Freedom Financial Network

Bankruptcy can be a stressful ordeal for couples and families. Marie Jones, mother of one from San Diego, Calif., remembers that while facing bankruptcy can be daunting, educating yourself on the subject can help lesson the anxiety.

"I felt scared and anxious at first, until I researched into it and found out how many people have to take this route," Jones says. "And once we started the process and I met other people filing, I realized that it was nothing at all to be afraid of or ashamed of."

Jones felt that most of the people she met in court had simply fallen on hard times and weren't abusing the system at all. That is one of the reasons why she is so wary of the new bankruptcy laws. "I do know that they are not on the side of consumers and working people, and that they will make it terribly hard for people who have fallen on hard times to get their lives back in order," says Jones. "People do not realize that bankruptcy can save lives, and that some people with nowhere else to turn may not be able to survive these new laws."

Andrew Housser, co-CEO of Freedom Financial Network in San Mateo, Calif., is concerned as well. He says he has never seen such a confluence of consumer pressures as he has this quarter. "Bankruptcy reform comes at a time when many families are already struggling," says Housser. "It spells trouble."

The new bankruptcy law that went into effect October 17, 2005, primarily affects Chapter 7 bankruptcy filings, which typically wipe out all unsecured debt.
The crux of the new law is a "means test" that determines eligibility for Chapter 7 protection. Those whom the law deems to have enough income (as defined by each state's median income) to repay at least a portion of their debt will be unable to obtain Chapter 7 protection.
Chapter 13 filings – which require consumers to repay debt on a repayment plan – are still available.

Housser believes these new laws come at a particularly difficult time for consumers for many reasons. The first is the rapidly increasing cost of living. "The squeeze is on consumers nationwide right now with soaring energy costs, increasing health costs and rising interest rates," he says. "For families who may have been feeling pinched before, this quarter makes it that much harder."

Another reason may be the slowing in home equity appreciation. Housser says until recently rising home prices have fueled consumer spending. As long as interest rates were low, consumers could refinance and use surplus cash they took out of their equity to pay down debt. But now that home values are rising more slowly and the Federal Reserve has been raising short-term interest rates, this is getting harder to do.

Another factor to this puzzle is credit card companies increasing their minimum payments. "In 2003, the Office of the Comptroller of the Currency – the agency that regulates national banks – issued guidelines urging banks to increase the minimum payments they require of credit card holders," says Housser. "While it was not a regulation, merely advice meant to encourage consumers to pay their debts in timely fashion, almost all banks are making the change. Those that haven't already done so will at the beginning of next quarter."

Sandy Shore, senior credit counselor and Certified Financial Planner for Novadebt, a nonprofit consumer credit counseling agency with offices throughout the United States, says one of the major benefits to the new legislation is that consumers will be required to get some kind of credit counseling. "Under the new law, all consumers will get pre-bankruptcy counseling," says Shore. "The counseling will give them their options and the consequences. They will also need to complete a Financial Management Education Course prior to the discharge. It will also be harder to file a Chapter 7 bankruptcy. Filers whose income is above the state median will have to file a Chapter 13 and will have to pay back a percentage of the debt."

According to Shore, people will now be required to take a means test that will look at your expenses and income to decide how much you will have to pay back. Expenses the filer thinks are necessary may not be allowed by the court. You will not be able to file if you owe taxes, delinquent student loans or child support. There are residency requirements to qualify for high home equity exemptions that are available in some states. This will usually only affect very wealthy people, who move to take advantage of these exemptions.

What does this means for families? Shore says there is both a negative side and a positive side.

It will be harder and more expensive to file for bankruptcy. There is a cost for the pre-bankruptcy counseling and the Financial Management Education Course. Chapter 13, which more consumers will have to file, is more expensive than Chapter 7. More filers (Chapter 13 only) will have to sell assets, including their homes, to complete the bankruptcy.

Parents who are not meeting their support obligations will be forced to pay their child support before they can file. Some consumers will find other options through the pre-bankruptcy counseling and may not have to file. The education course will show consumers how to handle their finances properly and avoid problems after the bankruptcy. The restrictions on the amount of equity a filer can keep will make it fairer. Previously, if you lived in a state that had a high or unlimited exemption, you got to keep all the equity regardless of how much you owed while in other states you could keep much less. Knowing that discharging your debt through bankruptcy is going to be harder and more expensive may encourage consumers to seek help earlier, before bankruptcy becomes the only option.

"I speak to consumers every day who have made poor choices about filing bankruptcy and some who end up filing multiple times," says Shore. "If this law helps consumers make better choices and avoid future problems, I am all for it."

Shore offers the following steps that families can take to avoid going through the hassle and stress of bankruptcy.

Know where your money is going. If you don't, track your expenses. Use that information to create a budget. Get the whole family involved in financial decisions. It is much easier to control spending if everyone understands why decisions are made.
Have an emergency fund. Although the statistics show the majority of bankruptcy filers file because of a catastrophic event like an illness or loss of work, Shore says from her experience with clients, the underlying cause is usually they had no savings for an unplanned event. Most consumers are intimidated by advice to have three to six month's salary for emergencies. That may seem impossible, but don't let that stop you from saving. Some is better than none. Save automatically. Have the money debited from your account or directly from your pay.
Get some financial education. Knowing your rights and obligations will help you avoid getting into financial trouble.
Consider carefully before you borrow. Look at what you will have left when you finish paying for the item. If the answer is nothing, you should not be borrowing. If you carry a balance on a credit card it takes years, possibly longer than your lifetime, to pay off this type of borrowing. Do you really want to finance dinner or a pair of shoes for years? If you are financing anything other than a house, improvements that will increase the value of an asset or education you should think twice. If you think carrying a balance on a credit card is not borrowing, you need help.
Help is available. There are credit counseling agencies, including Novadebt, who can help you if you are experiencing difficulties, need more financial education or just don't know how to get started. Don't wait too long to get help. The earlier you get help the less painful the solution will be.