Study: Most bankruptcy due to lawsuits, not debt level

A new study suggests that many people go bankrupt less because of how much money they owe than for another reason: fighting lawsuits to collect that debt.

The leading causing of personal bankruptcy is litigation by companies that buy consumer debt from other businesses, according to the non-profit Center for Consumer Recovery. According to the study, which examined more than 3,000 cases in which people declared bankruptcy in 2013, 78 percent of petitioners sought protection from creditors chiefly because they were being sued by debt collectors. 

"Respondents remarked that once they were sued they felt helpless and hopeless and at the mercy of an unforgiving court system where the odds were stacked against them," the group concluded. 

Bankrupcty can have a significant impact on an individual's or family's ability to purchase a car or house, obtain higher education loans or even get a job.

Conventional explanations of personal bankruptcy tend to emphasize how much people owe. For example, a 2013 study from personal finance site NerdWallet cited medical expenses as a major reason for bankruptcies. The site estimated that "three in five bankruptcies will be due to medical bills," rather than, as is often assumed, poor saving habits and excessive spending.

The Center for Consumer Recovery considered not only different types of debt, but also explored the psychological and emotional impact of facing crushing obligations. One noteworthy finding: the trigger for bankruptcy was not just how much was owed or the type of debt in question, but how far the collection process had gone and consumer attitudes toward their situation.

Nearly three-quarters of respondents said that they were being pursued by a debt buyer, a company that purchases debt for a fraction of the initial amount and then works aggressively to collect money from consumers. Seventy-two percent said that credit cards were their primary form of unsecured debt, versus property, like a house or car, that could be foreclosed on or repossessed.

About 57 percent of bankruptcy filers faced a host of problems: They were the defendant in a debt collection legal action, credit card debt was their major unsecured debt and they were being pursued by a debt buyer.

According to the Office of the Comptroller of the Currency, debt buyers often pay only 5 to 10 cents on the dollar to purchase debt.

From 2008 to 2012, big U.S. banks together sold an average of $93.2 billion in debt per year to debt collectors. The debt sold includes credit cards, auto loans, home equity loans, mortgage, and student loans (The latter cannot be discharged under bankruptcy.) The five largest banks are responsible for 82 percent of the annual total average sales of debt.

According to the Federal Reserve, household debt has been on the increase since shrinking for brief period shortly after the 2008 financial crisis. It rose 3 percent in the third quarter of 2013.