How to Avoid Going Bankrupt With Shadow Debt

Shadow Debt is a concerning phenomenon that gained traction during the COVID-19 pandemic. It can have a devastating impact on your financial future. But what is shadow debt, and what’s the best way to avoid taking it on?

What Is Shadow Debt?

The term “shadow debt” has been used for years to describe debt that isn’t typically reported to the major credit-reporting agencies such as Experian. Usually, this debt comes in the form of an unsecured loan — that is, a loan for no collateral is required.

Shadow debt can include personal loans from friends and family members, as well as payday loans, financing through medical practices, and the “buy now, pay later” loans that have exploded in popularity in recent years. By some definitions, shadow debt can also include credit card debt.

Because shadow debt lenders tend not to report these loans to the credit bureaus, it can be hard to collect information about how much of this “phantom” debt Americans owe. Hence the name “shadow” debt.

Many consumers who take on shadow debt tend to do so out of financial desperation. In 2020, when the COVID pandemic caused a loss of income for many American households, many people borrowed money to cover major yet crucial living expenses such as rent or mortgage payments.

By taking on shadow debt, households hoped to stave off bankruptcy. However, a December 2020 study by researchers at Brigham Young University and the Massachusetts Institute of Technology found that 7% of bankruptcy filers’ total debt was shadow debt. They discovered that the mean filer owed a whopping $41,680 on unsecured shadow loans.

The study made it clear that, in the long run, shadow debt isn’t helpful. By taking on this debt in an effort to avoid bankruptcy, consumers tend to only kick the can down the road.

Post-COVID Financial Pressures

Even after the main economic threat of COVID-19 has subsided, America’s debt problem is growing. In the first quarter of 2024, total household debt soared to an all-time high of $17.69 trillion. With the inclusion of unreported shadow debt, the “real” total is likely much higher.

Households are taking on this unwieldy amount of debt due to a number of economic pressures.

For one thing, persistent inflation has caused the prices for many goods and services to remain high, squeezing consumers’ pocketbooks. That has included the cost of rent. According to a report from StreetEasy and Zillow, on average, rents rose 30.4% across the U.S. between 2019 and 2023. But at the same time, wages increased by only 20.2%. The gaps between rent costs and wage growth were even larger in large cities such as Miami and Atlanta.

The Federal Reserve’s efforts to cool inflation down haven’t helped, either. In an effort to bring rising prices under control, the central bank has imposed an unprecedented series of interest rate hikes designed to curb consumer spending. Despite this, spending has remained surprisingly strong — and as a result of higher interest rates, consumers have only added more debt to the pile.

In addition, households will likely continue to take on debt as the Federal Reserve maintains its hawkish monetary policies. By keeping the federal funds rate high, the central bank can cause unemployment levels to rise. And higher unemployment levels mean more cash-strapped households will take on shadow debt to cover their needs.

When consumers become unable to pay back these mounting debts, the threat of recession grows stronger.

The Fed’s actions have also made homeownership more expensive. Although the central bank doesn’t directly dictate mortgage rates, its monetary policy decisions play a role in which direction rates move. And with the Federal Reserve’s benchmark rate remaining high, mortgage rates have followed suit. Analysts at lender Fannie Mae expect rates to remain well above 6% through 2025.

How To Protect Your Wealth During Difficult Economic Times

Thankfully, there are steps that can be taken to avoid taking on untenable debt and risking bankruptcy when times get tough.

For example, having an emergency fund in place can help compensate for lost income. Many wealth builders keep emergency funds in an interest-bearing savings account that can be easily tapped when needed. Although there’s no one-size-fits-all answer to how much money should be kept in an emergency fund, a general rule of thumb is to strive for at least three months’ worth of living expenses. By saving money in an emergency fund during times of prosperity, you can avoid going broke when the economy turns sour.

Households can also protect their wealth against economic turmoil by creating and sticking to a budget. By not living beyond your means, you can free up unnecessary expenses to build a war chest to use in case of recession.

In addition, households can prepare for times of economic crisis by stockpiling food and other necessities in a safe spot. Our grandparents certainly knew that root cellars could be a lifeline in times of scarcity. However, it’s important to follow all food safety protocols when canning and storing food.

Avoid Shadow Debt and Secure Your Wealth With Gold and Silver

Taking on shadow debt to compensate for a loss of income is not a financially sound solution and can only lead to more economic pain.

Instead of risking bankruptcy by relying on debt when times get tough, diversify your portfolio with emergency fund investments in precious metals. No matter what happens in the economy, precious metals maintain their intrinsic values, unlike government-issued fiat currencies.

Historically, as the value of the U.S. dollar has declined, the value of precious metals has tended to rise, making gold and silver investments an effective protection against inflation. And because savvy investors tend to seek out precious metals in times of economic turmoil, these periods of instability often cause the values of gold and silver to rise.

You can easily draw on these stores of wealth to cover your living expenses in times of economic turmoil and recession.

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