10 Common Reasons People File Bankruptcy

Many people believe that bankruptcy law only protects those with a “good reason” for filing bankruptcy. This belief is not true. You do not need to prove a “hardship” to file bankruptcy. There are a lot of different reasons to file bankruptcy.

Below are a few of the most common situations where people find that a bankruptcy is much better than their current circumstances.

1)      Loss of income.  Many people have worked hard to get a good career and good income, only to have that income significantly reduced by a layoff, or restructuring that is a result of the changing economy. In some cases people have been working a second job to make ends meet, and now that second job is no longer available.  Many self-employed business people have seen a dramatic decrease in gross income to their business, and after making every cutback they can to avoid bankruptcy, find that bankruptcy is a good option to get a fresh start.

2)      Divorce.  Divorce is financially very stressful.  Before a divorce two people were living in one household, and now the same amount of income must be stretched to cover two households.  There are so many challenges in making the major life changes that divorce requires, that the shared debt of the parties is often not seriously considered until after the divorce and where each side is ordered to pay certain debts.  Even though the court has ordered one side or the other to pay the debts, the obligation to pay is still on both parties (particularly in a community property state like Arizona), and the creditors can sue both parties, not just the one that is ordered to pay the debt.  Some people consider filing bankruptcy prior to a divorce to prevent the situation where one party who was ordered to pay a debt is not paying, and the other party is getting sued.  Many people file bankruptcy after divorce, in an attempt to clean up the mess that the divorce left in their financial life.

3)      Lawsuit. Many people have been working for years to try to pay off debt, knowing that they are either falling behind, or making slow progress.  They pay what they can to creditors, but it is not enough to meet the creditors’ demands.  They would not file bankruptcy even under these hard circumstances, but that all changes when they get served with a lawsuit.  A lawsuit may lead to garnishment of wages, up to 25% of gross income in Arizona, or other collection efforts.  Usually 25% of gross income is much more than someone can afford, and will make it impossible to pay for food, housing and other basic necessities.

4)       Marriage.  In the past, prenuptial discussions were focused mainly on assets, family inheritances, and property.  Now it is much more common for a couple to address debt issues prior to marriage.  If one party has large debt issues that will be a significant burden to the newlyweds, bankruptcy is often seen as a better option than a prenuptial agreement that addresses debt, and may or may not protect the innocent spouse from their spouse’s creditors.

5)      Foreclosure or Short sale.  With the major decline in housing prices during “the great recession”, many people find that they cannot pay for, or must sell a house that is worth much less than what is owed.  The sale through a foreclosure or short sale does not pay off all of the debt owed on the house, and in many cases leaves the homeowner with a large debt that they cannot pay. Bankruptcy allows for a fresh start for someone who has lost their home.  A homeowner may also file bankruptcy before a foreclosure or short sale for several reasons.  First, a bankruptcy will delay a foreclosure.  Second, a bankruptcy will not leave the homeowners with the same tax bill as a foreclosure or short sale where the debt is forgiven. (Forgiven debt may be taxable, but debt discharged in a bankruptcy is not taxable.)

6)      Retirement.  Many people find that they are not prepared for retirement, but are forced into retirement with significant debts.  In most cases, retirement accounts are protected in bankruptcy.  When someone is considering draining retirement accounts to pay for debts, they need to consider the consequences and whether a bankruptcy would better serve their long term goals.  Those people who are at or near retirement and need retirement funds to meet their basic living expenses especially need to consider this option.

7)      Disability. Short term or long term disability can create significant financial problems.  Medical disability often comes with large medical bills, and depending on insurance purchased prior to the disability, the loss of income and high medical bills may not be covered by insurance.  The challenges of dealing with a disability can be great.  Many people find bankruptcy is a good option to stop collection efforts of creditors so that they can focus on getting better and getting back to work.

8)      Collection Calls. Some creditors hire mean people to call you when you cannot pay your bills.  Reports of the things said in these collection calls can be shocking. Many people stop answering their phone and live in a state of stress and fear each time the phone rings. For those living with a barrage of collection calls with no way to pay creditors, bankruptcy stops the collection calls and provides a fresh start.

9)      Student Loans. In all but the rarest cases student loans cannot be discharged through bankruptcy, but bankruptcy can provide a payment plan to bring student loan payments current, or pay them off over 5 years.  If there are many debts in addition to student loan debts, a bankruptcy can make it easier to pay the student loan debts by discharging all or most of the other debts.

10)   Taxes. Taxes can be discharged in bankruptcy.  Not all taxes qualify for a discharge, but some can be wiped out.  Even when tax debt cannot be discharged in bankruptcy, wiping out other debt can make a payment plan to the IRS or state government possible.

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