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Common Mistakes to Avoid When Your Income is Reduced

As a bankruptcy attorney who has met with thousands of distressed consumers in the Augusta area, I have had the opportunity to evaluate the different methods that people have used to reduce their expenses in situations where income has been temporarily eliminated or reduced. For instance, a consumer may have been laid off and the unemployment income that they receive represents only 60% of their previous net income. Another common example is a worker who is injured on the job, and receiving worker’s compensation. Or a worker may still have their job, but their hours are cut or pay reduced. Regardless of the reason, the individual is facing the task of managing their household expenses on reduced income. Ideally, the reduction in income may be temporary, but it is always best to plan that the reduction will be long-term, just to be on the safe side.

But if your income has been reduced, what expense adjustments should you avoid until you are back on your feet?

1) Allowing your auto insurance coverage to lapse – obviously you are required to have liability coverage in order to comply with the laws of Georgia, but many people are unaware that losing full coverage insurance on a financed automobile is an event of default under the contract. This means that the vehicle could be repossessed even if the payments are up to date.

2) Reducing your income tax withholdings – while this may free up additional money, you will wind up owing taxes in the future. Income taxes are a non-dischargeable debt in bankruptcy. So while you may be able to pay credit cards and other unsecured debt with the additional money, you are replacing that with tax debt that you can’t eliminate if a bankruptcy should be necessary in the future.

3) Paying less than the monthly payment on secured debts – many consumers feel that if they are sending some money, even if it is not the full monthly payment, then their secured lenders will not take steps to foreclose or repossess their collateral. This is simply not true. If you start sending partial payments, the money may be returned to you or held in suspense, making it difficult for you and the lender to get back on track. You are better off holding the money until you can make the full payment, as well as any late fees that may be owed.

4) Alternating the payment of secured debts – this is another situation where consumers try to make everyone happy, and leave no one satisfied. For instance, a couple may have two car loans but can only afford to pay one. They may make a payment on the husband’s truck one month, and then pay on the wife’s care the next month. As a result, both loans go into default, and both vehicles are repossessed. In that situation, it is much better for the couple to decide upon the most practical vehicle to keep (based on family size, fuel economy, maintenance cost, etc.) and concentrate on making those payments. In this manner, only one vehicle would be lost.

5) Cashing out your 401(k) – admittedly this may be a necessary option, but the biggest mistake is that some consumers make it the first option, instead of carefully evaluating their budget. Not only do you lose the income that you will receive after retirement, but you generate an income tax liability.

6) Falling behind on utilities – utility providers can disconnect services based on non-payment. If the services are terminated, you have added an additional debt to your portfolio, and you will have to pay a deposit to obtain utilities in the future.

Ideally, a bankruptcy filing can be avoided by prudent money management during an income crisis. But if you find yourselves considering some of the options described above, it would certainly make sense to meet with a bankruptcy attorney, especially before the financial problems become compounded.