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New law to tighten bankruptcy process

Updated: May 3, 2013 12:14PM

Originally published: September 5, 2005

In 1894, more than 100 years ago, Congress recognized Labor Day as an official national holiday in tribute to the working class. Ironically, this year Labor Day also marks the start of a six-week period that will lead up to the deadline for a new, more stringent bankruptcy law that will take effect on Oct. 17.

That law will make it more difficult to qualify for Chapter 7 bankruptcy, which essentially wipes out all debt, except for back taxes, student loans and alimony. In the future, you’ll have to prove that your income cannot support at least partial repayment of your debt, even after bankruptcy.

First, take a few minutes on this Labor Day holiday to make sure you don’t slide into the sea of debt that ends in bankruptcy. There’s no question now that higher oil prices are going to impact your family budget.

Credit-card-industry surveys report more people switching from debit to credit-card usage at the gas station. But postponing the inevitable will be costly. Instead of paying more than $3 a gallon for gasoline, those who make minimum monthly payments could find today’s fill-up costing $6 a gallon or more as it is paid off over months or years.

Higher heating bills coming

The next round of increased costs will come in the form of electric, heating-oil and natural-gas bills this winter. So it’s wise to plan ahead and cut back on non-essential spending now, so you’ll have the money to pay your utility bills this winter.

Yes, if we all cut back -- as many already have, judging from the latest retail sales figures -- the economy will slow down. But consumers have carried the responsibility for economic growth far too long, financing their purchases through home-equity loans and credit-card debt.

It’s like a giant game of musical chairs. One day the music will stop. And you don’t want to find yourself sitting on a pile of credit-card debt.

Here’s a recap of the features of the new bankruptcy law.

Starting Oct. 17, bankruptcy courts will more closely scrutinize a debtor’s ability to repay at least a portion of the debt owed.

There will now be a “means test” to determine whether the filer can avoid payment of all debt.

If the debtor’s income -- net of approved expenses -- is less than $100 a month (or $6,000 over the next five years), then Chapter 7 can still wipe the slate clean. But with income above that level, debtors probably will be required to file a Chapter 13 partial repayment plan -- especially if their income is sufficient to pay at least 25 percent of outstanding debts.

The new law requires attorneys to be responsible for determining which of their clients qualify for Chapter 7 or 13. That means attorneys will spend more time on the bankruptcy process -- and charge higher fees!

Each debtor will be required to provide a certificate of credit counseling and a repayment plan from an approved agency within 180 days of filing. Proof of completion of a financial management course is required for discharge of a bankruptcy petition.

The new Bankruptcy Act also makes clear which assets are exempt from a bankruptcy and which debts survive a bankruptcy. For example, Individual Retirement Accounts and company 40l(k) or 403(b) plans are now clearly defined as protected assets.

Similarly, college education savings plans such as 529 plans, education IRAs and prepaid tuition plans are exempt if the money was placed in the account(s) at least two years before the filing.

Some states exempt homes from bankruptcy, but under the new law, you must have lived in a state for two years to use that state’s generous laws to protect the value of your residence. And regardless of state, you can exempt only $125,000 of value in a home that was acquired within 1,215 days before the filing.

Repaying recent purchases

There are new laws against “shop and drop.” Any luxury goods or services totaling more than $500 to a single creditor made within 60 days of filing must be paid for in full. Cash advances made within 70 days of filing are considered non-dischargeable.

Before heading straight to an attorney, you might want to contact Consumer Credit Counseling Services at (800) 388-2227. That number will connect you to the nearest local affiliated office.

Since credit counseling is required under the new law, it makes sense to get the counseling before you make your decision to file. That’s the Savage Truth.

Terry Savage is a registered investment adviser and the author of the newly published The Savage Number: How Much Money Do You Need to Retire? (256 pages, Wiley, $24.95).

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