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What are the REAL Causes of Bankruptcy?

“The popular conception is that people who file bankruptcy [3] 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 [4] 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 [5], 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 [6] 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?

(Photo: StockMonkeys.com [7])