People in deep debt beware: Any bright side of going bankrupt is about to get dimmer. Taking effect next week are stricter bankruptcy laws that President George W. Bush signed into law in April.
The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 aims to do basically what it says.
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For starters, people seeking bankruptcy must pass a means test, which means people who earn more than the median income in their home state – which in Rhode Island is $67,646 for a family of four – and have at least $100 per month left over after paying required expenses, must repay their debt, according to the American Bankers Association.
Yet there are exceptions to those rules. The test accounts for financial problems caused by such things as loss of income or serious medical ailments.
The evaluation resolves whether individuals qualify for Chapter 7 bankruptcy, providing substantial relief from their debts; or it may determine that people can afford to repay creditors and, in that case, would do so under Chapter 13.
The law also requires people to obtain lessons in personal finance. They must receive credit counseling 60 days prior to filing for bankruptcy. And to be “discharged” from bankruptcy, they must take a course in “financial literacy.”
Marjorie L. Girth, an expert in bankruptcy law at George State University College of Law in Atlanta, said the most striking change in the new law is the difference in tone.
The current law regards those undergoing bankruptcy as “honest but unfortunate debtors,” who were unable to fulfill their financial obligations due to harsh circumstances, said Girth.
The tone of the new law, however, is one that reflects a belief that debtors historically have abused bankruptcy.
“If a debtor cannot pass the means test, they are presumed to be abusing the system,” Girth said of the updated law.
A number of changes in the new law make bankruptcy a less attractive option to debtors, according to the ABA.
In the past, people were unable to gain relieve cash advances of more than $1,000 taken and pricey purchases made within 60 days filing for bankruptcy. The new law constricts those thresholds to $500 credit card charges within 90 days and $750 cash advances as soon as 70 days before filing.
The ABA reports that a loophole in the old law enables people to prevent creditors from seizing their lavish homes. This so-called homestead exemption has allowed people to buy fancy dwellings and file for bankruptcy in states with no limits on the amount of home equity that can be shielded from creditors.
To close the gap in the current law, the new law mandates that people must have lived in a state for at least two years and 10 days to qualify for its homestead exemption.
Also, the court can nullify a homestead exemption if a debtor is proven to have tried to defraud a creditor within 10 years of filing for bankruptcy.
The new law helps creditors collect more debts from bankrupt individuals through a number of new provisions, according to the ABA.
Exemptions are no longer granted for secured debt, for which a motor vehicle was used as collateral, incurred within two and a half years of filing for bankruptcy. Also, people must continue to make payments on secured loans for the 30 days after filing for Chapter 13 bankruptcy.
For bankrupt individuals who earn more than median income, the repayment plan for secured debt will be extended from three years to five years.
Under Chapter 7 bankruptcy, loans secured by personal property must be redeemed within 45 days of filing for bankruptcy. Otherwise, the creditor can repossess the property.
The updated law also sets new standards for creditors to give consumers a better chance of avoiding excessive debt, according to the ABA.
Lenders must disclose the cost of making minimum payments on credit card debt, the tax implications of home equity loans, penalties for late payments and important deadlines.
The law provides further relief for family farms that file for bankruptcy. The limit on the amount of acceptable debt under Chapter 12 family farm bankruptcies will rise from $1.5 million to $3.2 million with periodic adjustments for inflation. Also, the minimum amount of debt from farming operations will decrease from 80 percent to 50 percent.
The updated bankruptcy act takes effect on Oct. 17.
Girth said she expects the number of bankruptcy filings to drop after the new law takes effect, yet only because of the high number of filings entered in advance of Oct. 17 and due to the time needed for attorneys to become comfortable with the new law.
The prolonged legal process, and therefore attorneys’ fees, involved in each filing could also have an impact on the number of bankruptcies.
“The question is going to be: Will the debtor be able to afford what the attorneys need to charge in order to comply with” the new financial reporting requirements, said Girth.
