The average Canadian is quite capable of managing their debt, especially when that debt carries a low interest rate. For those who are in severe amounts of debt though, debt management becomes a case of crisis management. Unfortunately, the inevitable stress doesn’t always lead to the best financial decisions, often making a bad situation worse.
I’d like to talk about how the typical person in serious debt behaves prior to filing for bankruptcy. By understanding this cycle, many may be able to reach out for help sooner, rather than later, avoiding much of the torment of struggling under a heavy debt burden for too long.
Before understanding the behaviour of the average insolvent debtor, it is important to consider just how deep in debt they are. Research by my firm, Hoyes, Michalos & Associates, reveals that the average insolvent debtor in Canada owes almost $60,000 in unsecured debt. This includes more than $20,000 in credit card debt and another $20,000 in bank loans. For many student debt and tax debt also become unmanageable. However the cycle often starts with just a few thousand in credit card debt. What happens next is what determines whether they will be able to get their debt under control, or whether it will become unmanageable without an intervention like a bankruptcy or consumer proposal.
How the Average Insolvent Debtor Manages Debt
An insolvent debtor will do almost anything to maintain his access to credit. It’s his or her only way to continue to pay rent, eat and basically keep afloat. Here is a typical sequence of events that many follow:
- They will at first pay only the minimum balances on their credit cards in order to stretch their debt repayment budget a little further.
- Once one card is maxed out, they will apply for another. The average insolvent debtor carries four credit cards, all of these will balances owing.
- Once they have more than one card, they can begin to borrow from one card to pay another. They often take out cash advances on one card, to make the minimum payment on another card.
- Once their credit card capacity has been exhausted, an insolvent debtor may turn to quick cash lending programs or payday loans.
- Then just like with their credit cards, when one payday loan comes due, they will turn to another payday loan lender to find the cash to pay off the last payday loan. At the time of their insolvency, the typical debtor carries on average 3.5 payday loans each with an average balance of $794. That makes for a total payday loan debt of $2,749, more than a full months pay!
The average insolvent debtor pays almost $900 per month on debt interest alone. That increases to $1,700 a month if they carry payday loans. These high interest costs make it nearly impossible to keep up with debt payments any longer.
Concerns Over Money and Credit Score
During this whole cycle, the most heavily indebted people avoid taking action because they are worried about the impact on their credit score. The thing is, at this stage their credit situation is so bad it doesn’t really matter anymore. With such a high amount of debt, they will eventually not be able to borrow at all.
A bankruptcy remains on your credit report for six to seven years after your discharge. A typical first time bankrupt will be discharged in 9 months if they have no surplus income. Discharge will be 21 months if they do have surplus income. If they struggle for three or four years before filing, that’s three or four years where they could have started to rebuild.
The lesson to be learned from all this is to take action sooner. One of the most common things I hear from clients is ‘I wish I had called you sooner’. If you are struggling with even $10,000 in debt, contact a Licensed Insolvency Trustee. They may tell you that you don’t have to go bankrupt but they will be able to put you in the right direction to reduce that debt, rather than let it grow at all costs.