When people with above-average incomes encounter financial hardships, the reasons are surprisingly similar to people with more modest incomes
Sure, they have more money. And yes, greater wealth can allow them the flexibility to maneuver through hard times in ways not available to folks with less money.
But experts say that when people with above-average incomes go broke, the reasons are surprisingly similar to those of people with more modest incomes. Typically, they involve a major financial shock, such as a divorce or job loss, worsened by insufficient savings and an expensive lifestyle.
“The fundamental causes are in general not that much different,” says Todd Zywicki, a law professor at George Mason University who studies bankruptcy and consumer finance. “Generally, it’s a lot of things you’d expect: Somebody with not a lot of savings gets an unexpected setback.”
It’s hard to say precisely how many people with above-average incomes encounter financial difficulties. Clearly, people with less income tend to face financial distress more often than people with higher incomes. For instance, the median sale price of a home in foreclosure or owned by a bank was about $129,000 in November 2014 — 35 percent less than the price of nondistressed residential properties, according to housing data provider RealtyTrac.
Still, high earners often encounter financial problems. The average household income of someone seeking credit counseling was $55,500 in the first half of 2014, according to the National Foundation for Credit Counseling. That’s higher than the national median household income of $51,939 in 2013, according to the Census Bureau.
Before Congress overhauled bankruptcy laws 10 years ago, about 10-15 percent of personal bankruptcy filings were by people with above-average incomes, Zywicki says. The law reduced bankruptcy filings by wealthier people, who are now more likely to participate in debt repayment plans or other alternatives.
Mismanagement hurts when hardships hit
For people who make a lot of money, experiencing a sudden drop in income can create hardships because it can be tough to slash spending immediately. Yanking the kids out of a pricey private school and selling the beach house can be unappealing options, or at least not quickly accomplished.
Instead, people accustomed to higher incomes will start charging more on credit cards or running up home equity lines, where they tend to have plenty of credit available, according to bankruptcy lawyers and financial counselors who work with higher-income individuals. Convinced that the money will start flowing again soon, they start accumulating debts to pay for lifestyles they can no longer afford.
“We all expand to the size of our containers,” says Jeffrey Sklarz, a bankruptcy attorney in New Haven, Connecticut. “When you’re anticipating a certain level of cash flow and that cash flow is interrupted traumatically, it’s hard to downsize your life quickly enough … There are a lot of people who have high incomes but who are not truly wealthy.”
Failing to save enough money can exacerbate the problem. So can financial mismanagement. For instance, some people figure that they’re making good money and don’t need a budget.
Matt Conrad, a bankruptcy lawyer in Indianapolis, said he once had a client who told him he made $70,000 a year. When Conrad dug into the man’s finances, he found that the true figure was $90,000. The man didn’t know how much he was earning.
“The higher income cases where it’s primarily consumer debt, I find there often is serious money mismanagement — that they are not keeping track of where money is going, they’re not budgeting and, in some cases, they’re not sure how much money they make,” Conrad says.
Generally, people in households with higher incomes tend to have higher credit scores than people in lower-income households, according to figures provided to CreditCards.com by the credit bureau Experian. That means that people with higher incomes typically have easier access to credit on better terms than people with lower incomes.
Interestingly, though, people in the highest income bracket — in households making $500,000 a year or more — actually have lower average credit scores than people in households making $250,000 to $500,000.
The ‘wealthy hand-to-mouth’
As a real estate broker in the Chicago area who specializes in selling properties on the verge of heading into foreclosure, Bert Gor has worked with plenty of people who have run into financial trouble.
In September 2014, Gor sold a 4,100-square-foot house with five bedrooms and three-and-a-half bathrooms in the wealthy suburb of Hinsdale for $1.2 million. That might not sound like anything special, except that the seller had a $2 million mortgage on the house — which he built in 2003 with expensive hardwood floors and a third-floor bonus room — and was eager to sell after losing his job. The deal, Gor says, was DuPage County’s largest-ever sales price on a house that fetched less than what was owed on the mortgage, known in the real estate industry as a “short sale.”
“On the higher-end homes, the pattern I notice is some kind of catastrophic income loss,” Gor says. “Many times with the wealthier homeowners you deal with, they still have money, but it’s tied up in a trust … On paper, their cash flow might look horrible, but you go to the house and they’re still driving Bimmers (BMWs), and there’s still money there.”
Gor’s description of upper-income people unable to make their mortgage payments is an example of a demographic identified in a Brookings Institution academic paper last year: people who have little savings but who are not poor, whom the authors dub “the wealthy hand-to-mouth.”
Although not impoverished, these people respond to financial shocks in a similar way to lower-income people because so much of their money is tied up in property and other illiquid assets, says study co-author Greg Kaplan, an assistant economics professor at Princeton University. About 20-30 percent of the population could fit into this category, Kaplan said in an interview.
“What is surprising is the sheer magnitude of how many people there are like this,” Kaplan says.
They tend to be homeowners in the middle of their working lives, with an average age around 40 years old. They have a lot of financial obligations, but not a lot of extra cash that can be used as a cushion.
Financial planners generally recommend that people have around six months’ worth of expenses set aside in an easily accessed account for emergencies. But the people described in Kaplan’s study typically had cash reserves of only a few weeks. That suggests that when those people fall on hard times, they would start racking up credit card bills and other forms of debt.
The study could be proof that, like other Americans, those with higher incomes don’t save as much as they should — or that if they do, the investments are not in a form that is easily accessible. Americans across all income brackets saved an average of just 4.4 percent of their disposable income in November, according to government figures — less than half the percentage from 30 years ago.
At the same time, housing, student loan and credit card debt is on the rise again, following a downturn after the last recession. Consumer debt, including credit cards, consumes about 5 percent of disposable income.
Financial basics still apply
Bruce McClary, spokesman for the National Foundation for Credit Counseling, says personal finance principles differ little for the wealthy and not-so-wealthy. In good times, both should plan and save. When money gets tight, they can employ similar strategies to shed debt.
“On the balance, the basics apply to those with high incomes as well as low incomes, such as basic advice on budgeting and household money management,” he says.
Solutions become complex for consumers with many financial obligations. A person with more creditors and substantial debt might require a different approach than someone with a handful of creditors and little debt.
Sometimes, he says, wealthier people do not turn to credit counselors for help, when the truth is that anyone facing financial trouble can benefit from a fresh approach to the problem. “If you have someone with more debt, then the remedies become a little bit different,” he says.