In response to the increasing number of bankruptcies during the past decade, which has resulted in billions of dollars in losses to companies, Congress recently passed a sweeping set of bankruptcy reforms. Some of the important changes include:
- setting out specific amounts allowable for food, clothing, transportation and housing, and requiring the debtor to live within those guidelines unless he can show a reason to increase the allowed expenses;
- lengthening residency requirements in states before state exemptions can apply to the debtor;
- forcing the debtor to pay the full cost of an auto loan or lose the vehicle to repossession, even if the vehicle is not worth the outstanding balance on the loan;
- requiring debtors to attend courses in credit counseling and personal financial management as a condition for discharging debts;
- raising the priority of child-support and alimony payments;
- placing a $1 million maximum on the amount in Roth and regular IRAs that are exempt from creditors;
- requiring repayment of all credit card charges made in the 3 months before filing for bankruptcy; and
- allowing landlords, in some circumstances, to avoid the automatic stay and evict bankrupt tenants who are behind on their rent.
Additionally, the new law includes changes making filing for bankruptcy and liquidation under Chapter 7 much more difficult. Any person attempting to file bankruptcy must attend a credit-counseling program as well as pass a two-part "means test."
I have heard the new bankruptcy laws require me to get credit counseling. What is this?
Under the new law, anyone contemplating filing bankruptcy must attend a credit counseling class not more than 180 days before filing bankruptcy. After completing the course, the agency will issue a certificate of compliance, which must be filed with the court along with a copy of the repayment plan created.
SIDEBAR: Failure to file proof of compliance may result in your case being dismissed. However, if no approved counseling services are available in your district, this requirement may be waived.
What is a "means test"?
The means test is a formula applied to a debtor's income when that income is more than the state median. (The national average median income is $60,000 for a family of four.)
SIDEBAR: Debtors earning less than the median income for their state will be able to file for Chapter 7 bankruptcy.
Under the test, secured debts (e.g., mortgages and car notes) and necessities (alimony, child support and living expenses) are subtracted from the debtor's monthly income to determine what amount of money is left over for repayment of unsecured debts, such as credit cards. If there is enough left over so that the debtor can pay at least $11,700 toward unsecured debts over 5 years or $195 per month ($11,700 / 60 months = $195 per month), the debtor must file Chapter 13 bankruptcy and make repayments.
SIDEBAR: Debtors (with an average median income) who can find at least $195 left over after expenses are prohibited from filing Chapter 7 bankruptcies. This "means test" will limit Chapter 7 filings to individuals and families with little or no cash flow. Under prior law, courts did not have any set formula to determine how much leftover cash tips the debtor out of Chapter 7 and into Chapter 13.
SIDEBAR: Historically, almost two-thirds of consumer bankruptcies have been filed under Chapter 7, which allows consumers to wipe out credit card debt.
SIDEBAR: "Reasonable" living expenses for food and clothing, transportation and housing are determined by IRS guidelines. The guidelines take into account the region of the country where the debtor lives. A debtor is also allowed to deduct other reasonable living expenses, including:
- up to $1,765 in expenses annually for grade and high school (per each minor child)
- expenses of caring for elderly, chronically ill or disabled household family members, including children and grandchildren
- a domestic support obligation that first becomes payable after the petition is filed
- charitable contributions of up to 15 percent of gross income
- payment of expenditures needed to continue, preserve and operate a business
Can I file under Chapter 7 if I pass the "means test"?
Individuals who pass the means test must file Chapter 13 bankruptcy and enter into a plan to repay creditors. The means test requires a debtor whose income, based on the size of his family, is more than his state average to file under Chapter 13. Choice between chapters in filing for bankruptcy is virtually eliminated under the new law.
How do the new bankruptcy laws affect state exemptions?
Debtors who are eligible to file under Chapter 7 must have lived in the state for 6 months to use the state exemptions. This provision prevents debtors from moving to big-exemption states (such as Florida and Texas) to avoid losing assets to liquidation.
We are in the middle of our Chapter 13 plan. Will the new bankruptcy law affect us?
No. The law does not affect bankruptcies filed before its effective date.
What happens under the new law if we fail to complete our Chapter 13 bankruptcy plan?
The court can dismiss the case and your creditors will resume collection activities against you.
Can a Chapter 13 bankruptcy be converted to a Chapter 7 under the new law?
Yes. If you are unable to complete the repayment plan under Chapter 13 due to circumstances beyond your control, such as unemployment, illness or a decrease in income, you can petition the court to have your debts discharged completely.
SIDEBAR: To qualify to convert to Chapter 7 you must have been eligible for a Chapter 7 on the day you filed Chapter 13.
SIDEBAR: The court can revise the Chapter 13 repayment plan and require smaller payments because of a change in circumstances.
How can I avoid bankruptcy?
Although a bankruptcy does have an advantage in that it provides debtors with a fresh start, the damage to credit can have enormous consequences. Individuals should seek to avoid bankruptcy when finances become tight by getting a clear picture of their current financial situation.
- Write down all your debts-the amounts, the interest rate and the monthly minimum payments.
- Calculate all the net income you have available.
- Add up your expenses and forego items such as cable TV, cell phone service, housekeepers and lawn services.
- Make a budget and stick to it.
- Sell any personal property and vehicles that you do not absolutely require.
- Cut up credit cards (except for an emergency card) and make purchases with a debit card only.
- Reduce late fees by signing up for direct debiting from your bank account on some bills.
Once you have a complete understanding of your financial situation, negotiate with creditors, primarily credit card companies, to lower interest rates and monthly payments. Do not tell the creditor you are thinking about filing bankruptcy-they will flag your file and close your credit line.
TIP: Credit counseling services that negotiate with creditors on your behalf and pay them directly are not recommended. Typically, these services negotiate down your unsecured debts and have you pay the service one large payment, which is then distributed by the credit counselor to your creditors. Not only is your credit rating immediately damaged when the credit counselor contacts creditors, payments may be made late or not at all.