By: Gerri L. Elder
According to a new study, divorce and unemployment actually have a limited impact on the growing number of people filing bankruptcy in the United States, and overspending is the main cause of personal bankruptcy.
The Household Consumption and Personal Bankruptcy study by Ning Zhu, a professor at the University of California, provides statistics to suggest that purchases of homes and cars contribute significantly to bankruptcy filings.
Zhu found that serious medical conditions can also lead to bankruptcy, but not as often as overspending. Additionally, medical emergencies are much more likely to lead to bankruptcy if a household is already in financial turmoil due to overspending.
The study shows that overspending leads to households becoming financially strapped and thus more susceptible to filing bankruptcy during divorce or periods of unemployment, but these adverse events in themselves have only marginal effects on personal bankruptcy.
With the passage of the Bankruptcy Abuse Prevention and Consumer Protection Act on October 17, 2005, filing bankruptcy became more expensive for consumers and rules were revised to limit the number of people who could file Chapter 7 bankruptcy. With the more stringent bankruptcy rules, the number of people filing bankruptcy temporarily dropped. However, the bankruptcy rate quickly rebounded and now continues to grow.
Zhu says that over-consumption, overspending and households that simply live beyond their means are the primary factors that wreck finances and lead to bankruptcy. When household budgets are stretched to the limits and beyond, a single adverse event such as an illness or layoff can immediately lead to bankruptcy. While many bankruptcies may be triggered by these adverse events, the true cause of the bankruptcies is overspending, according to the study.
The study determined that patterns of spending and over-consumption influence the likelihood of filing bankruptcy. A high ratio of mortgage debt to household income, credit card debt to household income and credit card debts to household income are all factors contributing to bankruptcy filings.
On top of the debt to income ratio, medical conditions and illnesses raise the probability of bankruptcy by approximately 50 percent. However, divorce and unemployment have little impact on whether or not someone ends up filing bankruptcy.
The results of the study indicate that consumers strategically choose to file bankruptcy after overspending, rather than being forced into filing bankruptcy by adverse events.
It seems that people do not generally adjust spending in order to avoid bankruptcy. The study showed that in the households which file bankruptcy, more than five percent own at least one luxury vehicle. Mortgage debt is also high in bankrupt households and credit card debt is often equal to an entire year's income.
When consumers overspend and live beyond their means and then experience an adverse event, the study found that they are likely to file Chapter 7 bankruptcy because they do not have the ability to repay their debts. Chapter 7 bankruptcy allows these consumers to have their debts discharged with no obligation to repay them.