|President Bush talks about what the new bankruptcy law will require.|
NEW YORK (CNN/Money) – President Bush on Wednesday signed into law a bankruptcy reform bill that will make it harder for individuals to clear their debts through bankruptcy.
So, experts say, if you were thinking about filing for bankruptcy, you might think twice -- or act twice as quickly, since major provisions of the law will go into effect six months from the day the law is signed.
Individuals filing for bankruptcy usually do so either under Chapter 7 or under 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 legislation 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.
"The bill simply doesn't balance responsibility between families in debt trouble and the creditors whose practices have contributed to the rise in bankruptcies," said Travis Plunkett of the Consumer Federation of America in a written statement.
Here are some of the major changes for consumers under the new law:
A qualifying test: Currently, it's up to the court to 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 would 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, who is coauthor of the book "How to File for Chapter 7 Bankruptcy." 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 current law, the court has great latitude in deciding whether debtors may file for bankruptcy in consideration of their personal circumstances. Under the new law, there will be few if any exceptions made to the means test, no matter how sympathetic your case, said Leon Bayer, a bankruptcy attorney in Los Angeles.
Determining what you can afford to pay: Currently, if you file for Chapter 13 today, the court determines 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: Currently, if you declare bankruptcy, the state where you file may allow you to protect from creditors some or all of your home equity. In Florida, for instance, your home may be entirely exempt, even if you bought it soon before filing. In Nevada, you may exempt up to $200,000.
The new law, however, places more stringent restrictions on 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.
Filers may only exempt up to $125,000, regardless of a state's exemption allowance, 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.
Unlike most of the other provisions, the new homestead exemption rules go into effect immediately.
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.
Those who are willing are likely to charge more.
Credit counseling and money management: Under provisions of the new law you must meet with a credit counselor in the six months prior to applying for bankruptcy. And before debts are discharged, you must attend money management classes at your expense.
What should you do?
For those people who have considered bankruptcy, the time to act may be now, consumer advocates say.
Talk to a good bankruptcy lawyer, Plunkett said. If together you decide bankruptcy is the right call, you might consider speeding up your plans to file since most of the main provisions of the new law won't go into effect until six months from now.
Typically, it can take a couple of weeks to file for bankruptcy, said Bayer.
See Money magazine's 9-step program for tackling your debt problem.
Money 101: Controlling debt
Debt reduction planner