Ara Betty is a freelance financial writer and speaker about personal financing. She helps people realize their goals on becoming debt free with the use of debt consolidation. She hopes to expand her knowledge more about loans and debt to be able to write a book.
Bankruptcy laws by definition are a series of federal laws enacted to allow people to be relieved from their debts and start over with a clean slate. The laws have changed in 2005, known as 2005 bankruptcy law revision, making it more complicated to get a fresh start, so it is important to know bankruptcy definition, what is chapter 7 bankruptcy, as well as the laws under which it exists.
What is the 2005 bankruptcy law
This refers to legislation enacted by President George W. Bush in 2005 that revised the bankruptcy code for cases filed on or after October 17, 2005. The act created a means test that determines whether individuals filing bankruptcy can file for Chapter 7 bankruptcy, which discharges many debts in full), or whether they must opt for Chapter 13 bankruptcy ( which requires at least partial repayment of debts). Furthermore, the act increased the waiting period from when an individual last filed Chapter 7 bankruptcy to when they may file again.
What’s its purpose
Essentially, the purpose of the act was to make it more difficult to qualify for Chapter 7 bankruptcy by closely examining the filer’s ability to repay their debts more closely. The means test compares the debtor’s monthly income to the median income in his or her state of residence and provides an allowance for assumed monthly expenses at rates determined by the IRS as well as an allowance for actual monthly expenses. If the individual exceeds the median income and has too much money left over after accounting for living expenses, he or she will usually not qualify for Chapter 7 bankruptcy.
The means test
The bankruptcy “means test” determines whether your income is low enough for you to file for Chapter 7 bankruptcy. It’s a formula designed to keep filers with higher incomes from filing for Chapter 7 bankruptcy. High income filers who fail the means test may use Chapter 13 bankruptcy to repay a portion of their debts, but may not use Chapter 7 bankruptcy to wipe out their debts altogether.
However, having to take the Chapter 7 means test doesn’t mean that you must be completely penniless in order to use Chapter 7 bankruptcy. You can earn significant monthly income and still qualify for Chapter 7 bankruptcy if you have a lot of expenses such as high mortgage and car loan payments, taxes and other expenses.
How does the means test work?
The means test was designed to limit the use of Chapter 7 bankruptcy to those who truly can’t pay their debts. It does this by deducting specific monthly expenses from your “current monthly income” (your average income over the six calendar months before you file for bankruptcy) to arrive at your monthly “disposable income.” The higher your disposable income, the less likely you’ll be allowed to use Chapter 7 bankruptcy.
Only bankruptcy filers with primarily consumer debts, not business debts, need to take the means test. To take the means test, you must first determine whether your income is more or less than the median income in your state. If you earn more than the median, you must figure out whether you would have enough left over after subtracting certain expenses to repay some of your debt.
Is your income more than the median?
The first step is simple. If your current monthly income is less than the median income for a household of your size in your state, you passed the means test. There’s no need for you to complete the rest of the means test. You can file for Chapter 7.
Do you have enough disposable income to repay some of your debts?
For those whose household income exceeds the state median, the means test computations get significantly more complex. You must determine whether you have enough income left (disposable income) after paying your “allowed” monthly expenses to pay off at least some of your unsecured debts (such as credit card bills). If your disposable income adds up to more than a certain amount, you fail the means test and cannot file for Chapter 7 bankruptcy.
Median income levels vary by state and household size, and each county and metropolitan region has different allowed amounts for categories of expenses: basic necessities, housing, and transportation.
What happens if you pass the means test?
Just because you qualify under the means test does not necessarily mean you should file for Chapter 7 bankruptcy. It only means that you can if you want to. Any decision to file for Chapter 7 bankruptcy should be made only after considering alternatives and other factors.
If you don’t pass the means test, you are limited to using Chapter 13 bankruptcy which requires you to make monthly payments over a three- to five-year period according to a strict budget monitored by the US bankruptcy court. Most people who file for bankruptcy prefer Chapter 7 which requires no repayment. However, Chapter 13 bankruptcy is still the best way to handle specific types of problems like curing a default on a mortgage.
Credit counseling and money management
Under provisions of the 2005 bankruptcy law, you must meet with an approved credit counselor in your judicial district for a 90-minute session in the six months prior to applying for bankruptcy. Before your debts are discharged, you must attend money management classes at your own expense.
Applicability of exemptions
Under the old law, when you declared bankruptcy, the amount of your home equity that was protected from creditors was determined by the state where you filed. In Florida, for instance, your home would have been entirely exempt even if you bought it soon before filing.
The new act of 2005, however, is more stringent about the homestead exemption. For instance, if filers haven’t lived in a state for at least two years, they may only take the state exemption of the state where they lived for the majority of the time for the 180 days before the two-year period. And if their home was acquired less than 40 months before filing or if the filer has violated securities laws or been found guilty of certain criminal conduct, filers may only exempt up to $125,000, regardless of a state’s exemption allowance.
The Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) of 2005 limited the types and quantities of exempt household goods on which debtors could avoid certain liens. Part of the motivation for these changes was a perception that debtors were using their household goods as collateral to obtain loans that they never intended to repay. The Executive Office for U.S. bankruptcy trustees asked the corporations to analyze the similarities and differences in the amounts and types of loans secured by debtors’ household goods reported in bankruptcy cases filed before and after BAPCPA. They found no changes in debtor or creditor behavior due to the new definition of household goods. Some participants interviewed noted that it may be too early to tell whether debtors are changing their practices related to this issue.
Under the 2005 act, if information about a client’s case is found to be inaccurate, the bankruptcy attorney may be subject to various fees and fines. What that means for consumers is that it will be harder to find a bankruptcy lawyer willing to file because of the liability and the additional work required to verify a client’s information. Attorneys will be charging considerably more. Under the old law, a consumer might have paid between $1,500 and $3,500 to file for bankruptcy, but under the 2005 bankruptcy law, attorneys have increased their fees by between 75%and 100%.