How Cognitive Biases Lead You Towards Bankruptcy

How Cognitive Biases Lead You Towards Bankruptcy

The term cognitive bias defines an error in decision making or reasoning. This means disregarding an accurate, as well as, objective information in favor of subjective preferences and believes. In other words, people exhibit cognitive behavior when they go with their gut feeling, and overlook the objective information that is essential for the smart decision-making process. Adding to this, such persistent irrational behavior or bad choices can lead you to bankruptcy. Let’s have a look at the examples of cognitive bias.

  • Sunk Cost Fallacy

Sunk cost fallacy means that your decisions are tainted by the emotional attitude. The more you feed your mind for emotional decision making, the harder it becomes to abandon it. To avoid bankruptcy situations, one needs to make a rational decision with emotional intelligence. Therefore, the frequent cognitive bias which is usually visible in bankruptcy practice is the Sunk Cost Fallacy. In which the client normally refused to surrender an expensive house or car because they have put a hefty amount into that asset. Also, surrendering that asset means throwing away their money. Obviously, in crippled financial times, the sane mind says, that, you need to re-evaluate your situation and analyze what you can comfortably afford and what you cannot. Further, if you are considering bankruptcy then you need to fight against the sunk cost fallacy. There is a famous saying, that: “don’t throw your good money after bad”, which is a right approach if you are struggling with a sunk cost decision.

  • Framing Effect

Yet another example of cognitive bias is called “Framing Effect”. In which people responded to multiple choice in different ways depending upon how it is presented, either as a gain or as a loss. A case in point is when a salesperson utilizes selective facts to tempt their customer to make a purchase, which they really don’t need. Some slick salesman used the framing effect to convince their potential customers that they will save tens of thousands of dollars on their vacation by buying a timeshare in Orlando in comparison to the cost of staying in a hotel for a unique vacation, every year. After making the said purchase they are bombarded with multiple maintenance fees, which eat up their savings. Families who are victims of this framing effect still stuck with multiple timeshares. Besides this, some aggressive salespersons force a customer to make purchases on things they don’t need them such as carpet shampooing system, solar panel installations or water purification systems.

How Bankruptcy Can Help Undo Bad Decisions

In a nutshell, there are many more cognitive biases, identified by the experienced psychologists, which can lead you towards bankruptcy but you get the picture. There is no doubt that anyone can fall prey to lapses in judgment, though we need rationalization in the greater interest of ourselves. But, if you are unable to pay for your basic necessities like clothing, food, and shelter because the disposable income is allocated for the payment of housing and transportation. Then, in such a scenario, payment of non-necessities like timeshare or water purification system is not a good idea, and need of a bankruptcy lawyer is a must. A Detroit bankruptcy lawyer can save your financial condition by taking you out of the bad deal as well as poor decision making. Last but not least, it can help you in regaining your peace of mind.

How Bankruptcy can help you build wealth.

Give a fresh start for financial freedom through bankruptcy 

Bankruptcy is a new beginning, not the end of the world.

In days long past the word “bankruptcy” had such a stigma attached to it that the average person or family could run the risk of being thought of as a pariah, ostracized by family and friends, excommunicated by their places of worship, even attacked by the very creditors that they needed protection from.

Thankfully, today the perception of bankruptcy is very different. Our modern society is so dependent on the availability of credit to make both major and minor purchases that bankruptcy has become an everyday occurrence, with filings being from every rung of the social and economic ladder. Whether your personal perception of someone or some business entity filing for a bankruptcy is a positive one or a negative one, the reality is that for the foreseeable future, bankruptcy is here to stay.

Bankruptcy has been a facet of the United States government as far back as 1800 under President Thomas Jefferson. While many changes have been made from the earliest days, the core ideal of bankruptcy remains unchanged; Provide protection to an individual or business that no longer had the ability to repay debt that they incurred legally. Sounds simple enough, however more than 200 years ago, you simply could not be the one that took advantage of that protection because the personal consequences you would suffer, would in most cases be far more severe than anything a creditor could do to you.

However, in the United States today, everyone is filing for bankruptcy. Ok, maybe not everyone, but the list of famous people that have had to file for bankruptcy is a veritable who’s who of Hollywood and the professional sports world.
Toni Braxton, Walt Disney, Sherman Hemsley (George Jefferson), Don Johnson, Larry King, Willie Nelson, Wayne Newton, Burt Reynolds, Donald Trump, Mike Tyson and Michael Vick have all filed for bankruptcy, and many have made the best out of a bad situation and have become as, if not more wealthy than they were before filing bankruptcy.

Now of course, as a reader of this article it is very likely that you are not a movie star, professional athlete, or business mogul but the principal of bankruptcy still stands as it did when Milton Hershey (founder of Hershey Chocolate Company) filed in 1882, that a fresh start financially can give you the opportunity to regain control of your finances and let you start to rebuild wealth without dragging along excess baggage.

Now of course when you do finally transform your current situation of excess debt and a mountain of bills into one of being debt free and building toward a brighter financial future, it is doubtful that they will put your picture on the fifty dollar bill, but every time you see one, keep in mind that even Ulysses S. Grant, the 18th President of the United States, filed for bankruptcy in 1884.

Alright, enough of the history lesson, well sort of. How many times have you said to yourself, “If only I would have been able to do (insert random mistake here) again and do it differently”? Well, I personally could write a book on my “do-over” list, but it might take some of the luster off of your opinion of me and I don’t want that. But I assume that your story contains just as many moments that you would like to do differently as mine does. While you may not be able to reconsider who you chose for a wife/husband, choose a different college degree to pursue, or which career path you chose, how poorly you handled your finances and credit, or if it was a one-time event that caused you to be overwhelmed by debt is one area where you can get a fresh start and truly begin anew.

Just imagine how much easier your life could be if only you could obtain credit, whether for a credit card, automobile, or home mortgage loan at the same interest rates that the banks offer to their highly desirable “very good credit” borrowers. As an example if you had a mortgage loan for $100,000 and your interest rate is 8.75% (poor credit), your monthly payment for the principal and interest would be $786.00 per month, conversely if you had the same $100,000 mortgage at 3.5% (very good credit) you would be paying only $449.00 per month. That is a savings of $337.00 per month and the only difference is your credit score. So how does bankruptcy fit into your boosting your credit score from poor credit to very good credit? The answer is actually quite simple. When you have a fresh start financially you begin to rebuild your credit rating almost immediately. Think of it as ripping a bandage off quickly, sure your credit score is going to be affected by the bankruptcy filing, but if your credit is already poor, this is the least of your worries. With simple regular maintenance and repaying your bills on-time going forward, your credit rating will begin to rise almost overnight. It is not unusual for someone that filed a Chapter 7 Bankruptcy to add one hundred or more points to their credit score within the first year without doing anything but paying their ongoing bills on time.

Want to purchase a new home or refinance the one you are currently living in? The popular misconception is that since bankruptcy remains on your credit for ten years that buying a home or refinancing your mortgage is impossible. However, the reality is that a homeowner or someone looking to buy a home can do so in
three years after a bankruptcy. Mortgage financing is usually the most difficult credit to obtain, automobile financing and credit cards are available much sooner.

If you are truly looking for a fresh start to your financial life, bankruptcy can be the first step toward total financial restoration and open doors to previously unavailable credit, savings and wealth.

Now is the time to maximize your potential by erasing your debt and moving forward.