Bankruptcy is a federal court process that helps individuals and businesses repay their debts under the protection of the bankruptcy court or wipe their debts out altogether. The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 made major changes to bankruptcy law, making it more difficult for some people to erase debts by filing for bankruptcy. These changes were prompted by years of complaints by banks and other financial institutions who believed that the bankruptcy laws had been abused by many consumers. There are two basic types of bankruptcies that apply to most individuals: reorganization (Chapter 13) or liquidation (Chapter 7).
The New Bankruptcy Law
In a reorganization bankruptcy, you are required to file a repayment proposal with the bankruptcy court. Some debts must be repaid in full, some are repaid as a percentage of the original debt, and others aren’t repaid at all. In general, Chapter 13 requires you to pay back your secured debt and as much of your unsecured debt as possible. Payment plans usually cover a five year period. During the repayment period, the court will place restrictions on how you can spend money. In many cases, a set amount will be garnished from your wages and a trustee of the court will make the payments to your creditors.
In a liquidation bankruptcy, you must turn their personal property (with a few exceptions) over to the court, which sells it and uses the proceeds to pay all your debts or a portion of your debts. Chapter 7 has generally been the most common form of bankruptcy filing for those people who have no assets to lose and therefore are seeking a “fresh start.” However, recent changes in bankruptcy law have made this type of filing much more difficult.
What type of Bankruptcy would you qualify for?
If you’re considering filing for bankruptcy, it may be harder to erase your debts than you think. Under the old bankruptcy law almost anyone could file Chapter 7 bankruptcy. The new bankruptcy law includes a formula test, called the means test, to determine who may (and who may not) be eligible to file Chapter 7 bankruptcy. Those who do not pass the means test are then required to file Chapter 13 bankruptcy.
The Means Test
In order to file under Chapter 7 Bankruptcy, your income must be below the median income for same sized families in your state or you’ll be required to go through a bankruptcy means test. Your income is determined by calculating your average income from the past six months. For families with a recent loss of income due to job loss or declining wages, this average may not reflect their actual current income. Even if you pass the first part of the means test and you have an income lower than your state’s median, there is an additional test for your expenses which places severe restrictions on your spending. If the court believes that you have $100 or more per month in disposable income that you could apply towards your debt repayment after allowances for child support, food, housing, and other related expenses, you’ll be pushed into a repayment plan under Chapter 13.
Other Key Changes
Bankruptcy laws exist at both the state and federal level. Some states’ laws are more favorable than others. New residency requirements are designed to prevent debtors from moving to a state with more favorable laws and immediately filing bankruptcy. In general if you have lived in a new state that has more favorable bankruptcy laws for less than two years, you cannot use the more favorable provisions.
Mandatory Credit Counseling
The new bankruptcy law requires that anyone who files bankruptcy must received credit counseling and financial education by government-approved programs as a condition for filing bankruptcy and discharging debts. (See What is Credit Counseling? for more information about their programs) No one can file bankruptcy unless they complete an accredited credit counseling program within 180 days of their bankruptcy filings.
Increased Paperwork and Higher Legal Costs
New requirements under the bankruptcy laws put a heavier burden on you to document income, expenses as well as other various forms and filings. Those wishing to file for bankruptcy must provide:
- A list of all creditors, secured and unsecured.
- Schedules of assets and liabilities.
- Schedules of income and expenses.
- Certificate of credit counseling.
- Evidence of payment from employers, including pay stubs of the past 60 days.
- Statement of monthly net income.
- Tax returns for the most-recent tax year.
- Tax returns for several years prior to the filing, if those returns hadn’t previously been filed with the IRS.
- Photo identification.
If these documents aren’t provided to the bankruptcy court within 45 days of the initial filing, the court will automatically dismiss the case. Extensions beyond 45 days are up to the court. Legal costs under these new requirements are estimated to much higher than what layers charged under the old law. There is much more work required or lawyers. Bankruptcy attorneys are also required to certify their clients’ claims for their assets, liabilities, income and expenses, and could face court sanctions if they are not.
Filing for bankruptcy has serious consequences and should not be entered into lightly. Having your debts erased doesn’t miraculously solve your long-term financial problems. Filing for Bankruptcy, regardless of whether you file Chapter 7 or Chapter 13 may have long lasting negative effects on your credit history for up to 10 years. The negative marks of bankruptcy on your credit may make it difficult to apply for future credit, secure jobs that require a positive credit profile, rent an apartment, purchase a vehicle, etc.