Personal bankruptcy is sometimes described as a magic bullet that wipes away debt and lets a person start afresh. But is it really a financial panacea? Personal budgeting expert and MyBudget founder Tammy May explains personal bankruptcy, how it works and the consequences.
Nobody starts out intending to go bankrupt. Insolvency usually builds up over time—over many years in fact. It often starts with a cash flow crisis. With more money going out than coming in, the person begins to rely on credit to make ends meet. When a cash crisis is short-term, recovery is easier. The person can pay down their credit card and debts over time and gradually get back on their feet. But a long-term cash crisis can lead to a relentless cycle of interest charges, late fees and snowballing debt—a spiral of financial stress that feels inescapable.
Added to the financial pressure, there’s often enormous mental and emotional strain. Work performance can suffer; relationships can be tested. Daily life can be plagued by harassing calls from creditors and bullying collectors. The person may be forced to borrow money from family and friends. They may be facing eviction from their home or repossession of a vehicle; they could, in fact, already be homeless or couch surfing. Eventually, at some point, bankruptcy feels like the only option.
In legal terms, bankruptcy is a process that releases a person from their debts. In Australia, personal insolvency is overseen by the federal government through the Australian Financial Security Authority (AFSA). A person may lodge a voluntary petition to become bankrupt or a creditor may apply to force a person into bankruptcy.
Last year, just over 17,000 Australians entered into personal bankruptcy. What is life like for them? On the upside, their debts have been wiped out, they have no repayments to make and their creditors are finally off their back. However, the benefits are offset by many serious, challenging consequences.
Nobody starts out intending to go bankrupt.
When a person files for bankruptcy, a trustee is appointed by the government to value and sell their assets to pay back their creditors. The trustee also has the power to investigate and seize assets that may have been transferred to another person or company prior to the bankruptcy, and to command part of the bankrupt’s salary. The bankrupt’s name is permanently listed on a national register which, in some cases, may preclude them from certain occupations and professional positions, and from travelling overseas.
Most important to note is that bankruptcy lasts for a duration of three years and will appear on the person’s credit file for up to five years. With no credit cards and no access to credible forms of credit during that period, a bankrupt person will usually have to rely on their income alone to make ends meet. Even after the bankruptcy has ended, the person may find that their access to borrowing is limited. That’s why budgeting is incredibly important throughout the bankruptcy process.
Of course, there are situations where bankruptcy makes good sense and the benefits outweigh the bad, but it should never be taken lightly or viewed as a quick fix. The alternative is to explore your options for paying your way out of debt without becoming insolvent. This will involve sitting down and creating a detailed, long-range budget then talking with your creditors about what sort of payment terms are affordable. In my experience, creditors are usually willing to help sincere debtors pay off their debts over time. This approach takes commitment and discipline, but no more than the process of bankruptcy and it comes with the added benefit of avoiding seven years of bankruptcy in your credit history.
First published in August 2015.
Image: © Kaspars Grinvalds / Dollar Photo Club