path into bankruptcy is now rougher, the path
out is steeper, and the change could hardly come
at a more difficult time for many U.S. consumers.
overhaul of the bankruptcy code — which
took effect Monday — means that Americans
will face higher fees and higher burdens of proof
before having any debts wiped clean in court.
law aims to encourage more responsible behavior
by a debt-drenched nation, and to rein in abuses
of bankruptcy protection.
motive is laudable, many say. But the new law also creates
additional burdens for many Americans at a time of rising
pocketbook challenges. Energy prices have surged. Interest
rates are rising. Credit-card firms are boosting rates
for high-risk customers while raising minimum payments.
a trend of rising home values, which has helped sustain
consumer spending, may be slowing. "If that goes
... you've got a very combustible situation," says
Brad Stroh, who heads Freedom Financial Network in San
Mateo, Calif. "We think the fourth quarter could
be very, very difficult for the American consumer."
spending now drives more than two-thirds of U.S. economic
activity, and an era of low interest rates has helped
borrowers do much of that spending.
the climate appears to be shifting. Even as the price
of goods accelerates, so is the price of borrowing.
the same time, the hurdles for people who get into financial
trouble just got higher.
making bankruptcy tougher, the new law affects more
than 1 million people annually who typically face a
combination of debt and dire straits, such as illness,
a job loss, or divorce.
some ways it's going to affect everyone who files for
bankruptcy, because the cost is going to go up,"
says Deborah Thorne, an Ohio University sociologist
who has researched bankruptcy.
may charge another $500 or so because of new paperwork
requirements. And the government's fee for a Chapter
7 filing is now $274, up from $209.
the law's main impact is targeted toward those with
reasonably strong incomes. Its core feature is a means
test, designed to steer more of these people toward
Chapter 13 bankruptcy (in which they pay what they can
to creditors over a five-year period) rather than Chapter
7 (which quickly eliminates many debts).
the means test and higher bankruptcy fees, the result
could be to discourage some people from filing for protection
from creditors. The ranks of those "underground"
— struggling to avoid creditors and get by —
could grow. Others would achieve greater financial discipline,
in or out of court.
how the new system compares with the old:
now, the system relied strongly on a judge's discretion.
Petitions for Chapter 7 could be accepted or rejected,
but there was no standard means test.
new system has a multi-step test for entering Chapter
7. First, the filer's family income over the past six
months is considered. If it's below the state median,
Chapter 7 is available. If it's higher than the median,
the court will examine the filer's ability to pay debts.
The judge considers whether, after allowing for living
expenses, the filer can pay at least $100 a month to
creditors — and whether within five years the
total payments can reach either $10,000 or 25 percent
of unsecured debts (such as credit cards).
so, the door to Chapter 7 slams shut. Probably. The
law also provides for extraordinary circumstances to
qualify people for Chapter 7 protection. A severe illness
is one example. Another is hurricane Katrina. Storm
victims are being given some extra leeway.
data suggest that 15 percent of Chapter 7 filers may
be above the median income in the states where they
live, says Nathalie Martin, a scholar at the American
Bankruptcy Institute in Washington. But it may be only
about 5 percent, she reckons, who actually get bumped
out of Chapter 7 by the new law. Still, for those affected,
the shift is significant.
they file under Chapter 13, a judge will determine how
much of their income they can use for living costs —
a budget now based on formulas developed by the Internal
Revenue Service. The rest will go to creditors, generally
for a five-year period. It can be a grueling financial
workout, judging by the two-thirds dropout rate of debtors
who try to navigate Chapter 13.
including the bank-card industry, lobbied for years
to get the new law through Congress. But in the end,
America's bankruptcy woes are partly the making of lenders
themselves, some observers say. Lenders aggressively
market everything from credit cards to interest-only
home loans, and bankruptcy rates have risen in proportion
with consumer debt.
filings were up, but nowhere near as much as credit-card
profits," Brad Botis, an Alabama bankruptcy attorney,
said Friday as he raced to help people rushing to file
before the law took effect.
legal change comes alongside voluntary steps by the
industry to crack down on delinquent payers. In the
past year, it has become common for consumers to see
interest rates rise on all of their cards if they miss
a payment on one, for example.
change, forced on consumers by the federal government,
will test borrowers' wherewithal starting this winter.
New rules require sizable minimum-payment hikes, to
make sure each monthly payment covers at least 1 percent
of the balance on a card.
end goal is a good one" — to help people
avoid years of debt buildup, says Stroh, whose firm
tries to help people avoid bankruptcy. "The unfortunate
consequence is that some people living month to month
are suddenly in serious trouble."
here to go to Freedom Debt Relief's website