Different situations get people into financial trouble, leading them to bankruptcy. In most cases, a series of financial setbacks occurring in quick succession strain personal finances. For example, you could be involved in a car crash and, durin your recovery, lose your job. Your source of income is cut off, but the medical bills and other expenses keep piling up.
A variety of factors can affect your financial health. Here is a look at the leading reasons why people go bankrupt.
Loss of Income
Without income, you cannot pay your bills or invest in passive income-generating avenues. Therefore, it should not be surprising that loss of income is the leading reason most people file for bankruptcy.
As of June 2022, 61% of Americans live paycheck to paycheck. Therefore, when the income stops flowing in, the bills remain unpaid. This is the start of financial woes. Here is a breakdown.
After losing your income, you cannot pay your electricity bills, rent, car payments, or credit card debt. You risk being sued and subsequently kicked out of your apartment over rent arrears. Repossession of your car or other property is a possibility since repossessions aim to recover the unpaid sums.
Progressively, in the event of an emergency, you cannot afford to pay for it since you do not have the income to fund your emergency account.
Further, losing your job could also lead to losing your health insurance coverage. This means you are vulnerable to significant medical bills should you lack alternative coverage.
Therefore, you risk being homeless, without food or any means to sustain yourself, and susceptible to suffering medical illness.
Unaffordable Mortgage Expenses
Mortgage payments account for a significant portion of most American households' budgets. Mortgage payments are the single most significant debt and expense element, surpassing student loan repayments, car payments, and credit card debt.
Most people do not pay close attention to their mortgage expenses. If the expense component is significantly high, exceeding 28% of your gross income, you are likely to face financial challenges, especially with inflation. The value of the mortgage payment will significantly increase.
Mortgage payments become affordable for many individuals in two common ways.
-
Going for a House You Cannot Afford
It is easy to fall into the oldest financial trap of inflating your lifestyle to match your increased earnings. A sudden increase in income motivates individuals to immediately seek homes in better neighborhoods. This is not necessarily a wrong choice. However, you need to increase your investments and take some time before upgrading your neighborhood because a more expensive home means taking on bigger mortgages.
Losing your job means retaining substantial mortgage expenses you cannot afford, especially if you relied on that particular job to fund your lifestyle.
-
Divorce
Divorce almost always results in financial disruption. Some opt to secure the house in their name in the divorce agreement. This choice is not necessarily ideal. You and your partner chose the home with the understanding that a portion of the shared income settles the mortgage bill. However, one income paying for the mortgage and other expenses is too heavy a burden for many. It is likely to result in foreclosure or cause an individual to file for bankruptcy.
Medical Expenses
Medical treatment in America is expensive. Many families have suffered financial ruin while seeking medical attention. The sudden increase in GoFundMe medical campaigns is a testament to the impact medical bills have on most households.
Financial destabilization from medical expenses occurs in two ways.
First, you can seek medical attention for yourself or a loved one, but the cost is too high because your insurance coverage is insufficient.
The other scenario is individuals suffering from a medical illness that renders them incapable of performing their job. Therefore, job loss is inevitable. Most people fall into this category. In this case, the individual is stuck with medical expenses with no income to cater to them. It is also likely he/she will lose his/her medical coverage.
Several programs have been formulated to help individuals who lose their jobs keep their health insurance.
Continuation of Health Coverage under the Consolidated Omnibus Budget Reconciliation Act (COBRA) is one of the programs. This federal law allows laid-off workers to remain on their ex-employer’s health plan for a limited time. The challenge, however, is that the plan requires a contribution from the individual and the ex-employers share of the insurance cost. The coverage further imposes an administrative fee. Combining all these costs makes it unaffordable for many, especially when they have no jobs.
The Affordable Care Act (ACA), enacted in 2010, was also crafted as a solution. It aimed at making health insurance widely accessible to Americans who could not previously afford it. However, the jury is still out on its effectiveness.
A paper titled “Medical Bankruptcy: Still Common Despite the Affordable Care Act” suggested that the ACA greatly benefited the chronically poor in society. These individuals are less likely to file for bankruptcy. The ACA did not address the challenge for the more affluent individuals struggling financially, who are more likely to file for bankruptcy. They remain at the mercy of unaffordable medical care costs, including the ever-increasing deductibles and copayments.
Living Beyond Your Means
Overspending or living beyond your means will push you closer to bankruptcy. Whereas overspending takes different forms, it starts from not tracking your expenditure, the lack of a budget, or exceeding your budget.
It is easy to get carried away and max out your credit card, engage in unplanned shopping sprees, exceed your food budget, or spend excess funds on indulgences that could seem helpful at the moment but have a significant cost implication in the long run.
Without a budget, you will not know your cash inflow and outflow. It is, therefore, easy to spend carelessly with the false assumption that you will pay your bills later. This approach only delays financial ruin for so long.
Additionally, it is wise to ensure your income exceeds your expenses. You should invest in alternative sources of income and set up, and fund an emergency fund.
Helping Other Family Members
Conversations around helping family members are always one-sided. The primary focus is on the support of family members. People pay little attention to the financial strain it causes the individual offering aid. Consider the following statistics.
A 2020 AARP study found that 51% of individuals with children aged 25 or older have provided financial support to their loved ones. Nearly 33% of midlife adults with at least one surviving parent provide financial aid to their parents. 42% of these individuals expect to do so in the future.
Take note that the aid is not for one-off expenses. They help cater to running expenses. This means weekly or monthly payments to cater to food, electricity, rent, and water bills. 54% of the midlife adults stated that they provided at least $1,000 to their parents.
Aiding family members strains an individual's finances, affecting their ability to save and invest for their development and that of their household. Failing to address this situation boldly has caused many to suffer financial hardship enough to consider filing for bankruptcy.
Poor Management of Credit
Different credit components cumulatively affect your credit score. Four key considerations inform a credit score. They include:
- Your payment history, accounting for 35% of the score — The information includes whether an individual honors their obligations on time.
- The total sum owed, accounting for 30% — It also considers the value of credit available to an individual being utilized.
- Length of the credit, accounting for 15% of the score — Borrowers with shorter repayment periods are considered risky, while those with longer periods of debt are less risky.
- Type of credit or credit mix — Accounts for 10% of the credit score.
- New credit, accounting for 10% of the credit score.
Credit scores rate an individual’s creditworthiness. It identifies whether an individual is a risky or less risky borrower. Further, it also shows defaulters.
Several institutions utilize credit score details before granting you access to their services. Furthermore, they determine your rates.
Take insurance companies, for example. Individuals with poor credit scores are likely to pay higher premiums than individuals with good credit ratings. Banks are also likely to charge you a high-interest rate if you have a poor credit rating. All these extra costs increase an individual’s household expenditure.
The interest expense of your debt accumulated over time can be overwhelming enough to cause financial turmoil.
Poor Financial Decisions
Proper financial management requires planning. Lacking a plan is one sure way of messing up your finances and quickly going bankrupt.
In several areas, people make poor financial decisions that negatively impact their financial health and lead to bankruptcy, including:
-
Paying Off Debt With Savings
Invested savings help you access the benefits of compounding. Drawing from your savings account limits the value you could earn from the compounded savings.
Using your savings to clear your debt could seem ideal at the time. However, as many have discovered, you could face financial trouble and elect to use your savings to address the situation. You will be in trouble if you deplete your savings before fully paying off your debt.
-
Living Paycheck to Paycheck
Living paycheck to paycheck is not ideal. You will likely go bankrupt if unforeseen trouble occurs. While paying close attention to your expenses and aiming to reduce them is one solution, it is not sustainable. You will need more income.
Most people are comfortable at low-paying jobs, refuse to improve their skill sets to access better-paying opportunities or fail to seek avenues to increase their income, like working overtime or an extra job.
-
Improper Use of Home Equity
Home equity should only be accessed to invest in income-generating activities. It should not be used for speculative purposes or to clear household expenses.
Most individuals who have gone bankrupt utilized their home equity for the latter. Their speculative ventures either did not materialize or did not generate the anticipated revenue. Those who opted to settle running household expenses or renovate their houses suffered, especially when house prices dipped.
House renovation is also risky when the funds are insufficient to complete the upgrades. You will need more funds to complete the project.
Speculation, home renovations, and paying household expenses are some of the improper uses of home equity that have wiped out homeowners.
-
Buying a New Car
It is easy to fall into the trap of buying a car, especially one you cannot afford, by failing to check whether your finances can support the car payments, fuel expenses, insurance coverage, and maintenance costs.
-
Spending too Much on a House
A few details get lost in a rush to buy a home. People just look at the property value, the location, and the size and finalize the purchase plan. They quickly realize they overlooked additional details that add to the cost burden on their income. These issues include property taxes, utilities, and home maintenance costs.
People also overlook some additional costs associated with home ownership. They include:
-
HOA and Condo Fees
Homeowners’ associations (HOA) or condominium associations are monthly or quarterly fees. The charges cater to the services offered in the neighborhood, including garbage collection fees, security, snow plowing, landscaping, and other services. These costs are not fixed and could rise depending on the target project, including road recarpeting, upgrading the security system, revamping the buildings and the common areas, or repaving.
-
Heating and Air Conditioning Needs
Heating and air conditioning needs are particular to bigger units or those whose locations experience extreme weather conditions. For example, beachfront properties require more cooling, while houses in mountainous regions require more heating.
-
Renovation
Some people buy units and incur significant renovation costs, thinking it is an investment.
All these expenditures, left unchecked, are a quick way to bankruptcy.
Contact a Sacramento Bankruptcy Attorney Near Me
Facing bankruptcy is a difficult moment in life. Choosing to file for bankruptcy is even more difficult. However, you can reorganize your finances and rebuild with the right information and guidance. If you are considering filing for bankruptcy, reach out to the Sacramento Bankruptcy Lawyer. Contact our team at 916-800-7690 for assistance.
