Financial Limits on New Bankruptcy Laws

• The new bankruptcy laws place financial limits on bankruptcy debtors.money image by cherie from Fotolia.com
  
  According to the Journal of Economic Perspectives, "By providing consumers with an easy escape route from debt, U.S. bankruptcy law encouraged consumers to borrow and encouraged debtors to behave strategically and to file for bankruptcy even if they could afford to repay." New Bankruptcy laws mean that consumers with a high level of assets could gain from filing for Chapter 7 bankruptcy by converting their non-exempt assets to exempt assets prior to filing. Consumers could also move to a state with a high homestead exemption and use their non-exempt assets to buy a new house. The new laws have placed limits on who will be able to file for Chapter 7 and receive a quick discharge of debts.
  
  

Prior to the Act

• Before the new bankruptcy laws were enacted, a debtor had the choice of filing for either Chapter 7 or Chapter 13 bankruptcy. Under Chapter 7, debtors kept exempt property, but property not listed as exempt could be sold to pay off the debtor's creditors. State and federal laws provide lists of exempt property. Debtors need this property to live life as usual, such as a house, a car, home furnishings, insurance policies and wedding rings.
  
  Before new laws were passed, debtors would often choose to file for Chapter 7 over Chapter 13. In a Chapter 7 bankruptcy case, debtors do not have to pay most of their debts before being a granted a discharge. In a Chapter 13 case, however, debtors spend three to five years repaying their debts. The Bankruptcy Abuse Prevention and Consumer Protection Act, however, introduced in 2005, has made it more difficult for debtors to discharge their debts.
  
  

Chapter 7

• Because Chapter 7 is the most popular chapter of bankruptcy, most debtors want to file for Chapter 7. Under Chapter 7 debtors keep exempt property, which will allow them to live normal lives, and their non-exempt property can be sold. It only takes a few months for a debtor to receive a complete discharge of debts. Unlike in the past, a debtor cannot choose to file for Chapter 7 anymore. The debtor must qualify for Chapter 7 by taking a means test.
  
  

Means Test

• The means test is the most controversial part of the new law. The means test compares the debtor's income to the median family income in the debtor's state of residence to make a determination as to whether the debtor should be able to file for Chapter 7. If the debtor's income is below the state median income, the debtor can file for Chapter 7 bankruptcy. If not, the debtor must continue with the means test. The next part of the means test will determine the amount of disposable income a debtor has left over per month.
  
  If the debtor is left with $100 or more of disposable income per month, and that $100 would be enough to pay over 25 percent of the debtor's debts over five years, the debtor must convert to Chapter 13 if he wants to file for bankruptcy. A Chapter 13 debtor must use 100 percent of his disposable income to repay his creditors in a three-to-five-year repayment plan. The debtor will only receive a discharge when he completes the repayment plan.