Understanding the New Bankruptcy Laws

For most people, filing for bankruptcy is a last resort, but the new bankruptcy law that went into effect earlier this year makes that step a lot harder.

The new bankruptcy law was intended to cut down on the abuse of the system by those who had the means to pay but simply used bankruptcy as an easy way out of excessive debt. However, the tightening of the bankruptcy laws is likely to have a significant impact on many people who had no intention of abusing the system. It is important, therefore, for every consumer to understand how these new bankruptcy laws may affect their personal financial lives.

When individuals file for bankruptcy, they usually do so under either Chapter 7 or Chapter 13. In a Chapter 7 bankruptcy filing, the assets (not including those exempted by each state) are liquidated and used to pay off creditors, and the remaining debts are cancelled, providing filers with a fresh start. In a Chapter 7 bankruptcy, many creditors are left with nothing.

With a Chapter 13 bankruptcy filing, the debtor is put on a payment plan lasting up to five years. Any debts that are not repaid at the end of the plan do not have to be repaid. The new law makes it much harder for individuals to file under Chapter 7, forcing more people to file under the more restrictive rules of Chapter 13.

Some of the key changes introduced by the new bankruptcy law include:

The qualifying test – Under the new law, the individual’s income is subject to a two part means test. The first part of the means test involves a formula which exempts expenses such as food, rent, etc. to determine if the individual can pay 25% of so-called nonpriority unsecured debt (like credit cards). The second part of the means test involves comparing the debtor’s income to the median income for the state.

Individuals will not be permitted to file for Chapter 7 bankruptcy if their income is above the median for the state and they can afford to pay 25% of the unsecured debt owed. Those individuals may be able to file Chapter 13 bankruptcy instead.

Those with income levels below the median for the state who can pay 25% of their debt may be able to file Chapter 7 bankruptcy, but they may still be forced to file Chapter 13 by the court.

More stringent homestead exemptions – The new law also includes more rigorous homestead exemptions. Filers who have lived in a state with a generous homestead exemption for less than two years will not be able to take advantage of that state’s exemption. They will instead be forced to take the homestead exemption of the state where they spent the majority of the last 180 days.

In addition, bankruptcy filers can only exempt up to $125,000, no matter what the state’s exemption allowance, if the home was bought less than 40 months prior to the bankruptcy filing, or if the filer has been found guilty of certain crimes or violated securities laws.

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