By Dr. James M. Dahle, WCI Founder
Today, I would like to tell a story. You don't read stories like this very often, particularly on financial blogs and especially on physician financial blogs. People don't like sharing stories like these. In fact, people don't like hearing stories like these. But they happen all the time. I saw a net worth survey of physicians a few years ago that indicated that 1/4 of those surveyed live beyond their means and carry credit card debt. You don't have to think about that for too long before you realize that many of that 25%, even with a high income, run into major problems. This is one of those stories.
This is the story of a physician who declared bankruptcy. We'll call her Mary, although, as you might suspect, that's not her real name. She may not even be a her, and she may not even be a physician. But let's just go with it, remembering that these events are quite real, and the comments left on this post need to be sensitive to that fact.
A Story of Physician Bankruptcy
Mary was backed into a corner after her divorce, and she had to file Chapter 13 bankruptcy to prevent foreclosure on her home a few years ago. As a single mother who has already filed bankruptcy before, you can imagine why she might feel like a lot of the advice on this website doesn't apply to her. She wrote in asking for me to write something that would.
Mary's story begins with her divorce attorney seeing her name on the county court docket for an upcoming foreclosure on the home. After the divorce, she couldn't afford the home, and she was $150,000 underwater on it. She was working on a short sale, and she actually had a serious buyer under contract. In fact, the bankruptcy was more to facilitate the short sale than anything else, as she only had $25,000 in consumer debt and because her student loans—about $110,000—wouldn't go away in bankruptcy anyway.
Mary filed Chapter 13 bankruptcy just two days before the foreclosure (and the ensuing deficiency judgment in her state), and the short sale of the house went through. She kept the student loans outside of the Chapter 13 proceedings on the advice of her attorney in order to invite less scrutiny on the case (which bankruptcies on physician-like incomes seem to do). Of the remaining $25,000 in debt, only four creditors stuck around to file proof of claims. The rest just walked away, reducing the $25,000 to $10,000, and she was given a $400 per month payment with a decrease in her interest rate from 10%-15% to 4.5%.
Tax refund time came around, and she was due a tax refund of about $13,000, so she withdrew from bankruptcy so she wouldn't have to hand that over to the trustee as required. She then settled with the remaining creditors for 50 cents on the dollar and walked away with her retirement accounts and 529s intact.
At this point, Mary has her student loans paid down to $95,000, and she has a $26,000 car note at 10%. She can't get anyone to refinance her student loans, but her income is up and the significant attorney fees are long gone. She had to pay tax on the forgiven debt but not on the short sale, thanks to the 2014 Mortgage Forgiveness Debt Relief Act.
She shared this story with me and agreed to have it shared with all of you—recognizing that some would be critical, even mean—in hopes of providing some light at the end of the tunnel to other single-parent physicians facing foreclosure and bankruptcy. She states: “My intent was to start a conversation on how physicians post-bankruptcy could regain their financial footing. Also to show that bankruptcy is nothing to be ashamed of; it’s not the end of the world.”
A Very Brief History of Bankruptcy
Let's start with a brief overview of bankruptcy. I'm no attorney, and I'm certainly not an attorney in your state, so I'll probably get something wrong, which I'll update as soon as it is pointed out to me.
Bankruptcy is actually a fairly modern concept, although there are some ancient equivalents, such as the Year of Jubilee described in the Old Testament. Ancient Greece, the Koran, and Babylon all had some provisions for people who could not pay their debts, although, in some parts of Asia, you were beheaded if you went bankrupt three times. But throughout Europe and even after the founding of the United States, people who couldn't pay their debts went to debtor's prison. The last of those was closed in just 1849, although some argue a form of it still exists today when people are put in prison if they don't pay their fines. It wasn't until 1855 that the losses of corporation shareholders were limited to the amount of their investment and 1898 before the US had its first permanent bankruptcy law. Many economic historians cite bankruptcy laws as part of the economic engine on which the US and other countries with similar laws rose, because it allowed people and corporations to take more risks in their lives without fear of debtor's prison or beheading.
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There are at least six chapters under which bankruptcy can be filed:
This is liquidation bankruptcy, “straight bankruptcy,” or “complete bankruptcy.” The trustee collects all of the non-exempt assets, converts them to cash, and divides them among the creditors. The bankrupt person walks away with a fresh start and whatever assets might be exempt from the proceedings. A business declaring chapter 7 bankruptcy is going out of business.
This is for municipalities and is similar to Chapter 11.
This one is for the reorganization of a business. It allows the company to stay in business for 120 days while trying to work things out. For example, burdensome contracts or leases can be renegotiated; debts can be repaid, reduced, or discharged; and business operations can be rescaled.
This one is for family farmers with ongoing income and is similar to Chapter 13.
Chapter 13 is for an individual with a regular income and a desire to pay the debts but without the ability to do so. It protects the debtor from creditor actions—such as lawsuits, foreclosures, wage garnishments, and contact with the creditor. You make payments through a trustee for 3-5 years and then the remaining debts are discharged. It can be useful if you have debts that wouldn't be discharged under Chapter 7—such as tax bills or child support—if you're underwater on a house, if you are behind on payments, or if you have years of unfiled taxes.
This is used for those in bankruptcy who have debts and assets in more than one country.
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A Few Thoughts on This Particular Case
I commented to Mary that it seemed kind of silly to file bankruptcy on a physician's salary with just $25,000 in dischargeable debt because it really only eliminated less than $20,000 of it, about a month's worth of physician income. She noted she would do it again given the social situation; mounting legal bills; and mostly, the bank's decision to foreclose on the house (and get a deficiency judgment) rather than do the short sale. Critics will point out that she “didn't learn her lesson” given that the student loans have only been paid down about $5,000 per year since the bankruptcy and that she has a $26,000 car note, so I'll just do it right here in advance. But bear in mind, physicians are doing that stuff all the time, and nobody thinks twice about it.
Post-Bankruptcy Financial Tips
Leaving Mary's case, I'm sure this post will generate a pretty good discussion about high-income professionals and bankruptcy, but first, I'd like to give some financial tips about what to do afterward. I'll leave the decision about whether to file bankruptcy between you and your attorney, but prior to filing it, I would caution you to do all you can to avoid it. As you can see, many of the debts don't go away anyway, and there are serious hits to your credit score, your confidence, your reputation, and your cash flow. To me, “all you can do” means cutting your expenses to the bone, selling everything you can to free up cash, negotiating with creditors, short-selling the house, boosting income, getting family help, etc.
Now, on to the post-bankruptcy tips.
#1 Don't Plan on Buying a House Any Time Soon
Guess what? If you don't pay your debts, nobody wants to lend you any money. Chapter 13 bankruptcies generally affect your credit score for seven years (10 for Chapter 7), although it may not take all seven to recover to the point where someone will give you a mortgage. A short sale isn't as bad. You can often get a new mortgage just 2-3 years after a short sale. But either way, you'll rent for a while, you'll need to pay cash for a home, or you'll need alternative financing (like from the seller).
#2 You Can Borrow Money But Not at Good Terms
As this story illustrates, you can borrow money relatively soon after bankruptcy for things like a car, but you're not going to get a very good interest rate. Doctors often get car loans at 0%-2% but not doctors who just declared bankruptcy. Actually, 10% doesn't seem too bad in that scenario. But given the difficulty of borrowing, it seems a good idea to just not do it at all if it can be avoided. Drive a beater. Cut up the credit cards. Go all Dave Ramsey Gazelle Beans and Rice and just pay cash for stuff. Nobody is going to argue it's a good idea to borrow at 10% so you can invest.
#3 Student Loan Options Are Limited
Like other debt, your student loan refinancing options are going to be limited. If you plan to refinance, you might even try to do so before declaring bankruptcy. (In fact, if you're going into Chapter 7, you might try swapping some of those student loans for something that actually goes away in bankruptcy, because you're not going to be able to refinance afterward.) That's OK. Lowering your interest rate only helps a little. The way you get rid of student loans is to throw thousands of dollars at them every month. Besides, if the issues that led you into bankruptcy aren't resolved, you may be better off staying in the government IDR programs anyway. Of course, bankruptcy has no effect on PSLF. You can get rid of a lot of debt in just a few years after training if you can manage to make 120 payments while working for a 501(c)(3). If you have to change jobs anyway and you made a bunch of IDR payments in training, why not look for a nonprofit?
#4 Max Out Those Retirement Accounts
I'm always telling people to max out their retirement accounts. Obviously, this reduces your tax burden, builds your nest egg, and gets you into the mindset of looking at savings as a bill. But there is another great reason to max them out. In most states, they're protected from your creditors. What a lot of people don't realize, however, is that protection comes from declaring bankruptcy. You actually have to declare bankruptcy, or at least be willing to, in order to get that protection. The asset protection of 529s and HSAs is a little more variable (and uncertain), but it's almost certainly better than a taxable investing account or bank account. Bear in mind there may be some type of “look-back period.” Check with a bankruptcy attorney in your state.
#5 It's Usually Not Just Bad Financial Decisions
Despite what some people think, bankruptcy doesn't typically come just as a result of bad financial decisions. Lenders aren't stupid. They won't lend you money that you're unlikely to pay back in your current financial situation. But what happens is your financial situation changes. You get sick or injured. You get divorced. Your child becomes ill without insurance, and you run up a bunch of medical bills (medical bills are responsible for 64% of bankruptcies.) You lose a job. You have to move, and you're underwater. Then, the combination of bad financial decisions PLUS the new event is what causes the bankruptcy.
#6 But Fix the Bad Financial Decisions Anyway
The likelihood of you making all good financial decisions and then being wiped out by one severe life change is pretty low. There's a decent chance that you'll run into another severe life change in a few years, and if you don't change the bad financial decision-making processes in your life, you may end up right back where you are now. So, let's get the mess cleaned up as soon as possible. Just like a graduating resident, a doctor in or recently out of bankruptcy is one of the poorest people in the world. You're so poor that you had to go to the government to protect you from your creditors. So live like it. No living in fancy doctor houses. No driving fancy doctor cars. No going on fancy doctor vacations. No paying for stuff that rich people pay for, like their kids' college educations, their aunt's furnace, or a private high school. Wealth is not income; income is not net worth.
The car is usually an easy target. A reliable car that you can drive for a few more years can be had for $10,000. You can haul four kids in it. You don't have to spend $30,000, especially $30,000 you don't have.
“But it's not reliable!”
Sure it is. And if it dies (i.e. the repair costs more than its worth), go buy another one. You're still $20,000 ahead and won't have payments.
Vacations? When you're broke you vacation like poor people—you go see family and sleep on their floor. Private school? Are you kidding me? Stuff like that is fine if you can afford it, but there is a public school system and most of us made it through just fine and still managed to get into medical school. How bad can it really be?
If a lack of insurance was the catastrophic event that tipped you over, figure out a way to get insurance. Renter's insurance and umbrella insurance are cheap. So is term life insurance. Health insurance is tough for many Americans but not on a doctor's salary. It just has to be a priority. Disability insurance is important, too, if you still qualify.
#7 Nothing Happens Instantly
Just like a graduating resident with a net worth of negative $400,000, you didn't get into this hole in a single day or a single year, and you're not going to get out of it in a single day or a single year. You're in it for the long haul. But if you make good financial decisions and work hard with your nose to the grindstone, you'll pick up your head five years from now and be amazed at how far you've come.
#8 You Can't Live Like Your Partners
If you're single and broke, you can't live like your partners. I'm sorry. You just can't do it. When I joined my partnership more than a decade ago, many of my senior partners were in a very different financial situation. They graduated from medical school when tuition was under $10,000. Their student loans were long gone—if they'd ever had any in the first place. Some had their mortgage paid off. Several were married to another physician or another high-income professional. We knew we couldn't live like them if we wanted to reach our financial goals. So, we rented. Then we bought a house cheaper than theirs. We tried to figure out ways to boost our income. We stuffed our retirement accounts full. We paid off our debts. We didn't furnish half the rooms in our house. We drove a $4,000 Durango. For years.
But you know what? Now they're asking me about finances, how they can get themselves into a position where they can afford to not work nights or cut back on shifts. Younger partners show up and swap their Audis for beaters.
The point is, live your net worth, not your income.
#9 Remember You Have Expenses Others Don't Have
If you're a single parent status post-bankruptcy, you need to realize you have expenses that others don't have—child care, legal bills, higher interest rates. That means you've got to adjust other areas of your budget to make up for it. You've got to set your lifestyle expenses even lower. But you know what? A late start or a setback like divorce or bankruptcy is nothing compared to the power of a physician's income combined with smart financial decision-making. Living like a resident still works, and nobody is ever really more than about 10 years away from financial independence.
So, for Mary and all the other Marys out there, you're not alone, and this too shall pass. You've been knocked down and maybe even kicked while you were down, but you're in control. You can do this, and the entire WCI community can help.
What do you think? Have you or someone you know been through bankruptcy? What was it like? How did you recover? How long did it take before you really felt like it was behind you? Comment below!
[This updated post was originally published in 2018.]