• In 2005, a new bankruptcy law (the Bankruptcy Abuse Prevention and Consumer Protection Act, or BAPCPA) took effect and made qualifying for bankruptcy protection slightly more difficult for individuals.
• In the months preceding the changes, record numbers of people filed for bankruptcy, many of whom might have ordinarily waited, but who feared they might not qualify under the new standards.
• Directly after BAPCPA took effect, filings dropped off significantly (because so many people filed right before the new law hit), but in the years after, filings climbed upward steadily.
• Now, as we’re working through the worst economic downturn since the Great Depression, bankruptcy filings are topping the one-million-per-year mark, but are perhaps not nearly as high as they could be.

The point made on Credit Slips is that, while an estimated 1.6 million homeowners are 90 days or more delinquent on their mortgage payments, only about 400,000 Chapter 13 bankruptcy cases will be filed this year. This is surprising in part because Chapter 13 bankruptcy is known for helping homeowners avoid foreclosure because:

• The automatic stay takes effect as soon as a petitioner files her bankruptcy case with the court, may remain effective for the duration of the bankruptcy case (usually three to five years) and can prevent all collection actions from creditors, including foreclosure.
• The debt reorganization and repayment plan that Chapter 13 filers agree to typically includes a reshuffling of some debts and a discharge of others, which often frees up the money necessary for filers to catch up on their mortgage payments.

In other words, bankruptcy protection has the potential to help more struggling homeowners than are currently taking advantage of it.

The Dangers of Not Considering Bankruptcy

While filing for bankruptcy is not the solution in every debt situation (or even in every foreclosure situation), failing to consider bankruptcy early enough in the process of getting out of debt can have a seriously negative impact on your finances. Why?

Because some of your assets are exempt. While laws differ depending on where you live, every state has certain bankruptcy exemptions—property that the bankruptcy court cannot legally collect as payment for your debts. This means that those who might be helped by bankruptcy protection could be depleting resources (including retirement funds) that would have been protected had they filed for bankruptcy.

The question raised by Credit Slips is an important one, and serves to reinforce the importance of considering bankruptcy early enough that it can offer you its full benefits. Not sure about your case? Consider consulting with a bankruptcy lawyer in your area to help walk you through the specifics of your case.

The information included in this post is only general information and is not meant to be construed as legal advice. If you are in debt and facing foreclosure, consider speaking with a local bankruptcy attorney.

According to the St. Louis Post-Dispatch, a Missouri woman recently paid a debt settlement firm an upfront fee of $1,500 to enlist their services. The end result of their efforts was unsettling, though not rare. The woman, a nurse in a St. Louis suburb, says she received nothing in return and is even further behind on her bills.

In her report to the Better Business Bureau, the aggrieved woman said the Consumer Law Group’s only effort to help reduce her debt involved mailing letters to her creditors asking that they stop communicating with her.

Allegedly, the firm failed to provide documentation proving they engaged in any other sort of effort to help reduce her debt. As a result, the woman lost money that could have been funneled to her creditors instead.

Proposed Legislation to Curb Debt Settlement Scams

Stories like this are increasingly common, according to national consumer protection groups who are pushing legislation to regulate these debt settlement services. The proposed action, called Debt Settlement Consumer Protection Act, offers several regulations.

• First, the proposed Act would force debt settlement firms to provide more details about the services they provide.
• In addition, the new legislation would cap these firms’ fees at a reasonable amount and require companies to disclose the purpose of each fee.
• Finally, the proposed Act would give more authority to state and federal officials to crack down on predatory debt reduction services.

Self-Help Tips

Even if the proposed legislation passes, these types of debt reduction services should still be eyed with caution. Here are a few things to watch when considering using a debt settlement firm:

• Empty Promises: Be suspicious of firms that claim debt reduction is an easy, painless process. Attempting to eliminate your debt through a debt settlement service can sometimes take years, and it may have a major impact on your credit score.
• High Upfront Fees: These services often require you to pay large fees at the start. Why pay huge upfront fees to an unregulated firm when you could use that same money?
• Do Your Homework: Before signing up with any debt settlement service, contact the Better Business Bureau to get an independent report on the reliability of that particular firm.

If you are searching for an alternative way to free yourself from debt, filing for personal bankruptcy is a very popular choice. Since bankruptcy law is regulated by the federal government, many consumers feel safer using bankruptcy to alleviate their debts.

Additional Resources

To learn more about the debt settlement industry, check out these remarks from Federal Trade Commission.

But that’s exactly what the case may be, according to experts cited in a recent USA Today article.

BAPCPA, “Deadbeat Debtors” and the Cost of Filing

To understand why people are literally unable to file for bankruptcy protection, a little background about the law is useful:

• Prior to 2005, various corporations (including credit card companies) spent tens of millions of dollars lobbying Congress to overhaul personal bankruptcy legislation to make it harder for Americans to get bankruptcy protection, presumably because these companies lost money each year from filers whose debts were discharged.
• In 2005, the new Bankruptcy Abuse Prevention & Consumer Protection Act took effect. It raised the cost of filing for bankruptcy and tightened the requirements for filers interested in seeking protection under Chapter 7 of the Code, which offers filers a full discharge of many unsecured debts.
• One of the arguments for tightening the laws regulating bankruptcy was that a vast army of “deadbeat debtors” was gaming the system—buying lots of stuff on credit and declaring bankruptcy rather than paying the bills. In fact, the estimated number of fraudulent bankruptcy cases came to only two percent of all filers.
• Now that BAPCPA rules are in effect, people like the ones mentioned in the USA Today article are badly in need of the protection bankruptcy can offer, but unable to file, perhaps because of the costs introduced by the new law.

But there are other reasons Americans are struggling through their debt (whether that means defaulting on their bills or walking away from their homes) rather than turning to the court.

Mortgages & Non-Dischargeable Debts

Two major expenses for many Americans are student loans and mortgages. Here’s how they work in bankruptcy:

• Student loans: Even in Chapter 7 cases, educational debt is non-dischargeable unless a filer can prove undue hardship. But providing that proof means paying for a separate legal hearing, finding witnesses and more. So the hardest-hit student borrowers are not likely to gain any relief by filing for bankruptcy.
• Mortgages: While filing for bankruptcy does temporarily halt all collection action (including foreclosure), bankruptcy courts do not have the ability to modify the terms of mortgages for primary residences. While past-due mortgage debts can be repaid in a Chapter 13 bankruptcy, regular mortgage payments must also be met or the plan will be put at risk. This means that, even after going through a three- to five-year repayment process, some bankruptcy filers might lose their homes anyway.

The problem is real and could mean bad news for the entire nation, as debt-crushed people can hamper our collective move toward recovery.

SNAP, which stands for Supplemental Nutrition Assistance Program, is the new name of what were previously known as “food stamps.” The rebranding is apparently part of the effort to encourage people to use their government-funded buying power, which, like any spending, helps stimulate the economy. The USDA says that every $5 in benefits produces $9.20 in economic activity.

An Admirable Precedent

The Agriculture Department’s move highlights a common problem for those receiving financial assistance. The old mindset that receiving government help is reason to be ashamed is outdated—especially considering the millions of hardworking Americans currently receiving unemployment benefits because of the rough economy.

Filing for personal bankruptcy, like using food stamps, is another area that still suffers from negative press. We often hear of “moral bankruptcy,” and we all know that “Bankrupt” is the worst slot on Wheel of Fortune, even though actual bankruptcy protection in the U.S. boasts the following:

• Some of the most common reasons people file for bankruptcy protection include unexpected illness and medical bills, divorce, job loss and unexpected deaths.
• Those who file under Chapter 13 of the U.S. Bankruptcy Code enter into repayment plans and repay most or all of their secured debts over the course of three to five years.
• Thanks to the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), all bankruptcy filers complete a pre-filing credit counseling course and a pre-discharge debtor education course to make sure they emerge from bankruptcy with the financial skills they need to succeed.
• The government’s offer of bankruptcy protection has often been cited as one reason why America’s entrepreneurial spirit has thrived for more than two centuries.
• Two percent (or fewer) of all people who file for bankruptcy are “scamming the system”—in other words, the vast majority of filers truly need outside financial help.

Bankruptcy, it seems, could benefit from the sort of PR-makeover that the Agriculture Department has recently given to food stamps. After all, nobody seems ashamed to use government-funded road systems, mail services or public schools. Why should financial protection or food funding be any different?

Additional Resources

Bankruptcy Abuse Prevention and Consumer Protection Act

It’s no secret that Americans have a lot of consumer debt – that’s why so many of us are underwater on our mortgages and why record numbers have filed for personal bankruptcy in the last few years. Why? According to this article on consumer debt, these factors play a role:

• We go into debt for the wrong reasons. Taking on debt to buy a car or television is dangerous because these items begin losing value immediately. You have little to no chance of selling in the future them for more than you buy them.
• We’ve accepted the normalcy of debt. Before the Great Recession hit in 2007, our national savings rate was less than zero percent—that means we were collectively spending money we did not have. Nobody thought this was a big deal because so many of us were doing it. But when the economy slowed down, lots of us found ourselves in trouble.
• We don’t realize the cost of debt. Resisting consumer debt often means forgoing pleasure in the present (e.g. not splurging on a fancy dinner or the latest cell phone model we can’t afford) for peace of mind in the future (not having debt limit our lifestyles). If the price tag on items you bought with a credit card included the total of all the interest you’d eventually pay on it, your purchasing decisions might be very different.

Recovering from Debt

So what can you do if you’re currently strapped with more debt than you’d like? Luckily, you have a few options.

• Change your habits: Learning to tame your debt requires a combination of commitment, budgeting, lifestyle changes and a financial game plan. If you’re truly ready to eliminate your financial burdens, though, this method may work for you.
• Negotiate with your creditors: Again, you’ll have to commit to repaying your debts. But once you do, it’s often a good idea to contact all of your creditors and ask for lower interest rates or a reduction in the total dollar amount of your obligation. Many consumers are surprised to learn that creditors are often willing to work with them.
• File for bankruptcy: If your debts are beyond your current ability to repay them, protection from the bankruptcy court may be a good option. Depending on the type of personal bankruptcy you file, you may be able to walk away from your debts, or create a court-protected repayment plan.

Additional Resources

Drowning in Debt

• No emergency fund: In this economy, job security has decreased for many Americans, and even if your job is secure, unexpected injuries, illness, house damages and other expenses could wreak havoc on your finances if you don’t have any money set aside for such events.
• Too much house: This is a lesson far too many Americans learned from the real estate bubble that popped in late 2007. Many people get trapped into buying a house they can just afford, forgetting about related expenses like property taxes, heating and cooling expenses and maintenance. Plus, if something goes wrong (see above), you could face foreclosure.
• No sign of a budget: Underestimating what you spend per month, failing to factor in seasonal expenses and caving in to impulse buys can quickly drain your available funds. And, if you’re not keeping track of money in and out, you’re setting yourself up for surprise budget shortfalls and the costly bank fees and penalties that can accompany them.
• Debt avoidance: While it may not be pleasant to see how much you owe on your credit cards, your debt will not go away if you stop thinking about it. Attacking your debt head-on (either by contacting your creditors to negotiate for lower payments or by setting out a serious payment plan) is the only way to get rid of it.
• Reliance on credit cards: Credit cards may seem like a good solution if you’re strapped for cash, but they can do more damage than anything else in the long run. Remember that credit cards often come with sky-high interest rates and that you’ll be required to pay back every penny you borrow—plus interest.
• Gambling: Thanks to the Internet, you don’t even have to leave your home to lose massive amounts of money with little in return except maybe the thrill of the risk. But gambling isn’t the only costly habit—if you get a rush from spending money at a store, you could be just as likely to overspend and land yourself in debt.

Additional Resources

How to Get Out of Debt (PDF)

Gambling and Debt (PDF)

Bankruptcy attorneys are prohibited from advising potential bankruptcy filers to take on more debt leading up to their case, as it may lead to bankruptcy fraud.

According to the Washington Post, Minnesota bankruptcy law firm argued that this interfered with lawyers’ responsibility to give “unfettered, candid advice.”

In the case, Milavetz, Gallop & Milavetz v. United States, the firm challenged the constitutionality of the provision of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, known as BAPCPA, that prevents debt relief agencies, including bankruptcy lawyers, from giving certain types of advice.

The section of the law states

A debt relief agency shall not… advise an assisted person… to incur more debt in contemplation of such person filing a case under this title.

Trying to discharge debts that have recently been taken on is one sign of bankruptcy abuse, which could case a bankruptcy petition to be dismissed.

However, in the ruling, written by Justice Sonya Sotomayer, the court obliged that some new debts may actually be beneficial before filing bankruptcy, and that it is an attorney’s duty to provide accurate advice.

In a footnote, Sotomayer wrote

Advice to refinance a mortgage or purchase a reliable car prior to filing because doing so will reduce the debtor’s interest rates or improve his ability to repay is not prohibited.

It would make scant sense to prevent attorneys and other debt relief agencies from advising individuals thinking of filing for bankruptcy about options that would be beneficial to both those individuals and their creditors.

The ruling emphasized that, above all, attorneys and debt relief agencies should provide advice that is ethical.

Additional Resources

Full Text of the New Bankruptcy Law