When faced with problem debt people typically make an emotionally charged choice on how to deal with it.
Generally the choice they make addresses their emotional needs but fails to logically solve the underlying math problem. This is a subject I’ve talk about a lot here.
Today I want to talk about the real cost of getting out of debt. Dealing with debt has two costs. The one is the immediate cost of whatever solution you choose. Think about that as the program cost. The second is the future cost of making that decision.
In this example I’m going to use a credit counseling program as an example. But the fundamentals apply to any extended repayment plan by a creditor or in debt settlement as well.
A credit counseling plan seems responsible and innocent enough. It feels like the right thing to do for many.
In this example let’s say our 30 year old couple has $30,000 in unsecured debt they are struggling to pay. They contact a credit counseling agency and are told they can be out of debt in only five years with a monthly payment of $650 a month. Part of that payment, $50, is the credit counseling fee. That monthly fee in the credit counseling program will cost a total of $3,000 over the length of the program.
Our couple says they feel an obligation to repay the debt even if the monthly payment still leaves things tight and unable to save each month. For our young couple the emotional feeling of repaying their debt feels more immediate and of a higher priority.
In reality this might just be a classic example of hyperbolic discounting. Want to learn more about that, click here.
Our couple in trouble decides they can just make the payment and decide to launch into the program.
But what if the credit counselor had told them the program wasn’t going to cost them $650 a month but $1,043,721 in lost retirement dollars. Would our couple make the same choice to proceed?
If you would like to try the calculator for yourself and see what getting out of debt will cost you in retirement dollars, click here for the debt repayment calculator.
Now let me be clear, while clearing the debt quickly for our example couple would most likely mean a chapter 7 bankruptcy, which 70% of people qualify for, I’m not advocating the only answer is bankruptcy.
What I am trying to help people think about is in the face of a uncertain retirement funding for most people, and a concern if Social Security will be around in a few decades, making an educated decision about how to best deal with debt and what it will cost you is a smart thing to do.
Considering the facts here, what do you think? Is it better for someone to repay their debt today over five years or make some tough choices now and be better prepared for retirement when they will need the money the most?
What choice would you make?
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2 thoughts on “What Getting Out of Debt Will Really Cost You”
Steve, your assertion here is that entering a debt relief program (such as debt management) will end up impacting your retirement accounts because you sink such a large amount into paying off your debt instead of investing for the future. Your assertion is that the decision to enroll in a debt management program is the point in time that the person chooses that path.
People get into debt for all kinds of reasons, some by no actions of their own. But let’s take the case of someone who racked up a mountain of debt through blatant overspending and bad decisions.
Didn’t they really make the decision to sacrifice those extra funds for retirement via those bad decisions and overspending? There is a place for bankruptcy – for people that are insolvent (cannot pay, and have no hope of ever paying). My opinion – just because the road is hard doesn’t mean that you shouldn’t have to travel it…..
You raise an excellent point and a decision that individuals can only make for themselves after being fully informed. I have no dog in this hunt except for trying to help people make an informed decision.
Let me be clear that I am not suggesting that people who can continue to save for retirement and make at least their minimum payments should stop what they are doing.
But those that are struggling or have boxed themselves into a corner of problem debt need to fully contemplate the options and what they mean.
Debt relief companies prey on consumers by manipulating them with the moral message. You incurred the debt and it is your responsibility to pay it off, at all costs. They tacitly support this action, not because it is in fact mathematically best for the individual, but best for the company. No debt relief company benefits by not enrolling consumers.
For a look at the moral arguments see https://getoutofdebt.org/33451/is-bankruptcy-sinful-and-bad-or-right-and-moral-an-examination
But two wrongs don’t make a right. A past financial mistake and a future one does not make the morality of the decision more pure.
The question I often ask people at that moment of trouble is if they have a greater responsibility to fix the past or fix the future?
Some may feel it is better to sacrifice the next five years digging out of a hole they created, and I get that. But there are all sorts of arguments that support that may not be the right path, including biblical teachings. See https://getoutofdebt.org/48286/what-does-the-bible-say-about-bankruptcy-is-bankruptcy-scriptural
Applying a moral component to a debt situation is something only the consumer does. When the lender made the decision to take the risk and lend, they made a business decision.
When the lender makes a decision to not be flexible in payment arrangements when someone is down, that’s a business decision. I am not casting blame, just making an observation.
So when a consumer is faced with problem debt should they face it as a moral argument or as a business decision? See https://getoutofdebt.org/50842/how-do-i-get-out-of-debt-quickly-change-your-mindset
The math, which is neither moral or corporate, tells us that the younger you are when you put money away for retirement, the more it will grow to when the time comes to call on it.
Time can not be reversed and once past it is lost forever. Yet, even with bankruptcy there are no absolutes except consumer protection. You can still repay your debt after bankruptcy as you can best balance the needs of your future, your family and your moral commitments.
If someone wants to enter into an extended payment plan and is willing to throw away millions in retirement to do so, and they are aware and intentional about making that choice, then go for it.
If someone wants to short themselves millions in retirement they could have saved, leave themselves exposed to an uncertain future of Social Security, is not afraid of potentially laying the burden of that decision on their kids that might have to help support them, then go for it.
Until the data changes and the vast majority of people retire into non income producing years with sufficient funds to care for themselves when they can’t earn and are most needy, then we have to ask if the decision should be made on the moral argument of today or the moral argument of what life will be like when you are 82.