It isn't much of a surprise that when the economy suffers a downturn, the number of people filing bankruptcy increases. Since 2005, there have been several changes to U.S. bankruptcy laws that may make it harder to file than it used to be. As changes are implemented, it is important to know what your options are if you are considering filing.

Changes to the Laws in 2005
In 2005, the new bankruptcy laws made changes to filing Chapter 7 (liquidation) and Chapter 13 (repayment). These changes made it harder for higher income filers to file for Chapter 7. The filer's income now had to be measured vs. the median income for others in the filer's state in order to qualify. Those who hoped to file for bankruptcy also had to pass the "means test", which examined disposable income. This is the income that is left after paying required debt. Credit counseling also became a requirement. Those considering bankruptcy would need to attend counseling sessions with an approved agency from the United States Trustee's office.

Chapter 7 is about liquidating rather than repayment. It used to be that filers could choose whether they wanted Chapter 7 or 13. Now, if their income is high, they may not have a choice and will have to file Chapter 13. In order to file Chapter 7, a filer would have to prove (through the above-mentioned means) that he or she falls below a certain low sum of money. For Chapter 7, assets are sold and the proceeds go to the filer's creditors. (To learn more, read What Are The Differences Between Chapter 7 And Chapter 11 Bankruptcies?)

Chapter 13 is about repayment. All income goes into paying off debt. If available income is greater than that of the median in the filer's home state, the filer's allowable expenses will be determined by the IRS. This amount must come out of the filer's income during the six-month period before filing.

Once a person has filed for bankruptcy, only debt that was applied for will be forgiven. Remember that bankruptcy does not eliminate student loans or taxes due. And a bankruptcy is not an easy way to get rid of debt - it will stay on a credit report for 10 years and make borrowing very difficult (if not impossible) during this period.

Many question if they will be able to buy a home after a bankruptcy. They will be eligible for a mortgage two years after the bankruptcy has been discharged. They will probably find that once they are able to establish credit again, the rate they will be paying may be higher than they would have paid had they not filed for bankruptcy. This is because they are now a higher risk to the lender. (To avoid the perils of bankruptcy, see 9 Ways To Go Bankrupt.)

Obama and the Bankruptcy Act of 2009
The Bankruptcy Act of 2009 was designed to make changes to the original Act of 2005. Because it became more difficult to file under the 2005 act, this new act was designed to make it easier. In August of 2009, John Rao (attorney for the National Consumer Law Center) testified before the United States Senate, questioning the role of the bankruptcy courts. Rao noted that there have been efforts to help borrowers with loan modification through the Home Affordable Modification Program (HAMP) announced in the spring of 2009 by the Obama administration. However, not all who have requested loan modification have been successful in obtaining it. That is where loosening bankruptcy restrictions could help.

A new term you may be hearing throughout all of this is "cram down." Part of filing Chapter 13 is that you can lower the amount you owe, or "cram down" debt. The bill proposed by Obama was referred to as the "cram down" bill. This bill was designed to help reduce interest rates and mortgage balances. It could have increased the number of Chapter 13 filings. However, the senate shot down this legislation. It needed 60 votes to have it pass and only received 45.

There may be many questions someone still has after filing bankruptcy. If you owned a home before filing Chapter 7, your home may be exempt, which means you will get to keep it. If you filed Chapter 13, you also get to keep your assets because you have paid off your debt. Although the bankruptcy will stay on your credit report for 10 years, you can still begin to re-establish credit in the meantime.

Often, people are concerned about who will find out about their bankruptcy. Your employer and your landlord will not be notified. You can technically file for bankruptcy every eight years under Chapter 7. Under Chapter 13, you can file as many times as is necessary as long as you have paid at least 70% of your unsecured debt under your last Chapter 13 filing. (For more, check out Bankruptcy Protection For Your Accounts.)

As noted previously, taxes are not wiped out from filing bankruptcy. However, under Chapter 13, you will not have to pay interest or penalties. Under Chapter 7 some taxes may be discharged. A good bankruptcy attorney could help you distinguish between those that may qualify and those that do not.

The following are some of the common myths involved in bankruptcy:

  • You will lose everything you own.
    Each state has different laws, but certain assets are protected such as your home, car (depending on value), retirement money and certain clothing and personal items.
  • You will never get credit again.
    Although getting a home or a car may be difficult for a while, there will be lenders who will offer you credit (usually at a higher rate than before your bankruptcy).
  • You will get rid of back taxes.
    Usually you cannot get rid of taxes. However, you might want to check out something called tax bankruptcy if you have taxes that are more than three years overdue.
  • You can use bankruptcy as an excuse to max out your credit cards.
    It is considered fraud to do this before you file.

The Bottom Line
Even though it has become harder to file bankruptcy since the 2005 act, when the economy is down more people continue to file. Bills such as the "cram down" bill have been shot down by the Senate. However, creditors are actually being hurt by the 2005 act, due to record default rates. (For more, see What You Need To Know About Bankruptcy.)

Related Articles
  1. Savings

    Your 6 Worst Financial Mistakes

    Here are six financial mistakes you may be making, and a viable alternative for each.
  2. Investing Basics

    The Biggest IPO Flops

    Even with the uncertainties of IPOs, companies will keep issuing them in efforts to grow their enterprises, and some will end in disaster.
  3. Savings

    What is a Bounced Check?

    Bounced check is a slang term to describe a check that cannot be processed because its writer has insufficient funds.
  4. Credit & Loans

    Explaining Leveraged Loans

    Leveraged loans are loans extended to companies or people who already have large amounts of debt.
  5. Economics

    Understanding Default Risk

    Default risk is the chance that companies or individuals will be unable to pay their debts.
  6. Investing

    Why Is Financial Literacy and Education so Important?

    Financial literacy is the confluence of financial, credit and debt knowledge that is necessary to make the financial decisions that are integral to our everyday lives.
  7. Professionals

    How to Protect Your Portfolio from a Market Crash

    Although market crashes are usually bad news for your portfolio, there are several ways to minimize losses or even profit outright from market movement.
  8. Credit & Loans

    5 Credit Cards For the Super Rich

    Understand the difference between an average credit card and an elite credit card for the wealthy. Learn about the top five credit cards for the super rich.
  9. Budgeting

    Key Questions to Ask Before Moving in Together

    Moving in together is a big step. Here are some key financial questions to ask your partner before you make the move.
  10. Investing Basics

    What Does Plain Vanilla Mean?

    Plain vanilla is a term used in investing to describe the most basic types of financial instruments.
  1. How do hedge funds use equity options?

    With the growth in the size and number of hedge funds over the past decade, the interest in how these funds go about generating ... Read Full Answer >>
  2. What are the risks of annuities in a recession?

    Annuities come in several forms, the two most common being fixed annuities and variable annuities. During a recession, variable ... Read Full Answer >>
  3. Can mutual funds invest in options and futures?

    Mutual funds invest in not only stocks and fixed-income securities but also options and futures. There exists a separate ... Read Full Answer >>
  4. Will my credit score suffer from debt consolidation or refinancing?

    You have several options for reducing your debt burden. You can enroll in a professional debt management plan, or consider ... Read Full Answer >>
  5. Can I file for bankruptcy more than once?

    Filing bankruptcy is never a simple decision, but sometimes it is the best thing you can do in your current financial situation. ... Read Full Answer >>
  6. Does consumer protection cover my debts?

    The most impactful consumer protection laws and regulations in the United States are overseen by the Federal Trade Commission ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Purchasing Power

    The value of a currency expressed in terms of the amount of goods or services that one unit of money can buy. Purchasing ...
  2. Real Estate Investment Trust - REIT

    A REIT is a type of security that invests in real estate through property or mortgages and often trades on major exchanges ...
  3. Section 1231 Property

    A tax term relating to depreciable business property that has been held for over a year. Section 1231 property includes buildings, ...
  4. Term Deposit

    A deposit held at a financial institution that has a fixed term, and guarantees return of principal.
  5. Zero-Sum Game

    A situation in which one person’s gain is equivalent to another’s loss, so that the net change in wealth or benefit is zero. ...
  6. Capitalization Rate

    The rate of return on a real estate investment property based on the income that the property is expected to generate.
Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!