A:

Credit card companies and banks hate deadbeats who take from their bottom lines. They especially dislike the Chapter 7 bankruptcy that discharges a debtor and, if he or she has no saleable assets, eliminates their chances of reclaiming even a portion of the debt. Consequently, heavy lobbying by lenders resulted in the passage of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. This law is less a "Consumer Protection Act" and much more of an insurance policy for lenders.

Two-thirds or more of all personal bankruptcies leading up to 2005 were filed as Chapter 7, but under the act, qualifying for a "fresh start" via Chapter 7 bankruptcy has been made much more difficult. Now, debtors are required to file under the less attractive Chapter 13, which amounts to a court-ordered repayment plan. The scales used to separate debtors into Chapter 7 or Chapter 13 bankruptcies have been tipped by the introduction of means tests.

In the first means test, a debtor's finances are measured to determine whether or not he or she can repay 25% of outstanding unsecured debt. The formula exempts set amounts of basic expenses and considers the remainder in its entirety. Standard of living expenses are determined by an IRS evaluation and not by the debtor's standards. A debtor who passes the first means test without being led to Chapter 13 will be subjected to a second metric of median income. If the debtor's income exceeds the state median, he or she will have to file Chapter 13, which means lenders can recuperate at least some of the debt.

Exemptions also have been tightened to the point where a debtor could reasonably file for bankruptcy and still lose his or her house in the ensuing case. In addition, filing for bankruptcy has incurred another downside in the form of higher lawyer fees resulting from the increased paperwork involved in processing bankruptcy filings. In fact, bankruptcy law is on the verge of becoming a specialized field and the skyrocketing fees reflect that.

At best, a debtor loses in a bankruptcy filing because his or her credit rating is crushed. Now that new bankruptcy laws have tilted the scales in favor of lenders, it is more important than ever for individuals to monitor personal finances carefully and to control debt.

(For more on bankruptcy, read Changing the Face of Bankruptcy and What You Need to Know About Bankruptcy.)

This question was answered by Andrew Beattie.

RELATED FAQS
  1. Do shareholders lose all their equity once Chapter 11 bankruptcy is filed?

    Learn what happens to an investor's equity when a company files for Chapter 11 bankruptcy. Find out what happens if a company ... Read Answer >>
  2. How will bankruptcy affect my ability to get credit in the future?

    Learn how filing bankruptcy affects your ability to obtain credit in the future, and find out how long a bankruptcy stays ... Read Answer >>
  3. What happens to the shares of a company that has been liquidated?

    Learn what happens to a company's shares during Chapter 11 and Chapter 7 bankruptcy proceedings, and understand how much ... Read Answer >>
Related Articles
  1. Taxes

    Changing The Face Of Bankruptcy

    A 2005 law attempts to unmask fraudulent debtors and still save those who are struggling. Will it affect you?
  2. Taxes

    5 Myths About Personal Bankruptcy

    There are some persistent myths that hover over the process of bankruptcy that are either half-truths or completely false.
  3. Taxes

    Bankruptcy Filing Changes That Could Affect You

    When the economy is down, more people file for bankruptcy. Make sure you know about the changes that have been made to this process.
  4. Taxes

    How To Survive Bankruptcy

    Bankruptcy is not the end of the world. You can survive it and come out on the other side more financially solid.
  5. Personal Finance

    What You Need To Know About Bankruptcy

    Don't choose this last-resort option until you learn how it will affect your future.
  6. Taxes

    How to Hire a Bankruptcy Lawyer

    How do you find the right bankruptcy lawyer? What you should look for to determine the right attorney for you.
  7. Small Business

    How Investors Can Profit From Bankrupt Companies

    Learn how a bankrupt company can provide great opportunities for savvy investors to find the best undervalued investment opportunities to profit from.
  8. Personal Finance

    Life After Bankruptcy

    Find out what you have to look forward to after filing for Chapter 7 or 13.
  9. Insurance

    Personal Bankruptcies Cut Almost in Half After Obamacare

    Access to health insurance many have saved many Americans from going broke.
  10. Managing Wealth

    Benefit Issues When Your Employer Goes Bankrupt

    A company's bankruptcy can mean significant changes for your insurance coverage and benefits, learn how bankruptcy can affect you and how to stay safe.
RELATED TERMS
  1. Bankruptcy

    Bankruptcy is the legal proceeding involving a person or business ...
  2. Chapter 7

    Chapter 7, known as straight or liquidation bankruptcy, of Title ...
  3. Wage Earner Plan (Chapter 13 Bankruptcy)

    A wage earner plan (Chapter 13 Bankruptcy) enables individuals ...
  4. IRS Publication 908

    IRS Publication 908 explains the basic federal income tax aspects ...
  5. Automatic Stay

    An automatic stay is a legal provision that temporarily prevents ...
  6. Debtor in Possession (DIP)

    A debtor in possession (DIP) is a person or corporation that ...
Trading Center