Filing for bankruptcy is often the result of multiple factors coming together to create a financial crisis. While irresponsible financial behavior, like excessive borrowing, can contribute, there are other significant circumstances that can push someone toward bankruptcy. Here, we will delve into the top five reasons people go bankrupt in the United States.
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5 Common Causes People Go Bankrupt
Many people find themselves considering bankruptcy due to a combination of the following factors: loss of income, overwhelming medical expenses, unaffordable mortgages, excessive spending, and financial assistance to loved ones. Typically, bankruptcy is a culmination of several of these factors.
1. Loss of Income
One of the primary reasons people file for bankruptcy is a sudden loss of income. Unemployment can create a substantial financial burden, especially if an individual’s budget is already tight. According to a survey conducted in September 2023, 78% of Americans live paycheck to paycheck, highlighting how vulnerable many are to financial instability if they lose their job.
2. High Medical Expenses
Medical bills are another leading cause of bankruptcy. Health problems can also result in job loss, further exacerbating financial troubles. If someone loses their job and, consequently, their health insurance, they may face insurmountable medical costs. Programs like the Consolidated Omnibus Budget Reconciliation Act (COBRA) allow individuals to keep their employer-sponsored health insurance after job loss, but the costs can be prohibitive. COBRA requires the individual to pay both their portion and the employer’s share, plus an administrative fee, making it unaffordable for many.
3. Unaffordable Mortgage or Foreclosure
Housing debt is the largest component of household debt in the United States. Far exceeding credit card, car, and student loan debt. By the end of Q4 2023, the Federal Reserve Bank of New York reported that housing-related debt, including mortgages and home-equity lines of credit, reached $12.61 trillion, accounting for about 72% of household debt in the U.S.
Sometimes, lenders approve mortgages larger than what the borrower can realistically afford, leading to foreclosure if they cannot make the payments. Adjustable-rate mortgages can also pose a risk if interest rates rise, increasing the monthly payment to an unaffordable level. In such cases, bankruptcy might become the only viable option.
4. Overspending
Living beyond one’s means is a common path to unmanageable debt. Maxing out credit cards on non-essential purchases and being unable to meet minimum monthly payments can cause debt to spiral out of control due to accumulating interest. To prevent overspending, it’s crucial to create a budget that ensures expenses do not exceed income and to build an emergency fund to cover unexpected costs without resorting to debt.
5. Providing Financial Assistance to Loved Ones
Supporting family members financially can also contribute to bankruptcy. Whether it’s aiding adult children or aging parents, many find it hard to refuse financial help to relatives in need. This additional burden can strain an already tight budget and lead to financial collapse.
Additional Reasons for Bankruptcy
Other factors also drive people to file for bankruptcy. For instance, student loan debt can be overwhelming. Although it’s challenging to discharge student loans in bankruptcy, a 2022 policy change has made it easier to do so under certain conditions by proving undue hardship.
Divorce or separation can also lead to financial difficulties due to legal fees and the division of assets and liabilities. In some cases, individuals file for bankruptcy to eliminate other debts so they can manage their student loan payments or other financial obligations.
Does Bankruptcy Eliminate All Debts?
Bankruptcy can clear many debts, offering a fresh financial start. However, it doesn’t erase all debts. Obligations like alimony, child support, certain taxes, fines, and some student loans typically remain.
The Downsides of Bankruptcy
While bankruptcy can provide relief from overwhelming debt, it significantly impacts your credit score. A bankruptcy filing can stay on your credit report for up to ten years, affecting your ability to obtain credit, rent housing, and sometimes even secure employment.
Divorced & Bankrupt
Filing for bankruptcy during a divorce is possible, but typically only one legal process will proceed at a time. It’s essential to consider whether to file for bankruptcy before or after finalizing the divorce to navigate these concurrent financial and legal challenges effectively.
Bankruptcy can offer a lifeline to those drowning in debt, but it comes with long-term consequences. Understanding the primary causes of bankruptcy—such as loss of income, medical expenses, unaffordable mortgages, overspending, and financial assistance to loved ones—can help individuals take proactive steps to maintain financial health. By managing debt responsibly, creating a budget, and building an emergency fund, you can reduce the risk of reaching a financial breaking point.