|CNN's Gerri Willis shares five tips on what to look for when choosing a credit counselor. (October 17)|
NEW YORK (CNN/Money) -
A new bankruptcy law goes into effect today, making it harder for consumers to prove that they should be allowed to clear their debts in what's known as a "fresh start" -- or Chapter 7 -- bankruptcy.
And those who file will be paying much higher fees to bankruptcy attorneys, who are expected to raise their rates by as much as 100 percent. That's to account for the increased liability the new law imposes on them, which will mean more time verifying and filing client documents.
Consumers who seek to file bankruptcy in the next couple of months may also experience delays at the bankruptcy courts, which have been overrun in the past four weeks as debtors scrambled to file under the less stringent requirements of the old law.
Based on preliminary data for the week ending Oct. 15, researchers at Lundquist Consulting estimate that there will be more than 200,000 personal bankruptcy filings. That's almost triple the number of filings in the week ending Oct. 1, which itself was a record high.
Here's a rundown of the key changes for consumers under the new bankruptcy law:
Chapter 7 vs. Chapter 13: In a Chapter 7 bankruptcy, your assets (minus those exempted by your state) are liquidated and given to creditors, and many of your remaining debts are cancelled, giving you what's known as a "fresh start." In 2004, over 1.1 million people filed for Chapter 7, accounting for roughly 72 percent of non-business bankruptcies.
Since many Chapter 7 filers don't have assets that qualify for liquidation, credit card companies and other creditors sometimes get nothing.
In a Chapter 13 bankruptcy, you're put on a repayment plan of up to five years. Any debts not addressed by the repayment plan don't have to be paid. Last year, there were 445,574 Chapter 13 filings.
Under the new law, fewer people will be allowed to file under Chapter 7; more will be forced to file under Chapter 13.
Lawmakers who favor the new law argue that it will prevent consumers from abusing the bankruptcy laws – using them to clear debts that they can afford to pay.
But consumer advocates argue that the new law is a gift to creditors – particularly the credit card industry, which may receive $1 billion or more from repayment plans due to the expected increase in Chapter 13 filings, according to Robert McKinley, CEO of CardWeb.com.
Credit counseling and money management: Under provisions of the new law you must meet with an approved credit counselor in your judicial district for a 90-minute session in the six months prior to applying for bankruptcy.
And before your debts are discharged, you must attend money management classes at your expense.
(See the list of federally approved credit counselors in your area.)
A qualifying test: Under the old law, the judge could determine if your case qualifies for Chapter 7 bankruptcy.
Under the new law, your income will be subject to a two-part means test.
- First, it will be subject to a formula that exempts certain expenses (rent, food, etc.) to determine whether you can afford to pay 25 percent of your "nonpriority unsecured debt" such as your credit card bills.
- Second, your income will be compared to your state's median income.
You won't be allowed to file for Chapter 7 if your income is above your state's median and you can afford to pay 25 percent of your unsecured debt, said California-based bankruptcy attorney Stephen Elias. But, he said, you may be allowed to file for Chapter 13.
If your income is below the state's median but you can pay 25 percent of your unsecured debt, you may be able to file Chapter 7, but the court can still require you to file Chapter 13 instead if it believes that you would be abusing the system by filing for Chapter 7, Elias said.
Under the old law, the court had greater latitude in deciding whether debtors may file for Chapter 7 in consideration of extenuating personal circumstances.
The new law lets debtors try to make the case that theirs are "special circumstances" in which a crisis beyond their control forced the bankruptcy filing. If the court agrees, they are more likely to be allowed to file for Chapter 7, even if they don't technically qualify for it as a result of the means test.
Two weeks ago, the U.S. Trustee, which administers the bankruptcy process and enforces bankruptcy laws under the Department of Justice, said that Katrina survivors filing for bankruptcy will be exempt from the law's credit counseling requirements. And it advised courts to treat Hurricane Katrina as a "special circumstance." That should make it more likely that survivors will be allowed a fresh start under Chapter 7.
(See the hard choices ahead for Gulf homeowners.)
Determining what you can afford to pay: Under the old law, if you filed for Chapter 13, the court determined what you can afford to pay based on what you and the court deem to be reasonable and necessary expenses.
Under the new law, the court will apply living standards derived by the IRS to determine what is reasonable to pay for rent, food and other expenses to figure out how much you have available to pay your debts. The IRS regulations are more stringent, and to contest them means asking for a hearing from a judge, which can mean more time and expense, Elias said.
Tougher homestead exemptions: Under the old law, when you declared bankruptcy, the amount of your home equity that was protected from creditors was determined by the state where you filed. In Florida, for instance, your home would have been entirely exempt, even if you bought it soon before filing.
The new law, however, is more stringent about the homestead exemption. For instance, if filers haven't lived in a state for at least two years, they may only take the state exemption of the state where they lived for the majority of the time for the 180 days before the two-year period. And if their home was acquired less than 40 months before filing or if the filer has violated securities laws or been found guilty of certain criminal conduct, filers may only exempt up to $125,000, regardless of a state's exemption allowance.
Lawyer liability: Under the new law, if information about a client's case is found to be inaccurate, the bankruptcy attorney may be subject to various fees and fines. What that means for consumers is it will be harder to find a bankruptcy attorney willing to file because of the liability and the additional work required to verify a client's information, Elias said.
And attorneys will be charging considerably more. Under the old law, a consumer might have paid between $1,500 and $3,500 to file for bankruptcy, said John Penn, president of the American Bankruptcy Institute
But under the new law, Penn has heard from attorneys that they may increase their fees by between 75 percent and 100 percent.
Filing for bankruptcy should always be a last resort for consumers, since it can damage your credit for many years. To help get a better handle on your debt, see Money Magazine's 9-step program for getting out of debt and our Money 101 lesson on controlling debt. And for help figuring out how long it will take you to pay off your credit card debt, try our debt reduction planner.