Why People Go Bankrupt (Top 5 Reasons)

Bankruptcy usually comes from a mix of reasons, not just one.

It might happen because of poor money choices, like borrowing too much, but other situations can also push someone to file for bankruptcy.

Let’s dig into the main five reasons people often end up facing bankruptcy.

Highlights:

  • Bankruptcy often results from a mix of financial difficulties.
  • Reasons for financial struggles can stem from bad choices or unforeseen situations.
  • Common causes of bankruptcy include job loss, medical bills, and rising mortgage payments.
  • Overspending can also play a role in pushing someone towards bankruptcy.
❌ Common Reasons for Bankruptcy ❌✅ How to Avoid Bankruptcy ✅
1️⃣ Losing your job (or income)Build an emergency fund to cover expenses during job loss.

Diversify income streams to reduce reliance on one source.
2️⃣ Getting sickObtain health insurance that covers essential medical expenses.

Investigate available government or nonprofit programs designed to assist individuals with medical costs.
3️⃣ Too much house debtChoose a mortgage within your means to avoid foreclosure.

Be cautious of adjustable-rate mortgages that could lead to higher payments.
4️⃣ Spending more than you earnCreate a budget that ensures expenses are lower than income.

Save an emergency fund to handle unexpected expenses without resorting to debt.
5️⃣ Helping others (without affording it)Supporting others financially, even when it strains your own finances, can lead to bankruptcy.

Set boundaries and only provide help within your means.

1️⃣ Losing your job (or income)

Experiencing job loss and losing a reliable income can create considerable financial pressure, particularly if you’re already managing tight finances.

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A recent CNBC study revealed that 58% of Americans feel they rely on each paycheck.

Losing your job might also mean losing health insurance, leaving you exposed to hefty medical costs unless you secure alternative coverage during this period.

2️⃣ Getting sick

Medical bills are a significant contributor to bankruptcy cases. Health issues can sometimes lead to job loss as well. If you’ve lost your job and your insurance, and then encounter medical problems, it can put you in a financially challenging situation.

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Various programs are designed to help individuals maintain health insurance coverage after job loss. One example is COBRA, a federal law that enables many laid-off employees to remain on their former employer’s insurance plan for a limited period.

However, COBRA often involves paying both your share and your employer’s portion of the insurance cost, along with an administrative fee. This can be unaffordable for many, especially when unemployed.

3️⃣ Too much house debt

Home mortgages often constitute the biggest part of a household’s debt in the U.S., surpassing credit cards, car loans, student debt, and other categories.

As of Q1 2023, housing-related debt, including mortgages and home-equity lines of credit, exceeded $12.04 trillion, making up around 71% of total household debt in the U.S.

In some cases, lenders might approve buyers for loans that are larger than they can realistically afford. Those who accept such loans face the risk of foreclosure if they can’t keep up with payments due to factors like job loss or financial setbacks.

Certain mortgages come with adjustable interest rates, causing monthly payments to rise when interest rates increase. If a borrower’s mortgage payment suddenly becomes higher and they can’t manage it, they might be compelled to file for bankruptcy.

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4️⃣ Spending more than you earn

Spending more money than you actually have or living beyond your means can lead to overwhelming debt.

When someone uses up all their credit card limits on non-essential items and can’t make the minimum monthly payments, their debt can rapidly grow due to accumulating interest.

To prevent the dangers of overspending, develop a budget that guarantees your earnings are higher than your expenses.

Additionally, aim to build an emergency fund that covers several months’ worth of expenses. This fund can act as a safety net for unexpected costs, reducing the need to resort to debt.

5️⃣ Helping others (without affording it)

At times, the responsibility of providing financial support to family members or others can play a role in pushing someone towards bankruptcy. Whether it’s helping adult children or elderly parents, saying no to a family member in financial need can be challenging for some individuals.

This willingness to assist, even if it jeopardizes their own financial stability, can contribute to their decision to file for bankruptcy.

➤ Other Factors Leading to Bankruptcy

Numerous other factors can drive individuals to seek bankruptcy protection. For instance, some grapple with overwhelming student loan obligations.

While student loans are typically challenging to discharge through bankruptcy, individuals may use bankruptcy to address other debts and better manage their student loan payments.

Divorce or separation can also inflict financial stress due to legal expenses, further straining one’s financial situation.

➤ Why People Go Bankrupt FAQ

Does Bankruptcy Eliminate All Debt?

Bankruptcy offers a fresh financial start by discharging most debts, but not all debts are necessarily cleared. Debts like alimony, child support, taxes, fines, and student loans may not be dischargeable through bankruptcy.

What Are the Drawbacks of Bankruptcy?

While bankruptcy offers a clean slate for finances, it can adversely affect your credit score. Bankruptcy records can stay on your credit report for up to a decade.

Can You Declare Bankruptcy During Divorce?

Filing for bankruptcy is possible at any time, but if you’re undergoing a divorce, only one legal process will usually proceed. It’s important to consider whether to file for bankruptcy before or after finalizing a divorce.

➤ Final thoughts

Bankruptcy serves as a lifeline for those overwhelmed by debt. Various factors can contribute to a bankruptcy scenario. To avert bankruptcy, practice sound financial management, including taking on manageable debt levels that you can comfortably repay.

➤ References

Sources
CNBC. “Your Money Financial Confidence Survey”
U.S. Department of Labor. “Continuation of Health Coverage”
Federal Reserve Bank of New York. “Total Household Debt Reaches $17.05 trillion in Q1 2023; Mortgage Loan Growth Slows”
Consumer Financial Protection Bureau. “An Essential Guide to Building an Emergency Fund”
USCourts.gov. “Discharge in Bankruptcy”
United States Bankruptcy Court. “Bankruptcy and Your Credit”
Experian. “How to Handle Bankruptcy and Divorce at the Same Time”

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Pavlos Written by:

Hey — It’s Pavlos. Just another human sharing my thoughts on all things money. Nothing more, nothing less.