12 Most Common Reasons Why People Go Bankrupt

Bankruptcy helps individuals, spouses, corporations, or other entities that can no longer pay debts. They can file bankruptcy and liquidate their assets or create a repayment plan to get a fresh start. 452,990 business and non-business entities filed for bankruptcy in 2023, a rise of 16.8% from the previous year.

There are several reasons why people go bankrupt. 

Medical Debt

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Nearly 17 million American adults owe a medical debt. Healthcare expenses are going through the roof in the United States. 9% of people are uninsured, 11% had a coverage gap, and 23%were insured without affordable access to healthcare in 2022. 

Debt accumulates when people burden themselves with out-of-pocket medical expenses, medical loans from friends/family or financial institutions, or overspending on credit cards. 

Unemployment/Loss of Income

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3.64%of the total workforce in the U.S. was unemployed in 2023, and expected to rise in the coming years. The layoff reached a 14-month high in March 2024, led by job cuts in tech and government sectors. Illnesses, disability, or injuries also put people out of employment or cause partial or complete income loss. The death of the primary income earner of the family also leads to significant financial setbacks for his loved ones.

When people don’t have a steady income, they increase their dependence on borrowing and credit cards. They cannot pay their bills on time, creating a vicious debt loop.

Inadequate Income

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66.2% of Americans live from paycheck to paycheck, indicating that saving for the future is challenging and putting their essential requirements at risk in case of payday delay. High cost of living, financial dependence, poor credit score, and excess debt are vital factors that cause their income to be insufficient to meet their monetary needs.

They are compelled to consider bankruptcy to make up for the inadequate income.

Credit Card Debt

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Credit card debt stands at $1.14 trillion, a record figure driven by inflation, unemployment, and rising food, healthcare, housing, and gas costs. Over one in three Americans has accumulated more credit card debt than emergency savings. 

One of the main reasons people are falling behind on their credit card payments is the high interest rate. The average interest rate on a new credit card is 24.84%, the highest since 2019. Late or no payments, along with other financial constraints, can lead to bankruptcy.

Student Loan Debt

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42.8 million American borrowers have federal student loan debt. However, they struggle to repay the loan as college tuition prices have soared faster than median incomes in the past 30 years. 

Borrowers can also not afford the payments because they want to prioritize meeting their daily and basic expenses. Students face an uncertain job market or cannot land their desired jobs. Hence, they are trapped in an undesirable debt cycle.

Divorce

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Couples divorce for numerous reasons, but it can cause them both emotional and financial devastation. 54% of Americans believe that a partner with debt is a major reason to consider divorce. One or both partners can file for bankruptcy before or after divorce to eliminate debt obligations. 

Couples commonly declare bankruptcy because of mortgage debt, court and legal fees, alimony, childcare support, and joint debts.

Home Foreclosure

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Mortgage debt accounts for 70.2% of total consumer debt in the U.S. People are lagging in their mortgage payments, putting them under intense pressure to foreclose. Over 170,000 properties were listed under foreclosure filings in the first six months of 2024, resulting in thousands of Americans losing their homes. 

Bankruptcy is the last resort for people who have exhausted alternatives to foreclosure, such as short sale, loan forbearance, or deed in lieu of foreclosure.

Natural Disaster

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The destructive Hurricane Elena that hit Mississippi in 1985 resulted in a 71.8% increase in bankruptcy filings in the following three years. Natural disasters such as hurricanes, earthquakes, storms, and floods displace people, disrupt their livelihoods, and destroy/damage their assets. The victims are uncertain about the course of their lives, let alone think about making payments towards debts.

In such a scenario, they may consider bankruptcy.

Overspending

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Many Americans are financially stressed. Hence, they are doom spending– an unhealthy habit of overspending to cope with stress. They are racking up credit card debt, going into debt for fun, and using buy now, pay later (BNPL) service for doom spending.

These people create a massive debt bubble; bankruptcy may seem the only way out when nothing else helps.

Car Repossession

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Car owners risk vehicle repossession when they default on the loan or lease payments. The lender or leasing company can collect and sell the car at an auction. Car repossession cases have surged 23% between January 2024 and June 2024 due to high interest rates and inflation.

Bankruptcy filing brings automatic stay into effect and prevents the lender from repossession until you figure out a debt repayment plan.

Business Failure

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Business failures occur when corporations incur insurmountable losses, default on millions of dollars in debt, or are held liable for forgery. For instance, the Texas-based energy company Enron Corporation filed for bankruptcy protection after being caught in an accounting scandal.

Debt Collection Lawsuits

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Unpaid credit card balances and home foreclosures are two common examples of debt collection lawsuits. Creditors can sue debtors for non-payment, and if the debt amount runs into hundreds of thousands of dollars, debtors can file for bankruptcy.

However, state laws governing debt collection lawsuits vary widely and may offer little protection to consumers.   

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