In the midst of the financial crisis, more and more Americans are filing for bankruptcy. And experts say the numbers are likely to get worse.
The Bankruptcy Abuse Prevention and Consumer Protection Act, which took effect three years ago this month, increased restrictions for Chapter 7 bankruptcy filings by applying a "means test" which would disqualify many consumers with higher incomes from discharging their debts.
Its supporters claimed the new rules would reign in abuses of bankruptcy laws, decongest the courts and educate consumers on money management. But after a steep dropoff immediately after the law took effect, bankruptcy filings are now on the rise again.
"The 2005 amendment was designed to make it more complex, more expensive and more difficult," said Professor Jack Williams, the American Banking Institute's resident scholar. But, "the people who thought they could reduce the number of filings have failed."
And the bill had other unintended results. Satisfying the means test became a difficult process, plus filers were also required to seek mandatory credit counseling and provide proof. All the additional paperwork further complicated the filing process, causing bankruptcy attorneys to raise their rates significantly.
"Bankruptcy became potentially more complex," said Stephen Elias, a bankruptcy attorney and author of "How To File For Chapter 7 Bankruptcy." "And with more paperwork and due diligence required, lawyers doubled their fees.
Personal bankruptcies filed in the federal courts totaled 934,009 from June 2007 to June 2008, up more than 28 percent from the 727,167 petitions filed in the same period a year earlier, according to the latest figures from the Administrative Office of the U.S. Courts.
The reasons for the sharp uptick? Rising consumer debt coupled with the mortgage meltdown left many consumers saddled with too much debt, Williams explained, and an increasing number turned to bankruptcy protection.
And with rising interest rates and a slowing economy, the number of filings will likely get even worse. "I expect bankruptcies in 2008 to exceed 1.2 million filings," Williams said. Next year, bankruptcy filings could increase by another 15% to 20%, he said, as personal income is outpaced by inflation.
New laws, same old problemsIn the weeks before the law went into effect, many cash-strapped consumers rushed to file, causing a record number of bankruptcies in 2005. But just after the law passed, the number of filings dropped off dramatically.
That's because, under the new law, it became harder for individuals to file for bankruptcy under Chapter 7, which would let them discharge their debts and get what's known as a "fresh start."
In a Chapter 7 bankruptcy, your assets, minus those exempted by your state, are liquidated and given to creditors, and many of your remaining debts are cancelled. Since many Chapter 7 filers don't have assets that qualify for liquidation, credit card companies and other creditors can get nothing.
The Bankruptcy Act aimed to push more debtors toward Chapter 13 filings, which require them to repay at least some of their debts within five years. This law was a boon for the credit card industry, which could recoup more losses from defaulting credit card customers under Chapter 13 filings.
But only those debtors with income above their state's median, who could also afford to pay 25 percent of their unsecured debt, were forced to file Chapter 13, Elias said. And few people actually fell into that category.
Chapter 7 filings still far outnumber Chapter 13. Chapter 7 filings totaled 615,748 through June, up nearly 37 percent from the year before. Meanwhile, Chapter 13 filings totaled 344,421, up 17 percent from the year-earlier period.
Experts agree that Chapter 7 is often the best option for consumers saddled with insurmountable debt. "The whole value of doing a personal bankruptcy is to discharge the debt," said Eric Tyson, author of "Personal Finance for Dummies." "The bottom line is that if you file for bankruptcy, your credit is trashed, it doesn't make any sense to do that if you're not going to get the relief."
The only benefit to filing Chapter 13, according to Williams, is the opportunity to hold onto your home. That's if your mortgage company is willing to work with you on a repayment plan.
For those considering it, experts warn that filing for bankruptcy should always be a last resort, since it can damage your credit for many years. And before seeking advice, be wary of any potential conflicts of interest from credit counseling agencies or bankruptcy lawyers that could potentially profit from your position, Tyson said. "I encourage people to get educated before they seek counseling or get an attorney."
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