Bankruptcy, a financial challenge that affects countless individuals, is often the result of various unexpected or unmanageable expenses. Knowing the root causes of bankruptcy can be a potential prevention strategy. This article explains the myriad reasons behind this financial predicament, emphasizing the significance of awareness and effective management of personal finances.
You will learn factors contributing to bankruptcy, the impact of life events like separation, divorce, and natural disasters on financial stability, and how to manage debt and avoid financial pitfalls.
Common factors that result in bankruptcy include:
Medical Expenses
Medical expenses are a significant cause of bankruptcy in the United States. A study shows that 66.5% of all bankruptcies are due to medical issues, including both direct medical expenses and indirect costs like loss of work due to medical problems.
The cost of healthcare in America is increasing, with projections estimating that healthcare expenditures will reach around $6.2 trillion by 2028, a 50% increase from 2020 levels. This escalation in costs is a major factor contributing to medical bankruptcies.
Medical debt affects various demographic groups differently. For instance, nearly 30% of black households have some form of medical debt, compared to 17.2% of white families. This disparity highlights the unequal burden of medical debt across different communities.
The average age of individuals filing for medical bankruptcy is approximately 44.9 years, and about 40% of Americans express concerns about being able to afford healthcare. In terms of the broader impact, around 20% of American households have medical debt. It is estimated that 14% of Americans had medical debt in collections in 2022, amounting to a total debt of $140 billion.
Policy changes like the expansion of Medicaid in some states have led to a decrease in both medical and non-medical debt, indicating the role of governmental policies in influencing bankruptcy trends related to healthcare.
Job Loss
The loss of steady income can create a financial vacuum, making it difficult to manage existing debts and living expenses. The loss of income makes it challenging for individuals to keep up with their financial obligations, leading to increased bankruptcy filings.
After a job loss, you may struggle to qualify for Chapter 7 bankruptcy if your average income over the past six months is still too high. This makes the timing of the bankruptcy filing crucial.
Filing for bankruptcy post-job loss can impact future job prospects, especially in the private sector, where employers may consider bankruptcy history during the hiring process.
Also, job loss often leads to immediate financial hardships. Even with severance packages, the uncertainty of finding new employment in a slowed economy adds to the stress, pushing many towards bankruptcy as a last resort.
Separation or Divorce
The dissolution of a marriage often leads to a complete restructuring of finances, with lasting effects on both parties. Divorce proceedings can be expensive, involving legal fees, court costs, and the division of assets and debts. This financial strain can push individuals toward bankruptcy.
Typically, incomes decrease following a divorce. This reduction in household income can make previously manageable debts overwhelming, leading to bankruptcy.
Obligations such as alimony and child support can place a significant financial burden on the paying spouse, potentially leading to bankruptcy, especially if their income decreases post-divorce. The division of debts and assets in a divorce decree can leave one or both parties in a precarious financial position, particularly if one spouse is unable to afford the ordered debt payments.
Excessive Use of Credit Cards
As of 2023, credit card balances saw a substantial increase, with the average annual percentage rate (APR) for all accounts being 21.19% and for new credit card accounts, 24.45%.
Credit card delinquency rates, which increase during recessions, reached all-time highs during the global financial crisis. These rates were particularly high among younger adults and households in financially distressed areas.
The global financial crisis and subsequent economic conditions have led to higher delinquency rates. Factors like job loss, which rises during recessions, play a significant role in increasing credit card delinquencies and potential bankruptcies.
Credit card debt has increased disproportionately among the poor and near-poor, with a notable increase in the percentage of families with incomes below the poverty line holding credit cards and their average credit card balances.
Higher unpaid balances on credit cards increase the probability of being behind on payments and, subsequently, the likelihood of filing for bankruptcy. Regions with high credit card debt relative to income typically have high rates of bankruptcy filings.
Excessive credit card debt is one of the many reasons leading to bankruptcy. The inability to pay off increasing minimum payments and the accumulation of high penalty fees and interest rates can push individuals towards bankruptcy as a solution to their debt problems.
Most credit card transactions are unsecured, meaning they can be discharged or eliminated in bankruptcy, providing a fresh financial start for individuals overwhelmed by credit card debt.
Unexpected Expenses
Unexpected expenses, such as medical emergencies, car breakdowns, or natural disasters, can disrupt financial stability and contribute to bankruptcy. The common types of unexpected expenses include:
- Household and Auto Expenses. This includes plumbing or electrical emergencies, appliance repair or replacement, car breakdowns, replacement parts, repairs, and car accidents.
- Medical Expenses. Accidents, injuries, illnesses, hospitalization, and hospice care are significant unforeseen expenses that can quickly lead to financial distress.
- Family and Other Expenses. Job loss, funerals, pet emergencies, school tuition fees, and tax increases can strain budgets unexpectedly.
- Natural Disaster Expenses. Fires, floods, tornadoes, hurricanes, ice storms, and blizzards can result in substantial financial burdens.
These unexpected expenses can stretch budgets beyond comfort zones, making it difficult to meet regular financial obligations and leading to increased debt or bankruptcy.
How to Manage Unexpected Expenses
- Establishing an emergency fund covering two to three months of expenses can provide a financial buffer against unforeseen expenses.
- Opting for insurance coverage, routine maintenance, and taking preventative actions can mitigate the financial impact of unexpected expenses.
- In the absence of an emergency fund, options like lines of credit, personal loans, or borrowing from family can be explored to cover unexpected costs.
Overspending or Poor Budgeting
Overspending and poor budgeting are critical factors that can lead to financial distress and bankruptcy. Nearly three-quarters of Americans (74%) have a monthly budget, with millennials being the most likely to budget. However, having a budget does not necessarily prevent overspending.
A significant portion of Americans, 16%, often spend more than their budgeted amount each month. The most common areas of overspending include groceries and dining out, with food prices being a contributing factor due to inflation.
About 48% of Americans prioritize emergency savings, recognizing its importance in offering a buffer against life’s unexpected expenses. However, many Americans lack adequate emergency savings, with 24% having no emergency savings and an additional 39% having less than one month's income saved.
The lack of an adequate emergency fund, combined with habitual overspending, can lead to financial strain. This strain can be exacerbated during economic downturns or personal financial crises, increasing the risk of bankruptcy.
Utility Expenses
Rising utility expenses, particularly for energy and water, can contribute significantly to household financial stress and result in bankruptcy. In 2022, U.S. investor-owned utilities requested rate increases totaling a combined $16.89 billion, reflecting a 14% increase from 2021.
These requests were driven by significant capital expenditure plans, including upgrading transmission and distribution systems and investing in new renewable generation. Rate increase requests by electric utilities amounted to $12.48 billion, while gas utilities requested $4.41 billion. These increases are attributed to the need to upgrade aging infrastructure and accommodate the clean energy transition, as well as factors such as inflation.
Rising inflation has been a key factor in recent utility rate cases. Utilities have noted increasing costs in areas such as insurance premiums, materials, and labor as key drivers for rate increase requests.
With capital expenditures in the power and utilities sector expected to continue rising, utilities are exploring various funding sources to balance record-high investments with customer affordability. However, customer bills have seen an average increase of 25% over the last five years, challenging regulatory bodies to limit further rate increases.
Rising utility expenses can place a considerable strain on household budgets, especially for low and middle-income families. The increase in utility costs, combined with other financial pressures such as housing, healthcare, and food expenses, can lead to financial distress.
For households already struggling with financial management, the added burden of increased utility expenses can push them towards debt accumulation and potentially bankruptcy.
Taking Huge House Mortgages
The increase in outstanding mortgage debt has been driven by more people with active mortgages and generally larger mortgage sizes. As of the third quarter of 2023, the average mortgage size per account was $144,593.
American households held $31.7 trillion in real estate equity at the end of the second quarter of 2023, a decrease from 2022. This shift indicates changes in property values and the equity that homeowners can tap into.
Mortgage balances rose modestly by $121 billion in the first quarter of 2023, with the total balance standing at $12.04 trillion. However, mortgage originations, including refinances, dropped sharply, reaching the lowest level since 2014.
Large mortgage loans can lead to high monthly payments, which may become unmanageable for homeowners, especially in times of economic downturn or personal financial crises. A decrease in real estate equity poses the risk of negative equity, where homeowners owe more on their mortgages than the value of their homes. This situation can lead to financial distress and increase the likelihood of bankruptcy.
The burden of large mortgage loans can lead to increased delinquency rates. If homeowners cannot keep up with mortgage payments, they face the risk of foreclosure, which can be a direct path to bankruptcy.
Student Loans
Student loans are a significant financial burden for many Americans, contributing to their debt load and, in some cases, leading to bankruptcy. However, discharging student loan debt through bankruptcy is challenging.
A credible study highlights that only a tiny fraction (0.1%) of bankruptcy filings caused by student loans are discharged each year. This difficulty stems from the requirement to demonstrate "undue hardship" caused by these loans, a standard that is hard to meet.
In recent years, there have been policy shifts aimed at addressing this issue. For example, in 2022, President Joe Biden's administration introduced new policies to simplify the process for discharging student loan debts in bankruptcy cases.
These changes were designed to make it easier for government lawyers to recommend that student loan debt be discharged, a move that most consumer groups welcomed. However, the legal validity of these policy changes was still under court review at the time.
Statistics from the Federal Reserve Bank of New York indicate that outstanding student loan balances grew to $1.6 trillion, with a negligible percentage of these debts being 90+ days delinquent or in default. This low delinquency rate was partly due to federal student loan forbearances not being reported to credit bureaus until at least the fourth quarter of 2024.
The analysis of the labor market outcomes for borrowers in repayment shows that student loan debt impacts various aspects of borrowers' lives, including employment outcomes and financial stability.
Pay Cuts
The financial impact of reduced income can quickly lead individuals and families into a debt spiral, struggling to meet their regular financial obligations. Many companies aiming to cut costs resort to reducing wages or downsizing their workforce. This economic instability makes more workers vulnerable to debt, particularly those who cannot supplement their income with additional work or side hustles.
Credible sources mention that bankruptcy filings in the U.S. have been increasing steadily since the 1980s, with a significant portion of these filings being made by individuals.
The process of bankruptcy can provide debtors with a repayment plan and potentially forgive many of their debts. Moreover, it can enable individuals to retain significant assets, including their homes, while eventually recovering their credit standing.
The economic downturns, like the pandemic, have exacerbated the situation, leading to increased unemployment rates and subsequent financial hardships. For instance, unemployment rates in California surged from 4% in 2019 to 15% in 2020 before settling at 9% in May 2021, affecting Chapter 7 bankruptcy filings in the state.
Such disruptions in employment and income are the primary drivers behind many individuals seeking bankruptcy protection as a means to manage their financial distress.
Helping Friends and Relatives
Providing financial assistance to friends and relatives is another less-discussed but significant factor leading to personal bankruptcy. This form of generosity, while noble, can sometimes put you in a precarious financial position, especially if your own financial house is not in order. The act of helping others financially can contribute to the accumulation of debt, ultimately pushing some towards bankruptcy.
Trying to help friends or relatives financially is a contributing factor in 12.7% of bankruptcy cases. These scenarios often arise when individuals extend loans or give away significant portions of their income or savings to help friends or relatives in need without considering their financial stability.
The decision to help others financially is a personal one and often stems from a deep sense of responsibility or emotional connection. However, it is crucial to balance this desire to help with one's financial reality. Providing financial aid without proper planning or consideration of one's financial health can lead to severe consequences, including the inability to meet personal financial obligations, resulting in bankruptcy.
Wage Garnishment
Wage garnishment, where a portion of a debtor's earnings is withheld by an employer for the payment of a debt, is a significant and often under-recognized cause of bankruptcy. This financial burden can be substantial enough to push individuals towards bankruptcy as a means of relief.
A study conducted by the Massachusetts Institute of Technology (MIT) revealed that about 1% of workers experience wage garnishment at any given time, with the average garnishment amounting to around 10% of gross earnings. This percentage is roughly equivalent to what people spend on groceries, indicating a significant impact on the financial stability of affected workers.
The study further found that wage garnishment is usually brief but painful, lasting an average of 8 months for student loan garnishments and five months for other creditor debts. These durations could indicate that some individuals eventually file for bankruptcy to end this financial strain.
Moreover, workers who experienced garnishment were less likely to remain with the same employer one year after the garnishment began, suggesting that garnishment might influence employment decisions.
Wage garnishment is not equally distributed among the population. It tends to be concentrated among people with lower levels of education, people from minority backgrounds, and middle-aged households. The study also showed that garnishments were much more common in neighborhoods with higher proportions of black residents, pointing to potential systemic problems with how wage garnishment is implemented or reflecting broader societal inequalities.
Bankruptcy can be a valuable tool in dealing with wage garnishment. When an individual files for bankruptcy, most debt collection activities, including most types of wage garnishments, must cease. This relief can be crucial for individuals whose disposable income is significantly reduced due to garnishment, affecting their ability to meet basic living expenses like rent and utilities.
Contact Los Angeles Bankruptcy Attorney Near Me
In this exploration of the common causes of bankruptcy above, you learned factors that can lead individuals and businesses to file for bankruptcy in Los Angeles. From the burden of medical expenses to the challenges posed by wage garnishment, each cause of financial distress has an interconnected nature.
According to the article, medical expenses remain a leading cause, often overwhelming even those with insurance. Bankruptcy is often the culmination of a series of challenging financial events or decisions. If you are facing financial difficulties, seek professional advice. For those in the Los Angeles area struggling with these issues, contacting a knowledgeable bankruptcy attorney can provide clarity and guidance.
At the Los Angeles Bankruptcy Attorney, we are reachable at 424-285-5525. We can help you find a solution tailored to your unique situation.
