Tuesday, November 13, 2007

Bankruptcy: A New World

By the National Endowment for Financial Education

Your employer downsizes and your job is gone. Your health deteriorates and you run up big medical bills. Your breadwinner spouse dies or divorces you. Your retirement nest egg disappears when the stock market drops.

For some people, these kinds of events can lead to financial disaster and, in the worst cases, possible bankruptcy. Those who seek bankruptcy generally are not spendthrifts who purchase fancy cars or cruise the Caribbean. They're not deadbeats who run up big bills, and then duck creditors. You might say they've had plain bad luck.

"For most of my clients, it's something that has happened to them," says Nancy L. Thompson, a lawyer specializing in bankruptcy in Des Moines, Iowa. "It's not something they could have avoided or something they did wrong."

And bankruptcy's not an easy choice, particularly for older people, many of whom consider being unable to pay their bills embarrassing.

"Older folks feel almost a moral guilt about bankruptcy," says Jose Vasquez, staff attorney for Colorado Legal Services, formerly Legal Aid Society of Metro Denver. "They look at it as a last resort. They see it as something they have to do, but they feel badly."

Both Vasquez and Thompson also cite deceptive or aggressive consumer practices as prime reasons older people end up in financial trouble. Among the culprits: home-improvement scams, predatory mortgage lending, and aggressive solicitation of credit cards. "I've seen them offered cards with limits way, way beyond what they're capable of paying," Vasquez says.

How Many Older People File for Bankruptcy?

The number of older people turning to bankruptcy remains small but is growing, according to the Consumer Bankruptcy Project at Harvard University. The project's 2001 analysis showed that a little more than 82,000 Americans 65 years or older filed for bankruptcy that year—up 244 percent in a decade. Despite that increase, older persons are still a small portion of the overall cases.

Total filings have jumped in 2005 as word has spread that new, stricter laws are to take effect in October 2005. "We were flooded with requests for bankruptcy," says Vasquez. "People's perception was they have to file soon because the laws are changing."

New Law Reforms Bankruptcy

The new Bankruptcy Abuse Prevention and Consumer Protection Act—supported by credit card companies, banks, and other lenders—makes it more difficult to discharge debts, requires credit counseling and education for persons filing for bankruptcy, and raises the cost and complexity of a bankruptcy case. Most parts of the law will go into effect October 17, 2005, although homestead exemptions are in effect now.

The new laws maintain Chapter 7 and Chapter 13 bankruptcy filings.

Chapter 7, under which most individual debtors now file, allows a debtor to keep certain exempt property (defined differently among the states). Other property—when there is any—is sold and proceeds are divided among creditors. Most remaining debts are erased, giving the person a fresh start.

Chapter 13 allows a debtor to keep non-exempt property-such as a home-while following a plan to pay back creditors over three to five years.

But big changes were made to bankruptcy as well:

  • Means Test. There's a new "means test" that is designed to steer more debtors to Chapter 13's repayment system rather than Chapter 7's erasure of debts. If the debtor's income is below her/his state's median income, s/he can file under Chapter 7. If her/his income is over the state median, a complex formula weighing income, expenses, and unsecured debt, comes into play to decide which chapter is appropriate.
  • Debt Repayment. If the debtor files for Chapter 13, stricter IRS guidelines will be used to determine what s/he can afford to pay.
  • Higher Costs. Chapter 7 filing fees increase under the new laws, and attorneys predict legal fees will rise as well because the new laws require more work.
  • Creditor Actions. Creditors who won't receive any money owed in a bankruptcy case may now contest the ruling for Chapter 13 filings as well as Chapter 7 filings.
  • Waiting Period. The period a person must wait to file another bankruptcy case increases from six to eight years.
  • Homestead Exemptions. These exemptions allow the debtor to keep some of the equity in her/his home safe from creditors. The amount varies from state to state. As of April, 2005, the homestead exemption is stricter.
  • Retirement Accounts. Retirement accounts, such as Individual Retirement Accounts (IRAs) and 401(k) accounts, are protected for up to one million dollars in retirement savings per person.
  • Financial Counseling. The law also requires the debtor to take an approved financial counseling course outlining alternatives to bankruptcy within six months of filing. At the end of the bankruptcy, he must also take an approved financial management course to learn the personal financial skills needed to avoid future financial problems.

Thompson doesn't expect the new means test to affect very low-income older people because their low income will still allow them to erase their debts under Chapter 7, in part because the means test does not count Social Security payments as income. Middle-income people will see the biggest change from the new means test. "Before, bankruptcy has always been an option for persons who cannot dig out of their financial hole to start over," she says, "but now it's going to be more difficult."

Regardless of income or age, the new law's higher legal and filing costs will be burdens, she believes, because those filing for bankruptcy are strapped for money to begin with.

The paperwork and documentation needed to file for bankruptcy also can be challenging for older people, Vasquez notes. Often, the personal property they have is old and its worth is impossible to prove through receipts or records. They may not have cars or they may have physical disabilities, both of which make getting appraisals difficult.

If you are in a financial situation in which you are wondering if bankruptcy is your only way out, talk with a lawyer who is aware of the new legal requirements. If you've just had a personal crisis that has changed your financial situation dramatically, assess what next steps are best for you. If you are living paycheck to paycheck just to keep up with creditors, look for ways in which you can get off the debt treadmill—getting credit cards and debt paid off not only saves money in fees and interest costs, it also creates a safety net should an unexpected event occur. While no one can fully prepare for the most catastrophic of life events, everyone can try to prepare for a more secure financial future.

New Bankruptcy Rules Temporarily Waived for Katrina Victims

Some of the new bankruptcy rules will be waived for people affected by Hurricane Katrina. The waiver applies to people who lived in any areas on August 29, 2005 that were declared by the President as part of the disaster. People seeking to file for bankruptcy do not need to be living in this area now or at the time they file for bankruptcy. Anyone who files for bankruptcy under the waiver must have been adversely affected by the Hurricane.

Specifically, the exceptions to the new bankruptcy act for Katrina victims are:

  • Means test. For Katrina victims, bankruptcy trustees will look at a person losing income, such as from their job, and how much their expenses have gone up. These are considered special circumstances and can mean a consumer may not have to meet the means test requirement.
  • Documents required. Katrina victims will not have to provide the amount of supporting paperwork that the new Act requires. This is because consumers may no longer have these documents or be able to get copies.
  • Location. Many people have been relocated or chosen to move out of the Hurricane Katrina area. Because of this, consumers will not, in most cases, have to return home to file for bankruptcy.
  • Credit requirements. The new law requires consumers to attend a meeting of creditors. However, Katrina victims will be treated with flexibility for this requirement. Bankruptcy trustees are allowed to waive the counseling requirement in a judicial district where consumers may not be able to receive credit counseling. This applies to consumers hit hardest by Katrina, including the eastern, middle, and western districts of Louisiana, and the southern district of Mississippi.

In addition, the new bankruptcy act states that people filing for bankruptcy must receive credit counseling within six months before filing. The waiver, however, lets consumers file without receiving counseling. They simply need to file their paperwork.

This column is meant to provide general financial information; it is not meant to substitute for, or to supersede, professional or legal advice.

Note: The content areas in this material are believed to be current as of this printing, but, over time, legislative and regulatory changes, as well as new developments, may date this material.

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