Debt, Personal Finance 

What are the REAL Causes of Bankruptcy?

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Bankruptcy“The popular conception is that people who file bankruptcy buy about three TVs a week and then fly to Aruba to relax,” Daniel Gershburg, Esq., says.

Gershburg is a bankruptcy lawyer in New York City, and he sees a number of cases each year. “Realistically, only a handful of cases fall into that category. There is so much more to bankruptcy.”

Some of the reasons that Gershburg cites include job loss, medical bills, and the accumulation of smaller bills that get out of control. But are these the main reasons that people go bankrupt? And what can consumers do about it?

Medical Expenses and Bankruptcy

In 2009, Harvard released the results of a study that indicated that 62% of bankruptcies were caused by medical expenses. On top of that, the study exploded the myth that health insurance can help you avoid personal bankruptcy due to medical bills. The study found that 78% of those who went bankrupt due to medical bills actually had health insurance.

The problem is that when medical catastrophe strikes, there are often deductibles and co-pays that need to be met. And, even after you meet your own obligations, there are instances where your health plan will only cover about 80% of your costs. That means that if you have a major hospitalization costing $200,000, you are still responsible for 20% of the cost — or $40,000. That’s a lot for many middle class families, and many of them can’t handle that kind of expense.

However, the situation isn’t as simple as it might look at first glance. Often, the medical bills represent the final straw. There might be other factors involved, such as debt, an underwater mortgage, and reduction in work hours. Everything combined can weigh on a consumer until it’s too much. Finally, a health care setback resulting in a major cost (even with health insurance) can lead to bankruptcy.

How Big of a Problem is Overextension?

If medical costs are often the final straw, is overextension the real reason for bankruptcy? Mark Billion, a lawyer and founder of Billion Law, points out that overextension alone really is one of the least common reasons for bankruptcy in the current market.

“While some people continue to spend more than they make, the credit crunch and general anxiety among consumers has largely curbed this,” Billion insists. If overextension is an issue, it comes as a result of tragedy. “Job loss and illness lead to maxed out credit cards, mortgage defaults, and repossessions.”

Billion continues: “This in turn often leads to payday loans that the client thinks will ‘buy some time’ to get back on track. These loans actually suck the last remaining liquidity from the balance sheet.”

Another issue that Billion runs into with bankruptcy clients is what he calls “expectation failure.” Many consumers think that they will be able to make a certain amount of money, or they expect to see assets grow. When these expectations aren’t realized, they are often in too deep. One big evidence of this situation is related to the real estate crash and the recent financial crisis. “People have to sell homes that they cannot unload for anywhere what they owe,” Billion says. “They have little equity cushion because they believed that home prices would not fall.”

When assets lose value instead of gain, or when higher pay fails to materialize, expectations are dashed, and the plans made based on these expectations can crumble into bankruptcy.

Bottom Line

In reality, bankruptcy is rarely caused by one thing. Often, a middle class family with a “normal” amount of debt runs into a financial setback. These setbacks can include medical catastrophe, job loss, or divorce. Finances might not be strained when the problem occurs, but any stress on the situation can mean financial issues big enough for bankruptcy.

What do you think are the causes of bankruptcy? What would you do if faced with bankruptcy?


{ 11 comments, please add your thoughts now! }

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11 Responses to “What are the REAL Causes of Bankruptcy?”

  1. I worked for a time as a credit counselor, and part of my job was the mandatory counseling session that people must go through before their bankruptcy can be consummated. Though I saw a lot of folks with medical expenses they could not pay, I think the #1 reason for bankruptcy among my clients was simply living beyond one’s means for years and years. The credit card debts build–one client had $120k in credit card debt alone–until servicing is no longer possible. Often this happens abruptly, like when one of two wage earners loses a job. I never figured out what went on in people’s heads as they racked up debt they must have known they’d never be able to repay. The siren song of consumption was just too luring I guess.

  2. bloodbath says:

    Those I know who filed for bankruptcy viewed money as a means to an end. My sister filed twice because she spent much more than she earned – She values the COST of an item more than the item itself. When given a gift she always wants to know the price and if it is less than she wants it to be she becomes verbally abusive. My daughter spent compulsively to fill an emotional void – she’s a hoarder. She buys not for value but for literally less space around her.
    My best friend boasts laughingly about his motto”: ‘I had money’ He spends because he thinks he should have anything he wants and worry about payment later. He sees no reason to honor payment unless he will get in trouble for it. The house is always on him. All three are currently heading for bankruptcy again.
    So, to me bankruptcy comes from an unrealistic view of what money is/means resulting in poor money management.

    • jim says:

      Thanks for sharing a few good stories. Poor money management, along with divorces, addictions, and job losses is what caused all of those foreclosures after the great recession of 2007-2008. Yet everyone blamed it on the banks. Americans can never take the blame themselves.

  3. admiral58 says:

    i hope i never file for bankruptcy

  4. idau85 says:

    After graduation I had a friend who wanted to file bankrupcy due to student loans. She did not think in advance of the decision nor did she have realistic expectations. It is almost impossible to get out of student loans.

    She wanted to graduate school with a new beginning and be able to live a comfortable life. But in reality, if you take out large students loans you have to pay them off.

  5. Yana says:

    One major cause of bankruptcy is that it is socially acceptable to file for it, and those who actually cannot pay their bills cannot afford the process. Often, they do it anyway, because they don’t understand finance and the credit system. I was in a debt situation years ago, and did not file bankruptcy. I don’t imagine that I ever would do so, but one can never say never. After my own debt experience, I turned against the idea that one should use credit at all, and our rule is that if we can’t pay for a thing outright, we don’t get it at all.

  6. Steph says:

    I agree with Kurt & bloodbath. I think it’s spending beyond your means because you don’t know how money works or how to use it.

    There aren’t a lot of good role models for learning the answers to these questions if your parents didn’t teach it to you, and the government certainly has no clue either.

    The first step to getting out of debt and learning how money works is to set up and stick to a budget (that doesn’t exceed your earnings, obviously)! If you weren’t taught how or even that you need to do this, you can easily get lost in the debt game.

  7. Rob says:

    Going into bankruptcy casue of Medical bills is ok. But declaring bankruptcy cause of C/C debt and high living, should be like student loans…NEVER FORGIVEN !!!

  8. PawPrint says:

    My daughter went through bankruptcy after leaving an abusive marriage. She had no income because she had to leave the state where she was living, and she couldn’t possibly afford the payments on the stuff her husband had purchased (she’d had good credit and was in a classified position with the military) plus she was worried he’d rack up more debt and leave her to pay. My other encounter with bankruptcy was a friend whose husband had been out of work for two years. Because he worked for a religious institution, he didn’t have unemployment insurance. At the same time, she was diagnosed with medical issues that may result in a transplant and is on some costly meds. They’re paying $1500 a month for insurance because that is cheaper than reducing the insurance expense, but paying more for the meds and procedures.

  9. admiral58 says:

    I agree with Rob, cc debt is your own fault and the game we play in America. Spend more than you have available is a joke.

  10. Shirley says:

    A friend ended up filing for bankruptcy after his financial manager embezzeled funds, leaving him owing mortgages on three homes that he thought had been sold and paid for in full.

    After close to a half million dollars in attorney fees, the financial manager is in prison but that didn’t pay his debt. Even settlement agreements were more than he could pay, so bankruptcy was his only option.

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