Is Bankruptcy Right for You? A Summary of the New Bankruptcy Laws

The American financial system was designed to encourage risk-taking. While other countries imprisoned debtors or consigned them to lives of indentured servitude, America's Founding Fathers thought it better to allow people deeply in debt a "fresh start" by declaring bankruptcy. Bankruptcy has never been without its consequences - it is an ugly stain on your credit report, and it makes it very difficult to get credit until it is removed seven or 10 years later - but the system was designed so that debtors and creditors shared the blame equally. The Founders believed that banks and other lenders should be cautious when making loans, and if they made "bad loans," the banks - not just the borrowers - were responsible for the consequences. Unfortunately, the Founders could have never envisioned the monstrosity that is the credit card industry and its vast lobbying efforts in Washington. As a result of their political influence, banks and credit card companies turned traditional bankruptcy on its head with the passage of new bankruptcy laws in 2005. This article summarizes what you need to know.

Your Legal Right to Bankruptcy Has Been Abolished

For the first 200+ years of our country, bankruptcy was a legal right, and as such, you got to choose which form of bankruptcy you filed. Now that right has been taken away, and courts decide whether you can file Chapter 7 or Chapter 13 - only rarely do you get to make the choice. First off, people with household incomes that are greater than the median for their state are not allowed to file Chapter 7. This means that they cannot discharge their debts and start over clean - they have to work out a plan to pay back their creditors. When most people think of "bankruptcy" they think of Chapter 7, not 13, so in a sense, the right to file bankruptcy has been eliminated for half of Americans. However, in the past, some people with below average incomes opted to file Chapter 13 in order to deal with their bankruptcy in a quicker, more proactive manner. After all, Chapter 7 bankruptcies stay on your credit for 10 years, whereas a Chapter 13 filing lasts for either three or five years and only stays on your credit report for seven. With the new bankruptcy law, most people with household incomes lower than the state median who want to file Chapter 13 will not be allowed to. In essence, the law has created a class system of economic segregation.

Bankruptcy With Dignity - A Thing of the Past

As if people forced into bankruptcy don't feel bad enough, the new law seeks to make them feel even worse. No longer are bankruptcy filers presumed to be honest people who got in over their heads - now they're thought of as likely criminals who are trying to cheat the system, or at best, financial children who need to be taught how to balance their checkbooks. In fact, you now have to enroll in credit counseling before filing either a Chapter 7 or Chapter 13 bankruptcy, and sign-up for a demeaning "budget management" class after your bankruptcy is processed. Worst of all is the way that the new bankruptcy law turns the traditional lawyer-client relationship on its head. Previously, as with all other matters of the law, your bankruptcy lawyer was your advocate. But with the new bankruptcy law, lawyers are personally responsible for any incorrect information in your filing, which changes their role from ally to interrogator. Now, even your own lawyer will find you guilty until proven innocent, and all of the extra work that he or she has to do verifying your claims takes time and money, which means that lawyers have to charge their bankruptcy clients higher fees.

Is Bankruptcy Right for You?

Even before the passage of the new laws, the answer was only rarely "yes." Normally, it is much better to work out deals with your creditors without going to court, although a lawyer pleading your case is almost always helpful. The point is that the old form of bankruptcy carried with it enough consequences - the social stigma, the scarred credit, the inability to get a loan or possibly even a job - that it was almost never a good idea, but with the new laws, bankruptcy is even less attractive. The best thing to do is educate yourself about the nature of your debts and contact a credit counselor or debt consolidation company to develop a new financial plan. The very threat of bankruptcy is usually enough to get creditors to work with you. Unfortunately, with the new laws, that threat may ring hollow if your income is higher than your state's median average.

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