If your image of bankruptcy is soup kitchens or the fallout from high-rolling excess, you need to think again. Bankruptcy has evolved dramatically over the last decade. Today, personal bankruptcy is a middle-class phenomenon, with college-educated homeowners leading the pack.

It may hurt to admit it, but traditional wealth building strategies like getting a college degree and owning your home might not be enough to lock-in financial security.

Filing for bankruptcy is never easy. Your credit score is destroyed. Under Chapter 7, back taxes and student loans may not be absolved, and you may even lose your home and car. But, whether it's bad luck or bad decision-making, sometimes your financial situation is so bad that bankruptcy is the only way out.

Five Most Common Bankruptcy Pitfalls

Last year, over one million Americans filed for personal bankruptcy; here are the five most common reasons:

Medical Expenses

According to a recent Harvard study, an astounding 62% of all personal bankruptcies filed in the U.S. in 2007 were caused by medical problems. And with health care reform being the topic of the hour, it may surprise you that over three-quarters of those people had some form of health insurance at the start of their illness.

According to the study, high medical bills caused 92% of the reported medical bankruptcies, with out-of-pocket costs averaging $17,943 per medically bankrupted family. Many patients faced job and income loss, and this, coupled with expensive medical bills, quickly wiped out savings, retirement funds, and home equity, pushing them over the edge.

Job Loss

During the last few years, we've watched the national unemployment rate rocket to 9.7%, and the average job search now lasts over 30 weeks, an all-time high.

Many people were caught unprepared and without the recommended three months of income socked away in a savings account. Even those with an emergency fund have found themselves out of work for much longer than expected, and many have found that three months of savings just isn't enough.

Unemployment benefits help some for a while, but it doesn't make-up for the security and benefits that come from having a steady job. Depending on the state they live in, some job seekers receive unemployment payments that cover only their most basic needs. Losing a job often also means losing health benefits.

Many eventually turn to credit cards, hoping to find a job before the debt becomes too overwhelming. But to add financial insult to injury, banks have been cutting credit lines and raising interest rates at exactly the time when the unemployed are turning to credit as an emergency source of funds. Furthermore, falling home prices have wiped out equity, making it impossible to tap homes for extra cash.

Poor Spending Habits

Bad financial habits can quickly send you down the slippery slope toward a bankruptcy filing. If your loan and credit card balances are so large that you have to borrow to make payments, you are already at the end game.

Debt consolidation plans have become a popular way for the indebted to lower payments on debt, but studies show that almost 78% of the time, the debt grows back. Some tap home equity as a way to consolidate debts, but if total spending isn't reduced, you have just put yourself at risk for foreclosure and bankruptcy.


The end of a marriage puts strain on more than just relationships. Each half of a divorcing couple can generally expect the double-whammy of higher expenses (legal fees, costs associated with setting up a second household) and reduced purchasing power. Incomes, belongings, children and assets are split up, leaving both sides with less. Many divorces end with at least one spouse in an unsustainable situation with bankruptcy as the only option.

Unexpected Expenses

There are a million ways a person can incur unexpected expenses, but many of them stem from a lack of adequate insurance. Catastrophic natural disasters can leave an uninsured homeowner or renter homeless, and even if the house is spared, the belongings in it can be destroyed or stolen. Most people fail to prepare for rare but life-altering occurances like fire, floods and tornados.

Avoiding The Pitfalls

So what can you do to avoid being one of those one million U.S. bankruptcy filers this year? The tips and tricks for staying out of bankruptcy are tried and true, and here are the top five:

1. Know Your Debt Situation
Most people who end up filing for bankruptcy never saw it coming. By the time you are hit with a major bill or an unexpected expense, it may be too late to evaluate finances and make adjustments.

The best way to avoid being surprised by debt is to know what your debt looks like now. Go through and tally up any outstanding debt -- student loans, house/car payments, and any unpaid credit cards. Next, look at your household income. Can you afford these payments now? If you lost your job, could you go on making payments?

2. Pay Off Your Debt
In a deflationary environment like the one we've been experiencing, our assets are worth less. Houses, stocks, consumer goods and almost anything else we bought in the last few years are worth less. Unfortunately, the debt we used to buy those assets has stayed the same. Some analysts have used the term 'balance sheet recession,' to describe this phenomenon.

Right now, debt is your worst enemy. Even if you're making your minimum payments with room to spare, you may want to consider using any extra cash to make larger payments. Consider the idea that larger debt payments save you interest on the debt you're paying down, enabling you to use the savings on interest to make larger and larger debt payments. Sound powerful? You bet it is.

Credit card companies are now required to disclose how long it will take you to pay off your total credit and how much you'll pay in interest if you continue paying the bare minimum. Pay attention to that number! By making larger than required payments, you'll be even closer to living debt (and stress) free.

3. Make An Honest Budget
You're not fooling anyone if your budget is not accurate. There's no point in telling yourself that you'll put off clothing purchases for the entire year and that you don't need a clothing line item in your budget. It's important to be honest with yourself.

When working out your budget, try to get a good feel for what you've been spending. Some people use receipts and bills to see how their expenses are allocated. Mint.com is an excellent resource for setting up a healthly budget. It automatically pulls transactions from your bank accounts, credit card accounts, and investment accounts to give you a complete and up-to-date picture of your finances. And it's free!

4. Call Your Creditors
If your debt problems are too big for you to handle, talking to the debt collectors circling outside your door may be the last thing you want to do. But many creditors are willing to work with you if certain circumstances (medical bills, job loss, divorce) have made it difficult for you to meet your debt obligations.

Suggest a temporary reduction in your payments, or a waiver of late fees or penalties. It may surprise you what they'll agree to. Don't forget, it's also in their best interest for you to eventually make your payments.

5. Start Saving For That Rainy Day
Saving isn't easy, but it's smart. A well-funded savings plan is a cushion when you encounter that unexpected disaster.

The best way to determine how much money you can afford to put away is to subtract your monthly budget from your monthly income. The amount left over is how much you can afford to put into a savings account. While you don't need to save every last extra penny, keep in mind that the more you save, the easier it will be to get through an emergency in the future.