Financial Literacy Month 2012 (April 24) Avoid bankruptcy with Pro Rata

April 24, 2012 by 3 Comments

Brad Chaffee from EnemyOfDebt.com offers some great advice for those who are falling behind on debt payments and considering bankruptcy.

The Pro-rata Method can keep creditors off your back and help you avoid future judgments, or the execution of a judgment because you are declaring hardship and essentially asking for an alternative plan until you can afford to make the original monthly payments for all of your debt.

It is in the creditor’s best interest to accept this plan because it’s better for them to receive something rather than the nothing they’ll receive if you filed bankruptcy. You borrowed the money though and you want to pay it back, you just need a little wiggle room until you can get back on your feet.

Pro-rata Method

  • The Formula
  • Communication
  • Transparency

The Formula

The formula is based on your disposable income (money you have left over after paying for essential bills)

Let’s say you have the following debt load:

Debt 1 $7,500 (current minimum $500)
Debt 2 $5,000 (current minimum $200)
Debt 3 $2,500 (current minimum $100)
Debt 4 $2,500 (current minimum $100)
Debt 5 $2,500 (current minimum $100)

Total Debt $20,000
Total Minimum Payment(s) $1,000/mo
Disposable Income $700/mo
You are $300 short.

Formula 1: Figures out what percentage each debt represents of your total debt.

Debt 1 $7,500 divided by $20,000 = .375 (37.5%)
Debt 2 $5,000 divided by $20,000 = .25 (25%)
Debt 3 $2,500 divided by $20,000 = .125 (12.5%)
Debt 4 $2,500 divided by $20,000 = .125 (12.5%)
Debt 5 $2,500 divided by $20,000 = .125 (12.5%)

Formula 2: Determines what your new minimum payments will be.

Debt 1 $700 multiplied by .375 = $262.50
Debt 2 $700 multiplied by   .25 = $175
Debt 3 $700 multiplied by  .125= $87.50
Debt 4 $700 multiplied by   .125= $87.50
Debt 5 $700 multiplied by   .125= $87.50

Communication & Transparency

Communicating with your creditors and being as transparent as possible will make this process much smoother. When/if your disposable income changes so should your minimum payments.

It’s important for you to let your creditors know that you wish to honor your obligation. You have every intention of paying them what you owe; you just can’t pay them the full minimum payments as they are.

Send each creditor a letter explaining your situation, why you’re experiencing hardship, and be sure to attach your budget and pro-rata forms with the letter.

The key is communication

If your creditors feel you are doing everything you can and have every intension of paying them the money you owe them, the less likely you are to end up in court or to have your wages garnished.

Filed Under: Financial Literacy Month
3 comments
  Livefyre
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enemyofdebt
enemyofdebt

You bring up a good point Travis. The Pro-rats Method is more of a temporary solution than a debt repayment plan. It is possible for someone to negotiate a lower interest rate though to make this more beneficial for them while they're playing catching up. The aggressive debt repayment would begin once the debtor was once again able to pay the original monthly payments. This plan is merely a last chance effort to avoid a judgment or the execution of a judgment. If I were in a situation where I needed to use this method I would definitely call to have my interest rates lowered. Generally people who seek to file bankruptcy - at least those who I have talked to - say a judgment or wage garnishment was what they were trying to avoid. That's what makes this plan so useful but I have found that someone who really wants to file bankruptcy is going to file regardless of this option. This option is for those who want to honor their obligations without the added stress of court proceedings and garnishment. As you know most people who file bankruptcy aren't truly bankrupt; they're either genuinely scared or looking for an easier way to escape their debt.

DebtChronicles
DebtChronicles

BTW, great to see you on video, Brad - can't wait to hang with you in person again later this year at #fincon12.  :)

DebtChronicles
DebtChronicles

I had never heard of this before, and find it extremely interesting!  One comment I have is, for this to work, the creditors may also have to reduce the interest rate as part of alteration of the terms of the account.  If you reduce the minimum monthly payment as per your budget, that payment *may* fall below how much interest is being charged (especially if you're unlucky enough to have one of those 24.99% interest rates..or more) - people may find themselves making little to no headway on their actual balances, or worse yet, accumulating more debt.

 

If the interest rate is reduced along with the payment, then this could definitely work.  It's essentially a "do it your self" Debt Management Plan.  Monthly payment based upon disposable income + reduced interest rate is exactly how a DMP works....except in this case you're negotiating the terms yourself whereas in a DMP a debt relief company does it for you.