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| The Basics | Bankruptcies surge as tough law looms
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There's an Oct. 17 deadline looming: Changes in bankruptcy law will make erasing debts more difficult. But many who rush to file may find their troubles are worse later on.
By Liz Pulliam Weston
And the rush is on.
Bankruptcy filings are rising in advance of a new federal law that will make erasing debts more difficult and complicated for some filers starting Oct. 17. Research firm Lundquist Consulting said filings at the end of September had hit 13,000 a day, up 24% over the week before and twice the rate of a year earlier.
Year-to-date filings of 1.36 million are up 14% from last year.
Two powerful hurricanes, Katrina and Rita, deal a knockout punch to the U.S. Gulf Coast in August and September. By the beginning of October, 363,000 people had filed unemployment claims in the affected area and bankruptcy filings had climbed 16%. (Hurricane victims have gotten a break under the new law, but not the one you'd expect: It allows them to skip the newly required step of mandatory credit counseling.)
Many expect the frenzy to peak in the final days before the deadline, a Monday, as debt-plagued, procrastinating consumers try to beat the clock.
"There's going to be a mini-tidal wave at the very end," said Sam Gerdano, executive director of the American Bankruptcy Institute, a nonpartisan research group. "Lawyers are going to be submitting mass filings over that weekend."
The irony is that many of these filers may be panicking unnecessarily, and some -- far from getting a fresh start -- actually could be doing themselves harm.
Few likely to flunk means test
The new law purports to make bankruptcy harder by funneling more filers into Chapter 13, which requires them to repay some of their debts, instead of Chapter 7, which allows many kinds of debts to simply be erased. Under the new law, higher-income filers will be subject to a "means test" to determine how much they're required to repay -- regardless of what their expenses actually are or how tough it might be to make the required payments.
But only consumers whose incomes are above the median levels for their states have to worry about this possibility. (You can get a rough idea of what those medians are from this Census Bureau table.)
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The vast majority of consumer bankruptcy filers earn well below those medians and will be allowed to continue filing Chapter 7. Another group of higher-income filers will be subjected to the means test but will be determined not to have sufficient available income to pay off their debts.
"I think our original number of 2% to 3% (of total Chapter 7 filers who will be forced to file Chapter 13) is actually going to be high," Gerdano said. "Ultimately the story at the end of the year will be the dog that didn't bark as far as the means test is concerned."
A family facing the deadline
Some potential filers do need to be worried about the possibility, of course. Rick and Cori McCain of Castle Rock, Colo., support themselves and four teen-agers on a combined income of $90,000, but Cori McCain says it's not enough to pay the more than $65,000 they owe in medical bills, credit card debt and back taxes.
Still, their income is well above Colorado's $62,000 median for a family of six. If they file after Oct. 17, they could be shunted to a repayment plan rather than liquidation.
The McCains have been trying to avoid bankruptcy, but their credit card issuers raised their interest rates as the McCains maxed out their plastic. The couple now struggles to pay the minimums they owe.
"We tried to deal with some of the medical bills by putting them on the credit cards," Cori McCain said. As the balances grew, "our great rate of 5.9% went up to 24.9%. We make payments and (the balances) just keep getting bigger."
Like many bankruptcy filers, the situation has gotten so bad that the McCains are trying to figure out how to find the money needed to file their case.
"We are just squeezed so tightly that coming up with the $1,500 to file bankruptcy is in and of itself a problem," Cori McCain said.
Speeding ultimate financial recovery
There are many others, of course, for whom filing now could be advantageous. If you're struggling with unpayable bills, getting relief sooner rather than later could speed your ultimate financial recovery. Bankrupts who address and fix their financial problems can often restore their credit ratings to near-prime levels in just a few years, as I wrote in "Bounce back fast after bankruptcy."
But filing precipitously could leave other filers worse off. Among the reasons you might want to think especially hard about filing:
- Your most troublesome debt can't be discharged. Secured loans, like mortgages and car loans, generally can't be erased in bankruptcy court. Neither can student loans or recent taxes. You might want to go ahead if getting rid of your unsecured debt (credit cards, medical bills) will leave you sufficient breathing room to deal with your other loans. But you don't want to trash your credit with a bankruptcy filing if your debt situation won't be substantially better when you're done.
- You could lose valuable assets. If you have substantial home equity, savings not protected by retirement funds or a valuable collection of art or antiques, your creditors may get those assets in bankruptcy court. State laws vary tremendously about how much can be protected, so consult an experienced bankruptcy attorney.
- You may need bankruptcy relief more later on. If your finances deteriorate significantly after you file, you may have wished you'd waited and wiped out more debt -- especially if your income means you won't be subjected to the new means test.
Let's say you have a child with a chronic illness who's already racked up thousands of dollars in medical bills you can't pay. You could wipe out the debt now, only to have several more trips to the hospital in the coming months saddle you with more unpayable bills and no way to get rid of it for many more years.
Current law prevents you from filing another Chapter 7 bankruptcy for six years. After Oct. 17, that time limit will be extended to eight years. That's a long time to field calls from bill collectors if your debts snowball.
You could be smart in that case to wait until your child's health has stabilized or your finances have bottomed out before you use your once-in-eight-year shot. Again, you'll probably want to consult with an experienced attorney.
For more details about finding one, and about bankruptcy in general, see MSN Money's Bankruptcy Guide.
Liz Pulliam Weston's column appears every Monday and Thursday, exclusively on MSN Money. She also answers reader questions in the Your Money message board.
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