In Part One, we reviewed some options for accessing a sum of money in fairly short order. What about somewhat more lasting solutions? If you have arrived at a crisis moment, once the immediate panic has passed you need a strategy to get back to what feels like normal to you…perhaps a “new normal.” It is time to re-think some basic assumptions about your lifestyle. Such as where you live…
I am not referring to moving to a different city. (That may be an option, but let’s leave that discussion for another day.) Are you devoting more than 25% of your net income to rent or mortgage? If you are in a high-cost city that number may indeed be higher, but once you get north of 35%, red lights should be flashing. In your spending, housing is likely the biggest lever you can pull. Now is the time to evaluate very honestly if your home is actually a source of comfort in your life, or causing you stress that is impacting your well-being. Don’t be afraid to let it go.
In Part Two, I challenged you to look critically at your transportation choices. Do you absolutely need a car in order to maintain your employment? If so, keep a car (but perhaps not the current one). But if you have a car for convenience, that is not a good enough reason to keep it when you are in getting-out-of-crisis mode. If public transportation is an option to get to work or school, or to buy food — an option that you may find time-consuming and inconvenient perhaps — then that is where you must be. If part of your strategy involves moving, how can you use that as an opportunity to eliminate your need for a car, or at least reduce that need dramatically?
What about a second job?
A second job can be an incredibly effective way to build back your financial life. The important thing here is to make sure that this second job has a defined purpose. Rather than absorb the income from your second job into your lifestyle, use it to specifically extinguish your debt and/or to build an emergency savings fund.
If literally everything else fails, bankruptcy may be an option. I have no moral judgment to offer; I just want you to know a few basic facts about how filing for bankruptcy protection will impact your immediate life, and your future possibilities. It is not a decision to take lightly but it is also not a decision that should diminish your feeling of self-worth. There is a serious problem that must be dealt with and this may be part of the path forward.
For most individuals, the parts of the bankruptcy code that will be relevant are Chapter 7 and Chapter 13. Under a Chapter 7 (or “straight”) filing, your assets are liquidated to satisfy your creditors. Most personal bankruptcies happen under Chapter 7. But — and this is a big “but” — most of your assets are likely to be “exempt.” Laws vary by state, but you will usually be able to keep your home and your car if you own them outright. But here is another “but”: Chapter 7 does not extinguish the rights that your secured lenders have to their collateral. In plain English, if you file Chapter 7 bankruptcy and do not pay your mortgage or your car loan, you will lose your house or car.
On the other hand, under Chapter 13 your debts are “reorganized.” In short, you submit a plan to pay your creditors over time from your future income. An advantage is that you may be able to negotiate under Chapter 13 to get caught up on your house and car payments.
Bankruptcy gets very complicated very fast and rules vary greatly between states. You will need specialized legal assistance from a lawyer practiced in bankruptcy in your state. A good place to start is the National Association of Consumer Bankruptcy Attorneys (NACBA). The consequences of filing for bankruptcy are fairly long-lasting. You can expect the filing to stay on your credit report for seven to ten years. During that time, you may be able to rebuild your credit with a secured credit card, however you will likely find it difficult to get a home mortgage. Other kinds of secured credit — such as a car loan — will likely be available, but at an exorbitant interest rate.
As you think through your options to get through a financial emergency, bear in mind that in most cases your retirement account assets are protected in bankruptcy. A bankruptcy filing is not the end of your financial life, but it will — and perhaps should — press pause on some aspects of it for a considerable length of time. The key is how well you use this “time out” to your future advantage.
How do I keep this from happening? Or happening again?
There are three legs on this particular stool. Savings, insurance and budgeting.
Savings. If you were not a believer in the importance of having an emergency fund before your crisis hit, likely you are now. Part of the recovery process must include taking measures to not only restore your financial health to where it was before, but to actually improve upon it. Building up a reserve equal to at least three months of expenses must be a priority. Barring a windfall (such as a tax refund), it may take time to get to that milestone. Find out what works best for you. Can you set up a split deposit of your paycheck, depositing a set amount each pay period directly into a seperate savings account? If not, set up an automatic transfer at your bank from your checking account to a savings account. Will it be more effective for you to keep this savings account at a different bank? For some, micro-savings apps that round-up your purchases and deposit the change in an online savings account may be useful (but beware of the fees).
Insurance. Was there a specific event that caused your crisis that you could have insured against? Yes, you know all about auto and health insurance, and if you are a homeowner you almost certainly have homeowner’s insurance. What about disability insurance? Renter’s insurance? Liability insurance? And have you critically thought through the amount of life insurance coverage that you need?
Budgeting. When Hemingway’s character Mike Campbell was asked how he went bankrupt, he responded “Gradually, and then suddenly.” Your particular financial crisis may feel like that. Debts that seemed manageable for a long time gradually, and then suddenly, became a burden. And you may not specifically recall how they got so large in the first place.
Budgeting is the tool that we all have at our disposal to help avoid financial crises. Not every crisis, but certainly the preventable ones. Interrogate your monthly spending for the big ticket items that can lead to ruin if you face an unexpected setback for which you (a) have not saved for or (b) have no insurance to mitigate. For example, are your all-in housing costs (rent or mortgage payment, utilities) taking up 50% of your take-home pay? That could be a financial crisis waiting to happen. All of the brown bag lunches in the world cannot save you if your biggest costs — housing and transportation for most people — are out of line with your income. This is where our own Ideal Budget tool can help you develop a sustainable spending plan.
For some, the biggest troublesome line item in the budget may be student loans. Yes, we want you to pay off your student loans as soon as you can. But if your payments are causing you to spiral towards catastrophe, know that for federal loans there exist a plethora of programs, ranging from payments based on your income to deferral to even forgiveness in limited cases, that are available to you to forestall disaster.
Finally, while it may seem impossible and perhaps even ridiculous in the midst of a financial tailspin, you do have options.
1. Take action. Whatever the circumstance is, I can pretty much guarantee you that time will not heal the wound all on its own. You need to take control of the situation.
2. Avoid taking decisions that will make things worse in the future. Many short-term fixes may alleviate the immediate pain without solving the underlying problem. But worse still, they can leave you in even worse shape. Whatever action you take, think through all of the consequences, both immediate and longer term. If you are making a move that will decrease your net worth, what is your plan to rebuild this wealth?
The pandemic taught us that we are all vulnerable. Even those who were not specifically impacted by the financial fall-out, perhaps gained a new appreciation for the knife-edge that sometimes characterizes our financial lives. Responding to financial adversity with a well-thought through and well-executed plan cannot guarantee that another crisis will not hit; only that next time you will be prepared for it.