If your bank goes bankrupt your debts won’t disappear

Oct 072008

With all the madness that has been going on over the last few weeks in relation to the stockmarket and the economy it is easy to get caught up in it all. There is nothing but doom and gloom pouring out from every TV channel and news website.

The simple fact of the matter is that you have nothing more to worry about than usual and here’s why.

If you are in debt and owe the bank money and that bank goes bankrupt then you STILL owe the bank that money. You do NOT have your loans written off – in fact your loan is seen as an asset of the bank because it generates income for them. As a result your loan stays in place.

Unless you have thousands of dollars invested in the stockmarket, then your main concern should still be to repay your debts. On the other hand if you do have thousands of dollars invested in the stockmarket I would ask you, retirement funds aside, why haven’t you used these funds to pay down your debt?

No matter which way you cut it, your number one focus should still be on debt repayment.

Job losses

This is a legitimate concern but given the unstable nature of working life these days it was probably a concern you had long before now. It is true that if things continue the way that they are going then there will be a lot of people losing their jobs and not just on Wall Street. Even as it stands there are thousands of people who are losing their jobs each month.

To those of you who still have a job and are concerned about losing it I would say get your house in order. There is a reason why the motto of the Boy Scouts is ‘Be prepared’.  I wrote a previous article called ‘How long could you survive if you lost your job?’ that will help you understand what you need to do in order to weather the approaching storm.

Stick half of your head in the sand

This is the best advice I could give to someone who is worried about what is going on in the world today. I give this advice on the understanding that you have your financial affairs in order and that you are focusing on paying down your debts and building an emergency fund. I wrote an article called ‘Stop talking about recession, I don’t want to know’.

In this article I outline how I actually made some money during a recession by ignoring the negative financial self talk and hiding away from the bad news. It was a case of ‘ignorance is bliss’.

Nothing changes much

If you are on a debt freedom journey then do not allow a recession or talk of recession throw you off course. It is now more important than ever to be seeking debt freedom. At least that way if you are debt free (or at least on course to being debt free) and things get really bad you can be safe in the knowledge that you are in a much better position than a lot of people are. Ultimately whatever happens it is how well prepared you are that will determine what shape you will be in when you come out the other side.

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Saving while in debt – does it make sense?

Jun 252008

Saving while in debt seems to be a bit of a contradiction. If you are in debt then why should you save? Shouldn’t every last cent be going towards paying off your debt? Ah you must mean the emergency fund? Right? That fund that all the financial gurus recommend you have. Well the thing is that I’ve read a couple of articles recently that say you should not bother having an emergency fund and that all the money that you would have saved should go towards paying down your debt.

I disagree.

The emergency fund seems to be one of those worn out clichés that you hear about every time that you pick up a book on Personal finance and debt management. Its used so often that I feel it has become part of some text book response when some one is in debt. Very few commentators seem to go into much detail as to the true importance of the emergency fund and as a result people probably don’t put as much importance on it as they should.

Controlling your personal finances is a lot like playing a strategy game like chess. Chess is a game of strategy whereby you use various strategies and moves to defeat your opponent. One of the key things about chess is that you always have to leave different strategies open to you. You shouldn’t close too many options off by losing strategic pieces too soon into the game. When you are controlling your personal finances you have to employ various strategies to reduce your debt. An emergency fund is one of those strategies.

If you were to put all your money against your debt you would be limiting your options, limiting your strategies.

The main point that the authors who advocated putting all your money against your debt were making was related to the interest difference. If you have a high interest debt such as a credit card debt at say 17.5% but you only actually receive 5% interest on your savings then it is effectively costing you money to have savings because you are paying a higher interest rate on your credit card debt for longer than necessary. On a pure math basis then this makes perfect sense.

When you are in debt pure math and logic doesn’t always win the day.

That crazy little thing called psychology plays a huge part in controlling your finances and your emergency fund is no different. From a financial payoff point of view having an emergency fund is not optimal. However from a psychology point of view having an emergency fund is crucial.

As with the game of chess, it is important that you always have something in reserve when it comes to your finances. Having an emergency fund affords you some comfort that should some emergency arise that you are not going back into debt and in the wrong direction to tackle it. This provides a great psychological boost as it allows you to draw strength from the fact for the first time probably in a long time that you have not had to rely on your plastic to get you out of a tight corner. This can be empowering.

Take it a step further. When you see your emergency fund grow along side your debt shrinking you can’t help but get more motivated. The sense that you are gaining control of your finances can be immense. For most people this spurs them on to further action.

The other key thing I disagree with when it comes to not having an emergency fund is access to cash if there is an emergency. Imagine that you have no emergency fund but you have put all your available funds against paying down your debt. Then an emergency happens and you need cash fast. Where do you go for it? Borrow on your credit card? Ok it is an option but you are going back to square one, the same with a loan or and overdraft. They all lead you back to a place you do not want to be. In some case as soon as you have paid off your debts these avenues of raising cash may be closed off to you. This is of key importance if you decide not to have an emergency fund.

Bad things happen to good people

I’m not advising you whether or not you should have an emergency fund – this is something that you will have to decide yourself based on your own personal circumstances. However the one thing I will ask you is this. How often in the last three years have you found yourself in a tight spot when it came to money? How did you manage to get out of that tight spot? More borrowing?

I hate to say it but bad things happen to good people. The more financially prepared you are to respond to such emergencies the less of an impact the emergency will have. As with chess, financial management is all about strategies and options. It is up to you to make sure you have plenty of options available to you. For me an emergency fund along with adequate insurance is one of the best ways to prepare.

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