Bankruptcy Reform And You

Ray Martin: Bill Aims To Make Debtors Pay Something

(CBS)  Last week, the Senate passed a bankruptcy reform bill. The House is expected to quickly follow suit, and President Bush is expected to sign it into law.

The Early Show financial adviser Ray Martin explains how the changes will affect the average consumer.

According to the American Bankruptcy Institute, about 1.6 million individuals filed for bankruptcy during the year that ended in June 2004. While that was about the same number as in the previous year, it has grown over 150 percent since 1989. Recent studies indicate that a major contributing factor is the growing number of uninsured individuals and families who are faced with large medical expenses.

Bankruptcy Reform Looming

Over the past several years, Congress, with heavy support from the banking and credit card industry, has considered legislation that would make it harder for consumers to file for Chapter 7 bankruptcy, a form of bankruptcy where debtors get to walk away from debts and creditors get little, if any, repayments. Until recently, such legislation stalled each time it was introduced.

It seems that is about to change. Last week, the Senate passed the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. If the bill passes the House, the president will surely sign it, and later this year, it would become law.

At the heart of the proposed law are changes that make it more difficult for consumers to file for Chapter 7 bankruptcy. If the changes are enacted, individuals would be required to seek budget and credit counseling during the six months before filing for bankruptcy. Also, the changes would make it difficult for individuals to file for Chapter 7 bankruptcy if their household income is greater than the median household income in their state, and they can only keep assets allowed under their state's laws if they have lived there at least two years.

Since over 70 percent of bankruptcy filings are Chapter 7, the expectation is that more people facing this financial option of last resort would have to opt for Chapter 13 bankruptcy, where individuals and creditors agree to a court-imposed plan that requires some or all debts to be repaid over three to five years, with a trustee assigned to oversee the repayment process.

Critics of the measure say it needlessly increases costs, and creates obstacles for hard-working families who play by the rules and get hit with large, uninsured medical costs. Others say this bill does little to close loopholes for wealthier people who can still exclude from their income their payments for luxury cars and expensive homes. Others contest that special considerations should be given to workers who lose their jobs and retirement assets due to the bankruptcy of their employer.

While it's no surprise that the bill's supporters are banks and credit card companies, there is also a surprising number of Democrats who joined the Republican ranks to support the change. They say reform is needed to make it tougher for more individuals to walk away completely, if they can pay off at least part of their debts.

Financial Fallout And A Rush To File

It’s very likely that the average person doesn't believe he or she will ever file for bankruptcy, and probably will not care about these changes. But lawyers and consumer credit counseling companies who specialize in helping people facing extreme financial difficulty may see a rush of new business.

Some lawyers say they plan to inform their clients of the possible changes and encourage them to tell people they know who may be in financial difficulty to step up and file now, before the proposals become law. Credit counseling companies could see an up-tick in the number of people using their services, since the changes require debtors to use credit counseling services before they can file.

No matter what, getting unbiased advice on whether you should file for bankruptcy remains tricky. Many credit counseling companies get paid in part by credit card companies, based on the amount of debt they can get you to repay. On the other hand, seeking advice from an attorney who earns fees from getting you through the process also presents conflicts. While both can be good sources of education, individuals should make their own decisions and get an opinion from another financial professional who has no financial stake in the decision.

Bankruptcy Consequences

Under the reform bill, bankruptcy filings would continue to be reported on an individual’s credit report for seven years in the case of Chapter 13, and up to ten years for Chapter 7. Having "bankruptcy" show up on your credit report can make buying a car or house, renting an apartment, or even getting a job in some sectors, very difficult. When you do finally get a loan, the rate charged will be "subprime" -- industry jargon for higher than what's typically charged.

But surprisingly, getting a credit card wouldn't be impossible. Credit card issuers know that individuals aren't permitted to file for bankruptcy for six years from the date of their last filing. This, combined with the likelihood that the survivor of a recent bankruptcy has had plenty of remedial financial counseling, is experienced with debt, and is eager to begin rebuilding his or her credit, makes them potentially responsible customers.

Bankruptcy Survival And Beyond

Most importantly, individuals who file for bankruptcy should keep in mind that, while there is nothing they can do about their credit history, they are in the driver’s seat when it comes to their credit future.

Here are some of the steps that should be followed:

• Obtain and review a copy of your credit report every year. Get copies of your report from all three credit reporting bureaus.
  
  Experian – [phone]
  Equifax – [phone]
  Trans Union – [phone]
  
  
• Review all information on the credit reports, and correct any discrepancies.
  
  
• Submit an explanatory statement of up to 30 words to the credit bureaus. Include your reasons for financial difficulty, why it is now behind you, and what you have done to avoid financial problems in the future. This will appear on your report until you request that it be removed.
  
  
• Establish a new source of credit by getting approved for a credit card. As perverse as this may sound, you’ll need to demonstrate that you are creditworthy and can responsibly use credit. Ideally, a card from a national bankcard company is best, but any credit card, even a secured card, will do.
  
  
• Only use the credit card to charge items you already have the cash to pay for in full. Pay off all charges in full before any interest accrues. This process will ensure that timely payments are added to that account's history on your report.

Expect that it will take one to two years to become creditworthy for loans at good interest rates again.

The bottom line is that financial difficulties usually don’t happen overnight, and the process of repairing and rebuilding your creditworthiness will also take some time.