New rules meant to make it tougher for individuals to erase debt by filing for bankruptcy go into effect today and experts say consumers may be in for a shock if they run into financial hard times.
The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 is being billed as the first major overhaul of bankruptcy laws in nearly 30 years.
Race Against the Clock
The rules require that individuals consult with a credit counselor and also pass a means test before they are allowed to file for Chapter 7 bankruptcy, which can eliminate many debts and has been used as a way of creating a clean slate after a waiting period.
The means test examines a consumer’s income levels as well as the type of debt they face and is meant to exclude individuals who ran themselves into debt through discretionary purchases from seeking shelter in bankruptcy. Most filers with above-average income will not be allowed to use Chapter 7 bankruptcy to eliminate debt but instead create five-year re-payment plans.
Many jurisdictions nationwide saw a surge in the number of last-minute filings leading up to today’s deadline, with filings rising 10-fold in some locations.
Though they support directing debt-strapped consumers to counselors for advice, many consumer advocates have been critical of the changes, saying the changes fail to take into account whether credit card companies or others issued credit to consumers knowing they were bad risks. Some groups also worry that more aggressive collections activity will result.
Implications for Business
According to Nick Iezza, an attorney with Spiwak & Iezza, a top Southern California collection law firm, the changes will make it “substantially harder” for people to receive full bankruptcy protection from creditors.
The new law also has two implications for businesses: For those thinking about trying to file bankruptcy to buy time to reorganize, the new laws create shorter and more stringent deadlines for emerging from bankruptcy with a plan to repay debts.
And for those who are owed money by consumers, the changes will allow for more aggressive pursuit of collections, said Iezza.
Some credit card companies, who widely supported the changes and in some cases lobbied on their behalf, already saw a negative impact from the law before it took effect. Citigroup reported a decrease in its net margins as a result of more bankruptcy filings, the company said.
But the main thrust of the changes are aimed at consumers who use bankruptcy as a way of eliminating debt and starting fresh.
Hungry for More
Some economists warn that the U.S. consumers’ appetite for credit poses grave long-term risks, especially when interest rates are starting to rise, making it more expensive to attain credit from a variety of sources, from home equity loans and auto loans to credit cards.
Credit industry data estimates that Americans are carrying some US$800 billion worth of credit card debt, or more than $7,200 for each household in the country. Another $1.3 trillion is owned in car loans, personal loans and retailer-arranged financing for major purchases such as appliances and computers.
Kelly Rote, communications manager for Money Management International, a credit counseling company, said the best outcome of the change may be more awareness of alternatives to bankruptcy and increased awareness among consumers of the risks associated with credit.
“This bill ensures that consumers will be given tools to help avoid future financial trouble,” Rote said.