Top 5 Reasons People Go Bankrupt And How to Avoid It

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Many people struggle with managing their money. Sometimes, there just isn’t enough to go around. In fact, over 900,000 Americans filed for bankruptcy in 2014. You might think that those who file for bankruptcy are irresponsible spenders. That’s certainly some , but in reality many people are not excessive over-spenders. They’re simply unable to respond to unfortunate events.

According to a 2010 study, the top 5 reasons why people file for bankruptcy are:

  1. Medical expenses (42%)
  2. Job loss (22%)
  3. Uncontrolled spending (15%)
  4. Divorce (8%)
  5. Unexpected disaster like earthquakes, floods, and hurricanes (7%)

None of us want bankruptcy to happen to us. And yet, many people face illness, job loss, divorce, and natural disasters every year and it decimates their finances.

It’s difficult to recover after the fact, but you can take steps now to mitigate these financial disasters. Let’s go into some ways to prepare your finances for the unexpected.

You Need an Emergency Fund

reasons people go bankruptAn emergency fund is an essential tool to protect your finances from financial disaster. In fact, the lack of an emergency fund is probably one of the top actual reasons people go bankrupt. Sure, crazy expenses creep up and you might not know what they’ll be, but if you had a bunch of money set aside for a potential financial disaster, then your odds of bankruptcy will be severely reduced, plain and simple.

An emergency fund of 3 to 6 months of expenses is often recommended to help with job loss. But when determining how much you’d like to keep in your emergency fund, consider the deductibles on your health insurance, home insurance, and auto insurance as well. Make sure you have enough on hand to pay those deductibles, should the need arise. And, when building up your emergency fund, be sure to keep the funds in a safe place that’s easy to access, like a high interest savings or checking account.

Health Insurance

One of the other main reasons people go bankrupt is due to inadequate health insurance coverage. Many don’t realize it, but health insurance is a major part of protecting your finances. If you or a family member gets seriously ill, medical expenses will pile up quickly. At this point, just 87.1% of Americans do have health insurance, but with the introduction of the Affordable Care Act, the number of uninsured Americans is dropping.

Still, many health insurance plans do have a deductible before covering 100% of medical expenses. In order to protect your finances, you’ll want to make sure you have the money to cover the deductible.

There are also many other expenses that come with a sick family member, including missing work, in-home care, and even making accommodations to living spaces. Emergency funds can help mitigate the damage here as well.

reasons people go bankruptHome & Auto Insurance

Other top reasons people go bankrupt are due to a lack of home and auto insurance. No one likes to think about a flood, fire, tornado, or other natural disaster, but the consequences of being unprepared for disasters like these is enormous. Home and auto insurance helps mitigate the damage tremendously.

Homeowners often have hazard insurance, as required by their mortgage lenders, to protect the home and its contents from damage. Comprehensive homeowner’s insurance adds liability protection. But many policies have exclusions for natural disasters. If you live in a high risk zone for flood, earthquakes, and so on, you may need to purchase additional insurance. Many times, it’s a wise idea to go ahead and cover these exceptions.

Auto insurance acts in a similar manner. All legal drivers are required to have liability insurance to protect against injuring another person or their property in an accident. You can purchase collision insurance to protect yourself and your vehicle in an accident. Comprehensive insurance will cover damage due to hail, theft, and so on, though there are often exceptions like with home insurance.

Track Your Spending

While most bankruptcies are due to unfortunate events, some are due to overspending. It’s much more difficult to ignore any excessive purchases when you monitor your spending. Even if you suffer hard times from illness, job loss, or a divorce, you’ll need to understand your finances to be able to react appropriately to your new financial situation.

Use a spreadsheet, a budgeting program like You Need a Budget, or an online spending trackers like Mint.com and PersonalCapital.com. Programs like these help organize information about your financial life. Without this information, it’s hard to know when you are in financial trouble — or what to do about it.

reasons people go bankruptLife Insurance

An article about preventing financial disaster wouldn’t be complete without mentioning life insurance. If you have people who rely on you financially, you need life insurance. If the worst happens, your family will be vulnerable to any further disasters like illness, job loss, and more. Term life insurance is usually very affordable and well worth the price.

The Bottom Line

Illness, job loss, divorce, and natural disasters do happen. If fact, you probably know a handful of people that have been affected by these, so why couldn’t it happen to you? Are you financially prepared for it? By preparing in advance with insurance, an emergency fund, and good financial habits, you’ll be financially prepared to face unfortunate events.

Do you now understand why people go bankrupt? Will it happen to you?

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9 comments to Top 5 Reasons People Go Bankrupt And How to Avoid It

  • I understood why people go bankrupt when I got sick at age 19. I was under my parents’ fantastic coverage, so they ended up paying very little, really. But I went from completely fine to on life support in about 4 days. Then 18 days of ICU, two and a half months in a long-term care facility and 10 days at a physical rehab center.

    One of the doctors (there were 2 or 3) at the long-term care facility sent a bill for $70,000. That didn’t include food, meds, the room, my occupational/physical/respiratory rehab. Just one of the doctors.

    A friend of my husband’s family had a daughter with a heart problem. They either had bad or no health insurance, and they had declared bankruptcy because of the bills.

    It’s getting better now that more people are covered, but even the deductibles could kill folks’ budgets.
    Abigail @ipickuppennies recently posted..Prepaying debt

  • There are a lot of sad stories where people are overwhelmed by medical bills. Hopefully having good health insurance will go a long way to helping people get the help they need at a reasonable price.

  • Great tips. It’s scary how many people are thrown into financial chaos due to medical expenses. With the price of healthcare, being diagnosed with a serious condition can wreck even the most financially prepared among us.
    Mike Collins recently posted..My 5 Year Old Charged $209.45 On My Credit Card!

    • Yes, medical expenses can be overwhelming even for those of us that try to prepare for the worst. Hopefully with the number of uninsured dropping, people are better able to respond to medical emergencies.
      Jenna recently posted..Good News, Bad News

  • Great information, Jenna. With both my wife and I dealing with ongoing health conditions, I know how devastating medical costs can be to your budget. In addition to having good medical insurance, it’s also important to know how your plan works and what your rights are, as well as how to save on or negotiate medical bills. Another way to protect yourself is to get disability insurance so that you don’t have to deal with both medical expenses and job loss without some financial support.
    Gary @ Super Saving Tips recently posted..Best Retail Buys for May and June

  • Medical expenses usually take the largest chunk out of our savings but there are still a lot of people who aren’t prepared for them. Ironically, some think “we only live once and we might be dead tomorrow..enjoy our money now!” but what they fail to consider is what if they’re still alive, just really really sick. It’s always good to plan ahead and have something saved up for medical bills and other emergencies.
    Stan recently posted..The Men Behind The Curtain: Who are Market Makers?

  • […] Related: Top 5 Reasons People Go Bankrupt and How to Avoid It […]

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