What Bankruptcy Reform Means to You

by Michelle M. Haas-Dosher

One bad apple spoils the bunch. And that's what happens when a few consumers abuse bankruptcy.

Most people never will file bankruptcy, so why should you care?

Bankruptcy abuse has a cost for consumers who do not file for bankruptcy as well as for those who do. This cost comes in higher loan rates, lower savings yields, or higher fees to make up the losses from abuse. It's estimated that bankruptcy has been costing your family as much as $550 a year.

While most people filing for bankruptcy have no alternative due to events beyond their control, 10% to 13% of filers, according to the Credit Union National Association--the bad apples--have been taking advantage of the system. They rack up debts and then file bankruptcy to avoid paying them, even when they could afford to pay.

Credit unions wanted to help stop the abuse and protect all consumers, so they worked for passage of a new law aimed to stop bankruptcy abuse. The Bankruptcy Abuse and Prevention and Consumer Protection Act of 2005 passed in April, becoming effective mid-October, 2005.

Credit union leaders recognize that bankruptcy may be the only way for some consumers to get a "fresh start," but also believe that consumers who can repay their debts, should.

Among many changes in the law, credit unions most strongly supported three key elements:

• Protecting the ability of credit union members to voluntarily reaffirm debts with their credit unions,
  If you're struggling to manage your finances, call or visit your credit union for help.
• A meaningful "means test," and
• Mandatory financial education provisions.

Three key elements

1. Reaffirmation: Voluntarily reaffirming debt is a promise to repay the debt vs. discharging it in bankruptcy. Credit unions have a long history of working with members who file bankruptcy. Members often have the opportunity to work with a financial counselor to develop a plan to help them return to sound financial standing. Also, by reaffirming with their credit union, members preserve access to low-cost financial services and avoid paying interest rates of 25% or more from other lenders.

2. Means test: Bankruptcy reform establishes an income-based "means test" to see if a debtor qualifies to have some or all debts wiped away. The test determines if a debtor can file for Chapter 7 bankruptcy, which erases almost all unsecured debt, or Chapter 13 bankruptcy, in which the debtor repays some or all debt under a repayment plan that lasts from three to five years. Or, the court could order a debtor to pay bills as promised.

   Under the means test, if you have more than $100 a month left after paying approved expenses (no cell phones, restaurant meals, or movies), you will have to file Chapter 13 bankruptcy vs. Chapter 7 bankruptcy. The means test uses Internal Revenue Service living expense standards to determine which bankruptcy filing a debtor is allowed.

   Ten percent to 13% of bankruptcy filers have been taking advantage of the system.

   The majority of people who seek bankruptcy--because of job loss, medical problems, divorce, and other personal problems--will be unaffected by this provision. Less than 10% of the people who file for bankruptcy will have trouble meeting the "means test." But because more than one million people file for bankruptcy each year, a large number of people may have the means to repay at least some of their unsecured debts in Chapter 13.

   And even if the test shows that bankruptcy relief under Chapter 7 is not necessary, the person filing may be able to show why special circumstances justify a higher expense allowance. That would enable the consumer to file Chapter 7.

3. Financial counseling and education: The new law recognizes that people need information and assistance to understand what bankruptcy means and how to avoid financial problems.

   It requires that someone thinking about bankruptcy get information about credit counseling and help to analyze a budget. This way, consumers learn how declaring bankruptcy hurts their long-term financial health--and they gain a better handle on wise use of credit.

   Less than 10% of the people who file for bankruptcy will have trouble meeting the "means test."

   The new law encourages each state to develop personal finance curricula for elementary and high schools, so tomorrow's consumers have a better understanding of financial realities and can avoid getting into trouble in the first place.

   Bankruptcy reform also requires debtors to complete courses in personal financial management before their debts are discharged in bankruptcy. It lets debtors explore options other than automatically filing for bankruptcy.

Credit unions always have recognized the value of financial counseling for members. A recent Credit Union National Association survey found that 70% of credit unions counsel financially troubled members at the credit union. A similar percentage of credit unions also refer some members to outside financial counseling organizations such as the Consumer Credit Counseling Service.

Credit troubles don't have to lead to bankruptcy in most cases. If you develop credit problems or are struggling to manage your finances, call or visit your credit union for help. Or contact the National Foundation for Credit Counseling (NFCC), Silver Spring, Md., at 800-388-2227.

Published October 3, 2005

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