It is rarely just one thing that gets people into financial trouble serious enough to consider bankruptcy. More often, it is a sort of double whammy. For example, losing their job, then being diagnosed with a major illness. Or taking on a big mortgage right before the job they were counting on to pay the bill suddenly disappears. Irresponsible financial behavior can be a factor, too, but it is seldom the sole cause.
Key Takeaways
- People are usually driven to bankruptcy by a combination of financial setbacks, most of them unexpected.
- Job loss is one major reason, with medical expenses and unaffordable mortgages also high on the list.
- Overspending is a problem for some people, while providing financial help to relatives is a major burden for others.
Five Major Reasons for Bankruptcy
There have been a number of studies of why people file for bankruptcy in recent decades, and while the reasons may shift around in order, the major ones seldom change. The order of the following list is based primarily on a paper published in February 2019 in the American Journal of Public Health.
In that study (“Medical Bankruptcy: Still Common Despite the Affordable Care Act” ), researchers asked a sample of Americans who had filed for bankruptcy between 2013 and 2016 about the factors that had contributed to their decision. Because people could cite more than one reason, the numbers below overlap and add up to more than 100%.
1. Loss of Income
The study found that this was the single most common reason for filing for bankruptcy, cited by nearly 78% of the survey respondents. That shouldn’t be surprising, given that most of us rely on income from a job to pay our bills. In fact, a 2019 Charles Schwab survey reported that 59% of Americans live paycheck to paycheck.
When the paychecks stop, financial trouble can be close behind. And, unfortunately, few Americans have enough money in savings to tide them over for long. A 2019 Federal Reserve report found that 39% of Americans lacked the cash even to cover an unexpected bill of $400.
What’s more, losing your job can also mean losing your health insurance, making you especially vulnerable to big medical bills unless you can find other insurance in the meantime.
2. Medical Expenses
Nearly 59% of respondents in the medical bankruptcy study cited medical expenses as a major factor in their filing for bankruptcy. At the same time, 44% cited medical problems that had led to work loss, further demonstrating how these problems are intertwined.
There are several programs intended to help people who lose their jobs keep their health insurance. COBRAa federal law that has been around since 1985, allows many laid-off workers to stay on their ex-employer’s insurance plan for a period of time. The trouble is that COBRA requires the employee to pay both their share and their employer’s former share of the insurance cost, plus an administrative fee, making it unaffordable for many people, especially when they’re out of work. [4], [5]
The Affordable Care Act (ACA) of 2010 was supposed to help, too, by making health insurance more widely available to Americans who previously couldn’t afford it. The evidence on its effectiveness in reducing bankruptcies has so far been mixed. The title of the 2019 paper, “Medical Bankruptcy: Still Common Despite the Affordable Care Act,” pretty well sums up that study’s findings. Specifically, it maintained that while the ACA increased access to health care, its greatest benefit had been to the chronically poor—people with few assets and little likelihood of declaring bankruptcy in the first place. More affluent Americans, by contrast, remained at the mercy of unaffordable medical costs, including ever-rising copayments and deductibles.
3. Unaffordable Mortgage/Foreclosure
Cited by 45% as a motivation for bankruptcy, home mortgages represent the single largest portion of household debt in the United States, far surpassing credit cards, car loans, student debt, and all other categories. At the end of 2019, according to the Federal Reserve Bank of St. Louis , housing-related debt, which includes both mortgages and home-equity lines of credit, accounted for roughly 70% of household debt in the U.S.
While many people may buy more expensive homes and take on bigger mortgages than they can reasonably handle—especially if they end up losing their job or facing some other financial setback—lenders play a role here, too. When banks’ lending requirements are lax, as they were going into the housing bubble of the mid-2000s, borrowers can easily get in over their heads.
By contrast, in mid-2020, mortgage applicants are facing the “toughest loan-approval standards in years,” according to the trade journal American Banker . For example, some major lenders have raised their minimum credit score requirements and/or increased down payments to 20%. Although it’s no consolation to people who want a mortgage and can’t get one, those tightened standards may be reflected in lower bankruptcy rates some years from now.
4. Living Beyond Their Means
A little over 44% of people in the medical bankruptcy study admitted that overspending or living beyond their means was a contributing factor in their bankruptcies. Of course, overspending can mean a wide range of things—from maxing out your credit cards on regular shopping sprees to exceeding the family food budget by a little here and there. Whatever the cause, this is one area where people have some control, unlike job loss or illness, which they may be powerless to prevent.
5. Tried to Help Other Family Members
It isn’t just a person’s own financial difficulties that can drive them to bankruptcy. Sometimes, the need to provide assistance to relatives or others can be a factor as well, as 28% of the respondents in the medical bankruptcy study indicated.
A 2020 AARP study illustrates the family-related demands on many Americans today. It found that 51% of “midlife adults,” age 40 to 64, were providing financial help to adult children, age 25 or older, and 32% of them were helping support their own parents. While providing such support may help keep the younger and older age groups out of bankruptcy, it makes the middle group all the more vulnerable to it. In fact, close to 30% of respondents said that assisting their relatives represented a “high strain” on their own finances.
Under current law, it can be very difficult to get student loan debt discharged by filing for bankruptcy.
Other Reasons for Bankruptcy
Those five aren’t the only reasons people file for bankruptcy, of course. Respondents to the medical bankruptcy study also cited student loan debt (25%) and divorce/separation (24%). Although student loan debt is a crushing burden to many Americans today, one reason it may not have scored higher is that it’s very difficult (though not impossible) to have discharged through bankruptcy. So, if student loan debt is a person’s sole or primary financial problem, bankruptcy might not be the answer.