Even though legally there’s no such thing as a medical bankruptcy, many bankruptcies are caused by medical problems. Here’s a Q&A about these.
The last two weeks we’ve written about health insurance. Two weeks ago we discussed the 6 months of free health insurance provided by the recent American Rescue Plan Act. Last week we got into the broader topic of health insurance and bankruptcy. Today we broaden it out even more with a Q&A about medical bankruptcy.
What is Medical Bankruptcy, Legally?
Although the phrase is thrown around a lot, legally there is no such thing. The legally designated types of bankruptcy are labeled according to their Chapters in the U.S. Bankruptcy Code. Chapter 7, the so-called “straight bankruptcy,” and Chapter 13 “adjustment of debts,” are the most common forms of personal bankruptcy. Both Chapter 7 and 13 can deal effectively with medical debts and other financial problems arising from medical events.
What is Medical Bankruptcy, Practically?
Although there’s no such legal designation, in fact a large percentage of bankruptcies are caused by medical events. One study estimated that more than half—about 61%–of personal bankruptcies had one or more medical causes. (Note that this was pre-COVID; this percentage is likely significantly higher during and after the pandemic.) The list of medical causes this study cited provides a good summary of the diverse kinds of “medical bankruptcies.” Here are some of the items on this list, along with the percentage of all personal bankruptcies applicable to this medical cause:
29.0 %: Debtor said medical bills were a reason for filing bankruptcy
32.1 %: Debtor said a medical problem of self or spouse was reason for filing bankruptcy
29.0 %: Debtor said medical problem of other family member was reason for bankruptcy
34.7%: Had medical bills of $5,000 or more, or more than 10% of annual income
5.7%: Had mortgaged family home to pay medical bills
38.2%: Debtor/spouse lost at least 2 weeks of income due to illness/complete disability
6.8%: Debtor or spouse lost at least 2 weeks of income to care for ill family member
So, practically speaking, if you have any of these challenges you could be considered to have a medical bankruptcy.
What Happens to Medical Debts in Bankruptcy?
It’s a surprising common myth that bankruptcy does not write off—legally discharge—medical debts. In almost all situations medical debts are legally categorized as “general unsecured debts. These are the most straightforward debts that are not secured by any of your property. These are treated less favorably than other more “important” debts—secured and priority debts. Secured debts are legally tied to your property—such as vehicle loans and home mortgages. Priority debts are special ones that the law protects for special reasons, like income taxes and child support. As general unsecured debts, medical debts are not treated favorably in either Chapter 7 or Chapter 13.
How Does Chapter 7 Deal with Medical Debts?
Under Chapter 7 “straight bankruptcy,” general unsecured debts, including medical debts, are almost always completely discharged. The minute your bankruptcy lawyer files your case all creditors, including medical ones, must stop all collection activity. This includes all collectors of medical debts as well. The stopped collection activity includes lawsuits and garnishments.
Then usually about 3 months later the bankruptcy court enters an order discharging all general unsecured debts. This means that those debts are forever legally gone, permanently uncollectable.
Are There Any Exceptions to this Straightforward Scenario?
There are three noteworthy although relatively rare possible exceptions.
First, most personal Chapter 7 cases are “no asset” ones: everything the debtor owns is protected, “exempt.” However, sometimes an asset is not exempt, and so must be surrendered to the bankruptcy trustee. He or she then sells the asset (or assets), and pays the creditors. Often all the sale proceeds go to your priority debts—such as taxes—leaving nothing for your general unsecured debts. If there is enough left over for the general unsecured debts the trustees pays these pro rata, divided up based on the amount of each debt. In such relatively unusual situations your medical debts would be paid something. Usually the amount that general unsecured debts receive is only a small portion of their total amounts.
Second, while almost all medical debts are unsecured, in rare situations they are secured by your property This only happens if you have affirmatively acted to give them a right—a “security interest”—to your property. If so you may have to pay the debt or else lose whatever property or possession that secures the debt. Again, this is rare, and you would usually know if you have done this. If you don’t know and are concerned about this, talk with your bankruptcy lawyer.
Third, although virtually all medical debts are dischargeable, all creditors technically have the right to object to the discharge of its debt. This almost never happens with medical bills—it’s almost not worth mentioning here. The objection would need to be based on allegations of fraud or misrepresentation by you against the medical provider. Again, if you have any concerns about this, talk with your lawyer.
How Does Chapter 13 Deal with Medical Debts?
Chapter 13 is quite different from Chapter 7, involving a 3-to-5-year payment plan. They are usually filed when a person has significant issues with secured debts (vehicle loans, home mortgages) and/or priority ones (income taxes, child/spousal support). The payment plan is based on how much a debtor can afford to pay each month to all creditors. The plan designates which debts get paid how much and when.
Usually, general unsecured debts receive payment through the Chapter 13 plan only to the extent there is money left over. For example, a plan must pay all priority debts in full before anything goes to the general unsecured debts. If you’re catching up on a vehicle loan or home mortgage, you pay these in full before paying the general unsecured debts anything. This means that sometimes the general unsecured debts—including the medical ones—receive nothing. Often they receive only pennies on the dollar.
After the payment plan is completed, any unpaid medical debts—along with all other general unsecured ones—get permanently discharged.
Will My Medical Provider Stop Serving Me If I File Bankruptcy on Its Medical Debts?
Not likely. Any creditor, medical providers and otherwise, can chose to not serve you during or after a bankruptcy case. This is true whether you are asking for services on credit or not. But practically speaking most medical providers don’t end their relationship with you because you avail yourself of the legal tool of bankruptcy.
But policies about this do vary, regionally and between various kinds of medical providers. So if you are concerned about a particular provider you may want to call them and just directly ask.
Can I Favor My Medical Provider in Bankruptcy?
People sometimes have special feelings for their medical provider, such as their personal doctor or an important specialist. They may fear disrupting that relationship by filing a bankruptcy which discharges that provider’s debt. So can and should you favor that provider by paying its debt more than or instead of other debts?
The simple general answer is no. One of the overarching rules in bankruptcy is that debts that are legally the same must be treated the same. That’s certainly true during the bankruptcy proceeding. In both Chapter 7 and Chapter 13 cases medical debts are treated like any other general unsecured debt. So, in the example of a Chapter 13 plan, you can’t earmark extra money to a general unsecured medical debt.
How about Paying a Medical Provider Before or After Bankruptcy?
It’s risky to try to favor a medical debt before filing bankruptcy. A significant payment to any creditor while you’re not paying other creditors can cause problems. It may be challenged as a “preference” payment. This is especially true if at that time you’re considering filing bankruptcy, and it’s close to when you actually file your case. Your medical provider could be ordered to pay the money back, but to your bankruptcy trustee. The specific rules about this are complicated, but generally it’s not a good idea to be paying medical providers more than other creditors before filing bankruptcy. Again, this is a topic to discuss with your bankruptcy lawyer.
After finishing a bankruptcy case nothing prevents you from paying a medical creditor, but it’s almost never worthwhile to do so. You are allowed to pay any creditor once the case is over. But there is almost never any practical benefit. The creditor can’t require you to pay a discharged debt, or condition continued services on you doing so. There would be no benefit to your credit record. The only reason to do this is for moral reasons, to fulfill some sense of obligation. This is true whether this would be to a doctor, a friend, or to anybody else. Almost always at that point you should instead just move on and focus on rebuilding your financial life going forward.