Bankruptcy filings from state-to-state have nothing to do with the presence of payday lending and more to do with demographics.

For many individuals and families whose financial troubles have led them to the brink of insolvency, Chapter 7 and Chapter 13 bankruptcy filing options have been major landmarks on the road to credit repair. Even though filing for bankruptcy can be costly (in money and property), have an adverse effect on a consumer’s ability to borrow and potentially come with the baggage of social stigma, it can be a viable option when options are few.

This legal resource to discharge debt has proven to be quite popular; from 1990 to 2003, the rate of bankruptcy filing went up from 8.4 all the way to 15 per 1,000 American households. It is clear that demand has risen, but what is not as clear is why.

Numerous studies suggest that demographics and bankruptcy laws are among the most accurate determiners, and there tends to be agreement in these areas. There are also rather vocal groups who contend that the presence of predatory lending in a state (a banner upon which they attempt to affix the emblem of payday lending and payday loans) contributes mightily to bankruptcy filings in said state. However, in light of the very recent findings of Lars Lefgren and Frank McIntyre of Brigham Young University in their study “Explaining the Puzzle of Cross-State Differences in Bankruptcy Rates,” such claims by critics of payday lending would appear anecdotal at best, PR fabrication at worst.

Why Do Bankruptcy Filing Numbers Vary Greatly Between Similar States?

That is the question. The authors use Census data separated out by zip code in order to examine the correlation between real bankruptcy filings, demographics and bankruptcy laws. “Overall,” they write, “our analysis suggests that cross-state differences in bankruptcy rates primarily reflect differences in garnishment restrictions, non-legislated legal institutions and demographic factors. These factors jointly explain about 70 percent of the variance in cross-state filing rates.” The recently instituted Bankruptcy Abuse Prevention and Consumer Protection Act will change the findings, but the author’s study was completed before the act became law.

Some Demographic Insights

“Family structure, race and education” are among the keys to the state-to-state variance. Occurrences were more frequent with African-American households and less likely with Asian or Hispanic households. Bankruptcy filings were found to be most common in zip codes where the average household income ranged from $30,000 to $60,000. The highest instance of filing by age fell in the late twenties, while the lowest was for those filers between 30 and 49. Urban location, whether or not subjects were divorced, whether the household was led by a male or female and race are all determining factors. Oddly enough, unemployment and the increase in housing prices showed a negative correlation in relation to bankruptcy filing.

Wage Garnishment, Assets Also Factors

Wage garnishment (versus full-scale discharge of debt) is another factor the authors consider. The federal limit of 25 percent of wages per week (so long as those wages exceed 30 times the federal minimum wage) is allowed, although some states raise or lower certain requirements. Understandably, states where garnishments are less desirable that bankruptcies tend to show a greater number of bankruptcies.

Fay, Hurst and White’s 2002 article in American Economic Review entitled “The Household Bankruptcy Decision” found that bankruptcies are “correlated with a household’s financial benefit of filing, which is related to the generosity of financial exemptions.” Most households that filed for bankruptcy did not have assets of such size that they rose to the exemption limit.

Access to Credit Defends Against Bankruptcy

While the forms of available credit may vary greatly by state and the financial situation of the consumer, the authors point out that states where regulated forms of credit like payday lending and title loans are readily available show fewer bankruptcies. This echoes the sentiment of a recent Clemson University study that posits that payday loans do not lead to bankruptcy. There is “little systematic evidence” that payday loans are a factor, state the authors. In fact, small loans in the amount of $100 to $1,500 can be just what a consumer needs in order to avoid default.

Lawyers Getting Paid

The legal culture of a state also has an impact on bankruptcy filings. The “norms of bankruptcy judges, trustees and attorneys” are possible factors, although this is somewhat anecdotal. Jean Braucher’s 1993 American Bankruptcy Law Journal study “Lawyers and Consumer Bankruptcy: One Code, Many Cultures” indicates that those court jurisdictions which allow attorneys to charge their clients higher fees for Chapter 13 filings often feature attorneys who push clients toward this type of filing -  “even if this is at odds with their best financial interests,” write the authors.

Bankruptcy Rates and Payday Lending: No Correlation

In addition to exemptions, rates of government assistance and the legal culture of a state regarding bankruptcy, the authors found that payday lending is “incapable of explaining practically any of the variation in filing rates across states.”

Why do some states boast more filers than others, then? Cross-state bankruptcy studies of this nature, the authors suggest, are “largely meaningless for understanding differences in default behavior or social preferences for default.” Costs and legal practice seem to be the most obvious driving factors for the decision to then file for bankruptcy. There are noted problems with court-mandated repayment plans, but the Bankruptcy Abuse Prevention and Consumer Protection Act is intended to help remedy this problem. The results remain to be seen. It seems safe to rule payday lending and payday loans out of the formula of causation, however.

Today the government announced unemployment figures for June that are much worse than expected. Employers cut 467,000 jobs and the unemployment rate rose to 9.5%, the worst since 1983. Unemployment is a lagging indicator, so even after the economy begins to improve, the jobless rate is likely to rise for some time.

With no end in sight to rising unemployment and with foreclosure rates continuing to accelerate, people are turning in droves to bankruptcy. You may find it humiliating even to consider bankruptcy, let alone join that crowd in the courthouse corridor, waiting for your name to be called. But with an economic tsunami rolling over your home, job, and health insurance, it just may be your best course of action.

The time comes when it makes sense to give up the good fight

Many people — honorable to the bitter end — struggle much longer than they should to rein in unmanageable debt. By the time they give up, they’ve lost valuable assets that would have been protected in bankruptcy, which defeats the “fresh start” purpose of the law. If you are a candidate for bankruptcy, the best time to file may be when you’re on the losing track but still have assets worth protecting.

It’s true that a bankruptcy filing remains on your credit record for up to ten years and makes it difficult to obtain competitive interest rates on loans. Most bankruptcy debtors, however, already have badly damaged credit records by the time they file.  When you are faced with insurmountable debt, a compromised credit rating can be a small price to pay for the fresh start that only bankruptcy can afford.

Before you decide to file, consult an experienced bankruptcy attorney

Bankruptcy is a significant and complicated legal proceeding. There is nothing to prevent you from representing yourself in bankruptcy court, but it is not wise to do so. When you represent yourself, you are held to the same standards of knowledge and practice as a licensed attorney. Knowing exactly how to navigate the intricacies of the Bankruptcy Code and several other bodies of statutory and common law is essential to an effective discharge of debts.

It costs nothing to get an initial consultation with an experienced bankruptcy attorney practicing in your jurisdiction.  It is vital that you receive competent legal advice before deciding whether bankruptcy is the right choice for you.

Looking at the numbers, bankruptcy may not be such a tough choice

An Associated Press analysis for the first quarter of 2009 revealed that U.S. bankruptcy filings were up an astounding 46% from March of 2008 to March of 2009. The jump is an even more dramatic 81% since March of 2007.  Some economists predict that the situation will become even worse.

A little over four years ago Congress enacted the Bankruptcy Abuse Prevention and Consumer Protection Act, also known as the 2005 Bankruptcy Amendment Act. Bankruptcy filings surged in the fall of 2005 to a record-shattering 2 million cases for the year as struggling consumers rushed to beat the implementation of the new law. In 2006, filings plummeted to 600,000. This year, bankruptcy filings are soaring again, and the predicted numbers for 2009 range between 1.5 and 1.6 million.

Elimination of debts in Chapter 7 may be an option even for higher incomes

The majority of bankruptcy debtors file under Chapter 7 which eliminates most (but not all) unsecured debts. When Congress enacted the 2005 Bankruptcy Amendment Act, it sought to restrict Chapter 7 filings by requiring debtors to pass a “means test” designed to weed out those who appear to have the ability to pay all or a portion of their debts under Chapter 13. Despite this hurdle, many people still qualify for Chapter 7 relief. Read Bankruptcy|What Should I Do?

The means test allows debtors to deduct certain expenses from their incomes. The greater the deductions, of course, the easier it is to qualify. Despite the congressional intent, the means test contains several variables that may enable people with higher incomes to qualify for Chapter 7. Debtors who own homes with mortgages may deduct the full amount of the mortgage. Having several children or dependants, multiple cars with loans or leases, high childcare and insurance expenses, and making large religious donations may also facilitate qualifying for Chapter 7.

You may be facing insurmountable debt, the danger of losing your home or car, and continual harassment from debt collectors. Your struggles may be compounded by divorce, the loss of a job, uninsured medical expenses, or a combination of unexpected events. If you are in extreme financial distress, a quick payday loan clearly is not going to go the distance. But you know you need to do something.

Is bankruptcy the answer?

The two most common types of bankruptcy for individuals are Chapter 7 (where you can get rid of certain types of debts altogether) and Chapter 13 (where you can pay all or, more frequently, a portion of your debts according to a court-approved payment plan). To file under Chapter 7, your average monthly income for the six months immediately preceding the bankruptcy filing must not exceed the median income in your state. Alternatively, you may file under Chapter 7 if your income is insufficient (after subtracting certain expenses for basic necessities) to repay any part of your debts.

Ask an attorney

Determining whether you are a candidate for bankruptcy and whether filing for bankruptcy would be in your best interest requires in-depth legal analysis. Before you make a decision, be sure to get legal advice from an experienced and reputable bankruptcy attorney.

Chapter 7 debt liquidation

A Chapter 7 bankruptcy allows you to get rid of certain types of unsecured debts while keeping your exempt property. In many cases, you can keep all your property. Among the kinds of unsecured debts you may include are credit card balances, personal loans, debts remaining from repossessed property, utility bills, and medical bills. In some cases, you also may be able to discharge old income and property tax debts. Chapter 7 bankruptcy may be an effective alternative if you own little property and have an unmanageable amount of debt. Unemployment, unexpected medical expenses, and divorce are some of the things that can precipitate a Chapter 7 bankruptcy.

Chapter 13 debt adjustment

If you do not qualify for Chapter 7 and you have a regular income, you may be able to file a Chapter 13 bankruptcy. Chapter 13 involves a three- to five-year court-approved payment plan to pay your debts, or a percentage thereof, in an affordable manner. Chapter 13 may be an option if you are behind on your car or house payments and want to avoid a repossession or foreclosure. Or it may provide a manageable way to pay debts that you cannot get rid of in bankruptcy, such as taxes, child support arrearages, and divorce debts. Chapter 13 may also allow you to keep valuable assets that you would have to surrender under Chapter 7.

Life after bankruptcy

Although bankruptcy is designed to give you a fresh start on  finances, it will have a negative impact on your credit rating and can remain on your credit report for up to ten years. But if you are a candidate for bankruptcy, you are probably deeply in debt and behind on your  payments. As a result, your credit score is probably very low already. Improving your income-to-debt ratio by reducing your debt load can be the first step toward improving your score. Even if you have a perfect payment history, if you have more debts than you can pay using your income, you will have a poor credit rating and bankruptcy may actually be a positive turning point in your credit history.

If bankruptcy isn’t for you, read about other options in What Should I Do | Debt-Relief Options.