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Bankruptcy - An Updated Fact Sheet

Remar Sutton, DCU StreetWise National Spokesperson

Consumer debt, not including mortgages, in the U.S. has climbed to over $2 trillion and continues rising. Part of this surge represents growing credit card debt. Meanwhile, the Federal Reserve's campaign to keep inflation in check has forced interest rates higher. Rising interest rates in turn make credit card debt more expensive to pay off. To add pressure, the housing boom also appears to be cooling and in some areas growth in housing values has not just slowed, but declined. Higher interest rates and lower housing values make home equity loans harder to get and less attractive. In real life, all these economic “trends” mean that many consumers are getting deeper in debt and may be finding it harder to make ends meet. Some of these consumers may be considering bankruptcy.

But most consumer credit experts counsel using bankruptcy as a last resort, not a “quick fix.” Why? Filing bankruptcy affects your credit and financial affairs, not to mention other aspects of life, for many years.

In addition, the Congress recently enacted new bankruptcy laws that tightened restrictions on filing for bankruptcy. Their goal in part was to ensure that consumers pay back more debt, rather than having that debt discharged through bankruptcy.

So, if you're struggling to manage debt and thinking about bankruptcy as an option, it's very important that you educate yourself fully before making a move. This fact sheet provides some basic information and links to more extensive information. It also provides a link to more information about the excellent credit and debt management services that DCU provides for members.

What is personal bankruptcy?

Bankruptcy is a legal procedure, filed in federal bankruptcy court, that provides certain specific relief or protection from repaying debts and from harassment by creditors for individuals who are unable to repay debts.

What types of bankruptcy exist?

There are two forms of personal bankruptcy: Chapter 7 and Chapter 13. Both forms provide certain property exemptions for the debtor, allow the discharge of certain debts without repayment, and provide at least some partial repayment of debt to the individual's creditors. Within these parameters, there are significant differences.

Have changes been made to the Bankruptcy law?

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 made major changes to federal Bankruptcy law. It went into effect in October 2005.

What are the major changes?

Credit counseling is required before filing. Pre-bankruptcy credit counseling must be obtained within 180 days prior to filing bankruptcy. The counseling must be provided by an agency certified by the U.S. Trustee. The certificate of credit counseling must be provided as part of the bankruptcy documentation.
Means test. The means test determines if a bankruptcy filer is eligible to file under Chapter 7 or if they must file under Chapter 13. The filer's income is compared to the median income of the state where the filer lives. (The median income is available on the U.S. Trustee web site.) If the filer's income exceeds the state median and the means test also determines that the filer can pay at least $6000 over 5 years toward their debts, then they must file under Chapter 13.
Mandatory post-bankruptcy money management training. This training must also be provided by an agency certified by the U.S. Trustee and must be completed before the bankruptcy case can be discharged.
Residency requirements. If a filer has lived in their current state for less than 2 years, then the bankruptcy provisions of the previous state of residence are applied. (This is to prevent debtors from moving to a state with more favorable bankruptcy laws and then immediately filing bankruptcy.)

What are the differences between Chapter 7 and Chapter 13 bankruptcy?

The basic difference is that in Chapter 7 most of one's debts are discharged after one's nonexempt property is sold to pay creditors. Chapter 13 is a repayment plan, that the debtor develops under court supervision and that allows the debtor to repay the debts over a 3 to 5 year period while keeping certain property that might be lost under chapter 7. Both plans stop such activities as foreclosures, collection agency activities, and garnishment of wages. Here's a quick summary of these and other differences.

Chapter 7

Is often called “straight bankruptcy” or “liquidation.”
Non-exempt property is sold by court-appointed trustee to pay creditors in part or turned over to creditors. Non-exempt property, which varies by state, may include part of equity in a home, real estate, or certain investments.
Exempt property varies from state to state but usually includes car, clothes, work-related tools, household furnishings, certain personal effects.
Creditors who hold property such as a residence or car as collateral keep their right to that property.
Debts are usually discharged in four to six months.
Chapter 7 may be filed only once every eight years.
Bankruptcy filing remains on the debtor's credit report for 10 years.

Chapter 13

Is a repayment or “reorganization” plan for debtors who have a secure future income to use to repay debts over a 3 to 5 year period. The plan is supervised by the court.
The debtor gets to keep most property that would be non-exempt under chapter 7, including mortgaged house or car, investments, etc.
The plan may involve discharging portions of certain unsecured debts such as credit card debt.
Debts are discharged when the repayment plan is completed — usually in three to five years.
Chapter 13 may be filed only once every two to four years (depends on type of previous bankruptcy).
Bankruptcy filing remains on the debtors credit report for 7 years.

Does bankruptcy allow discharge of all debts?

No. The debts that can not be cancelled by bankruptcy include (but aren't limited to) child support, alimony, taxes, student loans, and certain fines and penalties such as traffic tickets, court-ordered repayments, income tax penalties, and recent property tax assessments.

What does discharge debts mean?

Discharging debt means that a debtor has been released from personal liability for specific debts and that the creditors can no longer force the debtor to pay the debt but the creditors still have the right to reclaim any property in which they have a security interest.

What affect does filing bankruptcy have on your credit?

Although filing bankruptcy can relieve the immediate burden of debt, during the period it remains on your credit rating securing a mortgage for a home, a car loan or other loan, a credit card or life insurance may be virtually impossible. If you do manage to get credit, it will probably be at high interest rates and penalty fees.

Where can I get help when financial crisis looms and before considering bankruptcy.

Start with your credit union. DCU provides its members a Financial Wellness Program that can help you consider your options and that provides access to the Balance credit counseling service.

Where can I find more information about bankruptcy?

Bankruptcy: Your right to a financial fresh start from Consumer Action

Ads Promising Debt Relief May Be Offering Bankruptcy from the FTC

Knee-Deep in Debt from the FTC

Before You File for Personal Bankruptcy: Information About Credit Counseling and Debtor Education from the FTC

Bankruptcy Basics from the U.S. Courts (The Federal Judiciary)

So, what do you think?

If you find this review helpful, please pass the word to your friends. Also email me with any comments or suggestions.

Remar Sutton

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