Picture it. You are 51 years old, newly divorced and staring down $180,000 in debt. Many Americans face a situation just like this.
Recent data from the Federal Reserve shows that the average U.S. household debt is more than $100,000. This includes mortgages, auto loans, student debt, credit cards and other forms of personal debt.
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But, what should you do if you find yourself with substantially more debt than average? Should you declare bankruptcy, or is there another viable option? The answer isn’t simple, but weighing the pros and cons can help determine the best course of action.
Remember, the type of debt and the repayment terms will be important in charting a path back to solvency.
Bankruptcy pros and cons
Filing for Chapter 13 bankruptcy offers those with a regular income a way to repay their debt as part of a structured plan. This typically occurs over three to five years, and allows people to catch up on overdue payments and, unlike Chapter 7 bankruptcy, retain important assets like their home.
Often, as soon as you file for bankruptcy you are granted an automatic stay. This halts foreclosures, wage garnishments, repossessions and other collection activity from most creditors. This can be crucial for saving your assets and helping you negotiate a manageable repayment schedule.
A Chapter 13 bankruptcy repayment plan usually requires secured debt (for example, mortgages and auto loans) to be repaid eventually. However, unsecured debt (like credit cards) is often at least partially forgiven. This means you usually only pay back a portion of the outstanding debt. This is why the type of debt you have is important when considering whether to declare bankruptcy.
There are big drawbacks to bankruptcy. According to Capital One, a bankruptcy can remain on your credit report for up to 10 years, dramatically lowering your credit score and restricting future credit opportunities.
Obtaining loans in the future might be harder. A poor credit score could even affect your job prospects or ability to rent an apartment.
In light of all these complex factors, consulting with a trusted financial advisor before making any decisions is strongly recommended.
Read more: Want an extra $1,300,000 when you retire? Dave Ramsey says this 7-step plan ‘works every single time’ to kill debt, get rich in America — and that ‘anyone’ can do it
Alternatives for digging out of debt
It’s a good idea to explore all your debt relief options before deciding to declare bankruptcy. A debt management plan offered by a reputable credit-counseling agency is based on structured payments to your creditors in amounts you can manage.
These are often financed at reduced interest rates. In many cases, you make a monthly payment to the agency, which then negotiates with your creditors to obtain lower interest rates.
Negotiating directly with creditors to settle debts and refinancing high-interest loans can also reduce your monthly payments.
Another option is debt consolidation, which means you roll several debts into one monthly payment. This has the psychological benefit of simplifying your repayments and it may help you obtain a lower overall interest rate than on individual cards or loans.
There are a number of repayment strategies you can follow. The snowball method targets your smallest debts first and aims to generate quick wins to build repayment momentum. The idea is to create motivation to move onto your larger debts.
In contrast, the avalanche method prioritizes the highest-interest debt in order to minimize the overall cost of paying back everything that you owe. Choosing between them depends on the type of debt accumulated and the personality of the individual.
What not to do
If you find yourself in a lot of debt, it’s likely not a good idea to tap into retirement funds like your 401(k). Early withdrawals before the age of 59 ½ can incur a 10% penalty on top of regular income tax. You’re also sacrificing gains from compound growth.
In other words, a large withdrawal at a young age could mean you have substantially less money available when you’re ready to retire. Also be wary of high-interest payday loans. Yes, they are relatively easy to obtain, but if you’re already heavily in debt it’s not a good idea to pile on even more at sky-high interest rates.
Be careful about cosigning a loan — this can be especially risky if you’re already in debt. According to the Federal Trade Commission, when you cosign a loan, you take on the risk. If the primary borrower misses payments or defaults, you are on the hook and your credit can be impacted.
Rather than opting for risky, quick-fix solutions, seek out repayment strategies with a clear structure. And, get the guidance of a financial advisor you trust.
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This article provides information only and should not be construed as advice. It is provided without warranty of any kind.
