 it’s now $2.1 trillion. That’s a growth of roughly 20% over 3 ½ years.
- An increase in real estate prices, a popular topic here on Debt Free in 30, drove total residential mortgage debt up 22% over the last 200 episodes.
- Not to be outdone, consumer credit grew by 14%.
- The average Canadian’s debt-to-income ratio increased from 163% when we started to 168% in early 2018 (although 168% is the lowest level it’s been in two years).
Canadians continue to use debt in record numbers.
During that same period, I’ve seen some pretty dramatic changes in the insolvency world as well.
- In 2014, just over 41,000 Ontarians filed either a consumer proposal or personal bankruptcy. By 2017 that number had fallen to just over 38,000. That’s the lowest number of insolvencies in Ontario since 2006. And 2018 is following the same trend – bankruptcies and proposals across Ontario are down another 4% in the first three months of this year.
- Those who are filing, are filing a consumer proposal in record numbers. So far in 2018, 63% of all insolvencies were consumer proposals, up from 53% in 2014.
- In September 2014, 24% of insolvencies as measured by our Hoyes Michalos Homeowner’s Bankruptcy Index involved homeowners. Today that number hovers at around 6%. The booming real estate market over the last few years means that if you’ve owned a home for a few years, you’ve generated enough home equity that you don’t need to go bankrupt, even if you have lots of other non-mortgage debt. Of course that may change if the real estate market weakens.
- Finally, in 2014 the average person filing insolvency had a family income of $3,100 after tax and owed roughly $57,000 on personal loans, credit cards, taxes, student loans and other debts. In 2017 the family income of the average insolvent debtor was just $2,980 and he owed less; about $50,000 in unsecured debts.
We’re living in good times, relatively speaking. Ontarians filing insolvency today tend to be people struggling on a lower income. Most of the rest of us can afford the debts we are carrying.
However, I’ve been working in the personal bankruptcy business for a lot longer than I’ve been podcasting. Hoyes Michalos started in 1999 and I saw the impact of the 2009 recession. So pessimist that I am, I expect that the rising level of consumer debt is going to cause a lot of people, who are getting by today, to suddenly find themselves experiencing severe financial problems.
Given all that, I wanted to use the milestone of our 200th episode to discuss a question that is at the core of many discussions I have with both people in financial trouble, and the people they owe money to.
That question is this:
Is bankruptcy morally wrong?
If, or should I say when, the economy turns, should you feel guilty for filing bankruptcy on debt you accumulated while times were good?
Should creditors and society expect someone to repay all of their debt, regardless of what it costs?
First of all, let me dispel a popular myth: virtually no-one wants to file bankruptcy and it’s not taken lightly by anyone who meets with me.
They come to my office, and they know they need help, but they also know that they incurred the debt, and they don’t feel good about “stiffing” their creditors.
They want to do the right thing.
They are in a quandary.
They know what they need to do financially, but they can’t bring themselves to do it, because deep down inside they believe that filing bankruptcy is morally wrong.
Of course it’s not just people in debt who believe that bankruptcy is morally wrong. The people who are owed the money, your creditors, also use the moral argument to encourage you to pay your debts.
I’ve had hundreds of clients over the years who tell me that they’ve received calls from collection agents who say “you borrowed the money, you have to pay it back”.
They say “if everyone didn’t pay their bills, the economy would crash”.
And they say “if you don’t pay your debts, that increases the costs for everyone else!”
They are making a moral argument: it’s your duty to pay your debts, or else everyone else in society will suffer.
They are saying that you will be judged for not paying your debts, and it’s true, society has judged people for failing to pay their debts for as long as debt has existed.
We say “if you can’t afford to pay for it now, don’t borrow”. Mainstream society believes that it’s just a matter of discipline – spending less and doing without.
We even have specific words to describe someone who doesn’t pay their debts. We call them a deadbeat, and no-one ever wants to be called that.
So why attach a moral dimension to bankruptcy at all? Why not treat it like any other business transaction?
I’m going to give you 5 good reasons why bankruptcy is a math decision, not a moral one.
First, your bank gets paid a risk premium – it’s called interest.
When you borrow money, say $4,000 on your credit card, you have to pay back more than $4,000. When the bank lends you money, they realize that there is a chance that you won’t pay, and a risk that you may go bankrupt. That’s why the interest rate on a credit card can be 19%; the lender knows they are taking a risk.
The interest rate on a mortgage is a lot lower, because there is less risk for the lender. If you don’t pay, they can sell the house and recover most, if not all, of their money.
And believe me this risk premium shows up loud and clear when you work in the insolvency business. In 2014 21% of all insolvencies involved payday loans. In 2017 that number was 31%. Yes 3 in 10 people filing insolvency in Ontario carry at least one payday loan.
Payday lenders get paid a huge risk premium. With an average effective interest rate of 390% in Ontario in 2018, payday lenders are paid enough for the risk they take. So should you feel morally bad when, after trying very hard (often times taking out a second and third payday loan to pay back the first) that eventually you can’t sustain this risk premium (your overwhelming interest payments) and bankruptcy results?
Yes, there are things you can do to help ensure you reduce your risk and your overall risk premium.
- Set your credit limits low so you are not tempted to borrow more than you can afford.
- Always search for the lowest interest option and avoid the steep costs of debt like payday loans
However, that’s not always possible so let’s go on to reason #2 why bankruptcy is not necessarily morally wrong.
Reason #2: Sometimes your lender is protected by the security, or collateral, you give them to secure the loan.
If I buy a new car and six months later I have a problem with it, I don’t call the car manufacturer a deadbeat for making a defective car. I take it in to the shop, and since it’s under warranty, they fix it. There’s no moral dimension to it. Perhaps there should be, but there isn’t.
Why isn’t a car repair under warranty considered a moral transaction?
Because we all know the deal going in to it. I buy a car, and I understand that part of the price I’m paying for the car is a warranty. I can even pay more and get an extended warranty, so if the car needs fixing, they fix it. It’s all part of the deal.
Offering the warranty is a cost of doing business for the car manufacturer. They hope they never have to pay out, but sometimes they do.
Legally, it’s the same with debt.
I go to the bank and I say I want a mortgage. The bank says okay, here’s your money, and here’s the deal: every month you will make a payment until the mortgage is paid off, or we can take your house.
So let’s say I decide to not pay my mortgage. I understand what will happen: eventually the bank will foreclose on my house.
Let’s take that story one step further. Let’s say I bought the house a few years ago, and it’s gone up in value. I get a new job in the United States, so I don’t need the house any more. I want to move quickly, and I don’t have time to list the house for sale and sell it, so I decide to pack up my belongings and move. I stop making mortgage payments.
It takes a few months, but eventually the bank seizes my house and sells it. If the bank sells the house for at least as much as they are owed, everyone is happy. The bank got their money, and I didn’t have to go through the hassle of selling my house.
Of course I’m giving you a silly example. I could have hired a real estate agent to sell the house, and that would have saved me all of the bank’s legal fees, and I would have ended up with more money in my pocket, but that’s not my point.
My point is that what I did is called, in the business world, a strategic default.
I decided not to pay back my debts. I decided to not pay my loan and, knowing the consequences, I did it anyway.
It wasn’t a moral decision, it was a business decision.
Let’s take it out of the realm of bankers (whom we often love to hate) and look at it from a different perspective.
If I call up my friend and say “my rent is due tomorrow and I don’t have the money; will you loan me $1,000? I’ll pay you back when I get paid next week”. If my friend loans me the money, and next week when I get paid I decide to do a strategic default and not pay him back, I consider that to be immoral. My friend helped me out, and I stiffed him. That’s wrong. I’m a deadbeat, because I had the ability to pay him back and I didn’t.
I made a promise and I didn’t keep it.
I didn’t enter into a business transaction with my friend. We didn’t have a written contract, and he wasn’t charging me any interest. I made a simple, one-sided promise. I agreed to pay him back when I got my paycheque next week. There was nothing in it for him, other than feeling good about helping me out. He took a risk, with no chance of financial reward.
My promise to my friend was to pay him back. There was no discussion of consequences if I didn’t pay him back, and that’s why a loan from my friend is different than a loan from the bank.
With the bank, we have a two-sided contract. I agree to pay them back, but the contract also describes what will happen if I don’t pay them back. It’s a contract that has enforcement rights.
My promise to my friend is just a promise to do something. My promise to the bank is a promise to do something and an agreement about what the bank can do if I don’t pay them back. Either I will pay them back, or they can sue me and garnishee my wages and seize my bank account and take whatever other collection action they deem necessary.
That’s how a mortgage works. Either I pay them back or they can take my house.
Both the lender and I go into the deal with our eyes open.
We both understand what will happen if I pay back the loan, and what will happen if I don’t.
When I borrow money from a friend, they have no option if I don’t pay them back, so it is immoral not to pay them back.
It would be different if I said to my friend “I need to borrow $1,000, and I’ll pay you back next week, but if I don’t, here’s a gold coin worth $1,500 that you can keep”.
That changes the story.
Now, if I don’t pay my friend back, he gets to keep something worth $1,500. He’s probably fine with that. Because we discussed up front what will happen if I don’t pay him back, and he agreed to that option, it’s not immoral for me to not pay him back.
It’s stupid, because I just gave up a $1,500 gold coin to satisfy a $1,000 debt, but it’s not immoral, because my friend had the opportunity up front to decide whether or not he wanted to lend me the money, and we both understood the consequences if I didn’t pay him back.
That’s how I think about the morality of debt and default.
If, when the loan was granted, both parties considered the circumstances of default, and both parties agreed on the penalties in the event of a default, it is not morally wrong to default. The risk of default was priced into the loan both in the interest rate charged and the security provided by the borrower. The bank charges more interest on a credit card than on a mortgage, because their risk is greater. When getting a mortgage, the borrower puts up a house as security, so the bank charges a lower interest rate on a mortgage than on a credit card, because their risk is less. That’s how it works.
Here’s reason #3 why I think debt is a math issue, not a moral issue: Debt isn’t about right or wrong, it’s a contract.
I know of a big public company that borrowed $60 million from a large pension fund. It was a five year loan, and at the end of the loan they could either repay the $60 million, with interest, or give up 20% of the company. At the end of the five years, 20% of the company was worth about $50 million, so it was an easy business decision for the company: instead of paying back $60 million, they handed over stock for 20% of the company, worth $50 million.
It was a strategic default.
Did the company do something morally wrong by defaulting on the loan?
No, because that was the deal: pay back the loan, or give up shares in the company. They picked option B.
If I default on my mortgage, I give up my house.
Any loan with a bank involves a contract.
A contract is an agreement that describes what will happen if you don’t live up to your end of the deal.
In a mortgage contract, if I don’t pay the mortgage, the bank can foreclose. There is a process for that. The bank can’t come in and change the locks one day after I miss my first payment. There’s a process, they have to follow a court foreclosure procedure, it takes time, but ultimately foreclosure is the penalty for not paying my mortgage.
Now of course most of my clients did not engage in a strategic default.
They don’t sit down and think about it and say “I think I will stop paying my debts”. That’s not how it happens.
In most cases, it can’t be helped. They lost their job, or got injured at work, or got sick, or got divorced, and didn’t have the money to make their debt payments. There was no decision to be made; they simply couldn’t pay.
So they default.
That brings me to reason # 4 – what happens if I don’t repay the loan is built into the business contract.
It’s math, not morality.
So why is this distinction important?
It’s important, because many of my clients suffer a lot of stress when they, through no fault of their own, are unable to pay their debts. They are stressed out because they believe they have morally failed.
How different would it be if they said to themselves “well, I made a bad business deal, but that’s life, now I deal with the consequences of my default”.
That’s still stressful, but it’s not nearly as stressful as believing you have failed as a human being.
So why do we think this way? Why do we feel bad about not paying our debts?
I’ve asked many of my clients that question, and many of them tell me that they feel bad, because they’ve been with the same bank for many years. They like their bank. Their bank has helped them out. They think of their bank sort of like a friend. They’ve been together for a long time, and they don’t want the relationship to end.
I say to them, “wait a minute”. Your bank pays you zero interest on your savings account, they charge you a monthly fee, and now they are charging you 19% interest on your credit card. They keep closing branches so it’s harder and harder for you to go in and talk to someone in person when you have a problem, and yet the largest bank in Canada earns a profit of almost $1 billion per month.
And you feel bad that you can’t repay your credit card?
Sure, the bank was good to you when things were going well. When you had a good job they were happy to loan you money to buy a car or a house. You had income, and collateral. But when you got laid off, or hit some other financial speed bump in your life, all of a sudden the bank was like “hey, sorry dude, you were a great customer for the last 10 years, but now we are raising your interest rate, and no, we won’t lend you any more money to help you out”.
I’m not blaming the bank. They run a business. They don’t have to answer to you. They answer to the shareholders, and the shareholders want to make money, and if that means raising your interest rate or increasing your service charges or closing branches or whatever, that’s what they will do.
That’s fine, they can do what is best for business, but so can you. You can do what’s best for you and your family financially.
I said earlier that I agree that it is morally wrong to stiff your friend when they helped you out, and you have the money to pay them back. That’s not nice.
But the bank is not your friend, and if you can’t pay them back, you should not go into a deep depression worrying about it.
The bank is not your friend.
You made a business transaction with them, and now you can’t pay, so now the bank will do what they have to do to collect, and you will do what you have to do to protect yourself, which may include filing a consumer proposal or bankruptcy.
So again, why is it so important to realize that the bank or credit card company is a business, and not your friend?
Because over the years I have met with hundreds of people who tell me “I’ve been worried about this for a long time. I can’t sleep. I’m trying to pay the bank, but now I’m getting behind on my rent, and I don’t have enough money to buy food for my family. I want to do the right thing, but I’m stressed out.”
I’m happy to help people who tell me that, because I know that they are honest people. They want to do the right thing, and because they are honest, it is causing them a lot of stress.
I tell them not to worry.
Yes, if you have the money, you should pay your debts. I agree. The economy works better if we all pay our debts.
But the bank knows that some people can’t pay them back. The reason you are not paying them back is because you can’t. You don’t have the money. That’s a fact.
Now, here’s the last reason why I think we should view bankruptcy as a business decision and not a moral one: bankruptcy is a necessary social safety net.
I mentioned earlier that the average household income for the typical person filing insolvency has declined over the past 4 years.
If you make $2,500 per month, and you have to pay rent, and buy groceries, and pay for transportation and all of your other living expenses, how much money do you have to pay off your debts?
Maybe $300 per month?
So if you owe $50,000 on your credit cards and other unsecured debts, even if your credit cards and other debts agreed to charge you zero interest, it would take 166 months to get out of debt. That’s 14 years – before interest costs.
But of course, the banks do charge you interest, and your interest is probably more than the $300 you have available. So, your debt grows. Most of my clients are faced with a burden of so much debt that they can never realistically hope to ever pay it off.
Worse, you may not have $300 every month. In fact, most of my clients can’t make their minimum payments. They are worried about having their bank account frozen and having their wages garnisheed.
For them, the only solution is to file a bankruptcy or a consumer proposal.
It’s no different than collecting unemployment insurance when you get laid off, or disability insurance if you become ill or injured. Bankruptcy is a safety valve for those burdened with more debt than they can ever repay.
Answer me this: if you only have enough cash this month to pay the rent and buy food, what should you do? Support yourself and your family, or make the minimum payment to the bank so that they can earn their billion dollars this month?
When I put it that way, most people realize that they have to do what is right for them and their family.
I believe that you should do what is morally right for you and your family. If you can pay your debts, great, do it. If you can’t, you have to do what is right for you. That is the morally correct decision.
So if you, or someone you know, is stressed out because they want to do the right thing and pay their debts, but they can’t, don’t worry. You made a business decision to get the loan, and now the terms of the contract will determine what happens next.
You have rights.
Consumer proposals and bankruptcy were invented to give the honest but unfortunate debtor a fresh start.
Getting a fresh start to protect yourself and your family is the morally right thing to do.
If you have the money to pay your debts, you should pay your debts.
If you have more debt than you can ever hope to repay, you have a math problem, and the solution may be to file a consumer proposal or bankruptcy.
It’s a math decision, not a moral one.
That’s our show today.
Thank you for listening to some or all of the 200 episodes of Debt Free in 30. My goal with this podcast is to bring a fresh perspective on debt, and to let you know that you have options.
I’ll have more new shows in July, and then in August we’ll replay the most downloaded shows of the last year, so please subscribe on iTunes, Apple Podcasts, or wherever you get your podcasts, and I always appreciate it if you leave a review, whether you agree with me or not.
As always, a full transcript of today’s show can be found at hoyes.com, that’s hoyes.com.
Thanks for listening, until next week, I’m Doug Hoyes, that was the 200th episode of Debt Free in 30.