Bankruptcy is one way to reduce a mountain of debt, but there may be other solutions.
Bankruptcy filings have plunged since the COVID-19 pandemic began in March 2020, but once government-enacted financial protections in response to the pandemic end, experts predict filings to increase again.
Despite unemployment increases in 2020, bankruptcy filings dropped 30%, from approximately 775,000 cases in 2019 to less than 545,000 in 2020, according to the U.S. Courts.
Increased federal unemployment benefits, stimulus checks, moratoria on evictions and foreclosures, student loan forbearance and credit card relief programs put in place because of the pandemic “probably bought a little bit of time for a lot of folks,” says Jackie Boies, senior director of housing and bankruptcy services for Money Management International, a nonprofit consumer credit counseling service.
Among the assistance was an extra $300 in weekly unemployment benefits from the federal government, set to end Sept. 6.
Some states, such as Ohio, ended the additional benefits early, and inquiries from consumers interested in filing for bankruptcy began coming to Marc Dann, a Cleveland bankruptcy attorney.
The extra unemployment money “kept a lot of people afloat who might otherwise file for bankruptcy,” Dann says. Now many are interested in learning what their options are.
New York bankruptcy attorney Anthony Vassallo says he had a substantial number of pending bankruptcy filings when the pandemic hit and things slowed down. Now he expects “a tsunami of filings” in the coming months.
What is bankruptcy?
Bankruptcy is a way for individuals or businesses to eliminate all or part of their debt or help them repay some of what they owe. The proceedings fall under the jurisdiction of federal bankruptcy courts.
The three types of bankruptcy
The most common type of bankruptcy is Chapter 7, in which an appointed trustee supervises the sale of your assets with exemptions for certain assets like cars and household items. The money raised from this sale pays your creditors, and the remainder of your debt is eliminated. Certain types of debts, such as student loans and alimony, can’t be discharged. Furthermore, if you file this type of bankruptcy, you can’t file again for Chapter 7 bankruptcy for eight years and the bankruptcy filing will remain on your credit report for 10 years.
Chapter 13 bankruptcy lets you keep your property if you pay part or all of your debt under a repayment plan over three to five years. You can file for Chapter 13 bankruptcy again in two years, and the bankruptcy remains on your credit report for seven years.
Businesses primarily use a Chapter 11 bankruptcy. According to the U.S. Department of Justice, you can still operate your business, but the court and your creditors must approve your debt repayment plan. Typically in a Chapter 11 bankruptcy, personal assets and business assets are kept separate, so your house and car wouldn’t be sold to cover debts unless they were owned by the business.
States with the most bankruptcy filings
The U.S. Courts reported that in 2020, there were:
- 378,953 Chapter 7 filings
- 8,333 Chapter 11 filings
- 156,377 Chapter 13 filings
Not surprisingly, given their size, the most populated states typically have the most bankruptcy filings, according to the American Bankruptcy Institute.
From January to July 2021, almost 249,329 people filed for bankruptcy. The states with the most bankruptcy filings were:
- California: 25,555
- Florida: 18,960
- Illinois: 12,703
- Ohio: 12,662
- Georgia: 12,139
For 2020, California again led, with more than 49,000 filings. Florida ranked second, with more than 36,000, followed by Illinois, with more than 30,000. Georgia was fourth, with more than 27,500 filings, while Ohio and Texas had more than 26,000 filings.
But the numbers paint a much different picture on a per-capita basis. From January to July 2021, the states with the most filings per 1,000 residents were:
- Alabama: 3.13
- Nevada: 2.85
- Tennessee: 2.49
- Indiana: 2.29
- Kentucky: 2.17
In 2020, Alabama ranked first, with 3.85 filings per 1,000 residents. Delaware and Tennessee ranked second and third, respectively, with more than three filings per 1,000. Nevada and Mississippi each had almost three filings per 1,000 residents.
In comparison, Alaska had the fewest filings, with 0.45 per 1,000 residents in 2020. Vermont, Massachusetts, Maine and New Hampshire rounded out the bottom five, and all had less than one filing per 1,000 residents.
So far in 2021, Alaska, Washington, D.C., Maine, Massachusetts and Vermont have had the fewest per-capita filings.
However, bankruptcy rates can change dramatically in a state from year to year due to economic and financial changes.
Despite the hundreds of thousands of filings each year, they have dropped considerably since their peak.
Bankruptcy filings topped 2 million in 2005. That same year, the Bankruptcy Abuse Prevention and Consumer Protection Act, which required higher filing fees, a means test for eligibility and mandatory financial counseling, became law.
In 2010, filings reached almost 1.6 million but have gradually declined in the following decade.
What causes bankruptcy?
A 2019 study by researchers at City University of New York and other universities found that more than 65% of people filing for bankruptcy did so at least in part because of medical bills.
About 45% cited unaffordable mortgages or foreclosures and another 44.4% cited living above their means. About 25% cited student loans or divorce.
With COVID-19, Vassallo says he’s getting calls from consumers whose lives were upended by job loss or divorce. “People are trying to pick up the pieces,” he explains.
At the same time, “unless there are more substantial changes in healthcare, medical bills will continue to be a driver [of bankruptcy],” Dann says.
Job losses also may be a significant cause in the future. The Bureau of Labor Statistics reports unemployment rates soared from 4.4% in March 2020 to 14.8% in April 2020 as the pandemic hit. It has since dropped to 5.4% in July 2021, but about 9 million people remain unemployed.
For people who lost their jobs, “the instinct is to pay their bills,” Dann says, even if that means running up credit card debt. “That puts them in a pretty bad cycle.”
Boies says some people run into trouble because of “too many cars, boats, houses,” and they “need to unload” some of their possessions.
Credit cards also may have a role to play in filings, says Bruce McClary, senior vice president of communications at the National Foundation for Credit Counseling. “People are in situations where credit card accounts become unmanageable,” he says.
Debtors can include credit card debt in both Chapter 7 and Chapter 13 filings.
McClary says he has found that consumers sometimes try to pay their student loans with their credit cards and then use bankruptcy to eliminate their student loan debt. “People try to game the system,” he says. “Eventually, they will be discovered,” and the effort to wipe out student loans won’t be allowed.
Vassallo says he has had clients who have credit cards with no balance, and they don’t report them in their bankruptcy filings because they hope to be still able to use them.
However, he says credit card issuers are notified if someone files for bankruptcy and the cards are shut down.
What to do if you’re overwhelmed by filing bankruptcy
If someone feels overwhelmed by debt, “their first line of defense is talking to a nonprofit consumer credit counseling service,” Boies says. The cost-free review can help consumers get a realistic look at their financial picture.
That will help them determine if they should file for bankruptcy or if there are other solutions.
“It’s hard to tackle on your own. There’s a kind of helplessness,” says Jeff Arevalo, a financial wellness expert at GreenPath, a nonprofit consumer credit counseling service.
With the help of outside experts, you might come up with solutions such as taking on an extra job, selling assets or possessions or getting a loan from family or friends, Arevalo says. You also might be able to contact credit card companies and reach an agreement to pay them less than what you owe, but this is not guaranteed.
When contemplating bankruptcy, “people really need to be honest with themselves about their situation and be realistic about the likelihood of paying back debt,” Dann says.