Photos Going...going... Tools E-mail this page Print this page Sponsor

The net effect of the new law is that people simply won't file for bankruptcy after the new law takes effect. (Tim Boyle/Getty Images )

Thousands of people across the nation and in Minnesota have been rushing to file for bankruptcy before a new law takes effect on Monday. The Bankruptcy Reform Act was signed into law last spring after years of lobbying by banks and credit card companies. Critics say the law will make it extremely difficult for individuals to get out from under their debt. Proponents say the new restrictions protect against abuse of bankruptcy.

St. Paul, Minn. — If you're filing for bankruptcy, one of two things will happen: you might be freed from some or all of your debts -- that's a Chapter 7 bankruptcy. But you might have to pay your creditors back-- that's a Chapter 13 bankruptcy.

Whether you wind up with a repayment plan or getting out from under your debts depends on how much money you make.

The current bankruptcy law only considers your income in the present moment. So if you're out of work, and your only income stems from unemployment benefits, you might easily qualify for debt relief under Chapter 7.

Starting Monday things get more complicated. The new law considers your median household income over the past six months. Then it compares that income to the state median income. In Minnesota, it's about $55,000 a year. If you're below that median, you can qualify for debt relief under Chapter 7. But if you were earning a high wage a few months ago, the new law might require you to pay at least $6,000 of your debts over five years.

Minnesota bankruptcy Judge Robert Kressel says the new income standard is unrealistic, because it doesn't account for the fact that someone's income can drop.

"You have to have real money to pay your creditors with," according to Kressel. "This artificial formula doesn't generate any money. Most people have no money left over. So they can't afford to go into Chapter 13."

Kressel says the net effect is that people simply won't file for bankruptcy after the new law takes effect. And he says that's unfortunate, because many people who file have no other options.

"A lot of them get in trouble from health problems or other problems not of their own making; a very large percentage. So it's a medical issue, a car accident that generates a medical issue, losing jobs. Some people it's losing their only job. Some people it's losing one of their jobs. It's amazing how many people have more than one job. And suddenly, your cushion is gone," Kressel says.

Consumer advocates say the new law is likely to leave laid- off workers and victims of natural disasters, like Hurricane Katrina, in especially dire financial situations.

But advocates of the new law disagree with that prognosis. Laura Fisher, of the American Bankers Association, says debt relief through Chapter 7 will still be widely available to people above and below the state median income.

"The majority of people automatically have access to Chapter 7 because they're low income. About 80 percent of filers make less than their state's median income. They're going to have automatic access to Chapter 7," Fisher says.

But consumer advocates say it will be tougher on people below the state median income as well.

"It's not accurate at all to say that people under the median income will be able to file Chapter 7 bankruptcy just as they always did," according to Travis Plunkett of the Consumer Federation of America. He says the new law creates plenty of other impediments, beyond the income-based means test, that could prevent people from filing for bankruptcy.

The paperwork required is extensive. Everyone filing -- whether Chapter 7 or 13-- must first take credit counseling on their own dime. And, Plunkett says, under the new law, individuals can shed less debt through Chapter 7.

"It's going to be more difficult; there are going to be more traps for the unwary that are going to trip people up. And these are people who have a very legitimate reason for being in bankrupty," Plunkett says.

It's also going to be more expensive to file, and Plunkett says that by itself will be a major problem for people who already have little cash.

Bankruptcy attorney Jay Halverson of Edina says lawyers fees alone are going to skyrocket, in part because the new law creates extra work.

"The cost is coming from my time to work through all the provisions to provide all the disclosures, to do all the work that's necessary to put together a bankruptcy petition and schedules, no matter what bankruptcy you're under," he says.

Halverson says people who know about all the new changes have been flooding into his firm in order to file before the new law takes effect Monday. He says he and his colleague had to stop taking new cases. Consumer experts say that's happening nationwide. So there may be little hope for individuals to get debt relief while the current, more lenient law remains in effect.