Bankruptcy
New Bankruptcy Law Requires Credit Counseling
Saturday, October 01, 2005
Amy Buttell Crane
BankRate.com
Provisions in the new bankruptcy law mandate credit counseling before a bankruptcy can be filed and a personal financial management seminar before a bankruptcy is complete.
And there ain't no free lunch -- most consumers will have to pay at least a nominal fee for both of these classes, adding to the financial burden of a bankruptcy filing. In fact, the entire process is about to get a lot more expensive and complex as a result of the new law. Known as Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, it was passed by Congress in March and signed into law by President Bush on April 20.
Federal agencies, courts, attorneys and credit counseling agencies are scrambling to comply with the many changes in this new law, which include restricting the ability of debtors to wipe out their debts under Chapter 7, to file repeated bankruptcy petitions and to select a more favorable jurisdiction for bankruptcy filings.
Consumer advocates say the law imposes too many burdens on consumers overwhelmed by debt. Travis Plunkett, legislative director of the Consumer Federation of America, or CFA, notes that there are two critical issues in the credit counseling and personal financial management provisions: whether consumers can find a reputable agency that will actually help them deal with their debts and whether the timing is right for them to benefit from such help.
"If most people can't benefit, then this will be an expensive barrier to both getting into, and emerging from, bankruptcy," he says.
No one knows, yet, exactly how the law will affect consumers, because it is untested. "The law is designed to prevent debtors from using the system as a way to avoid their creditors," says Howard Ehrenberg, an attorney with SulmeyerKupetz in Los Angeles, and a member of the Chapter 7 Bankruptcy Panel of Trustees. However, it will take time for trends to emerge in how the law is actually interpreted by judges, he says.
Bankruptcy basics
Under U.S. law, there are a number of categories under which consumers, cities and corporations can file for bankruptcy. Chapter 9 is reserved for municipalities, counties and school boards; Chapter 11 is for corporations and Chapter 12 for farmers. The consumer chapters are:
Chapter 7. Under Chapter 7, your assets -- if you have any, and except for certain types of property -- are liquidated and distributed to your creditors. Chapter 7 filers are released, or discharged, from many of their debts at the completion of their case.
Chapter 13. Under Chapter 13, you get to keep most of what you own and file a plan to repay your creditors over three to five years. Your bankruptcy isn't complete until you pay off all of your creditors according to your plan.
There are some debts that bankruptcy can't erase, including legal fees related to the bankruptcy filing, some taxes, student loans, alimony, child support and certain injury and criminal fines and claims.
As American consumers gorge on more debt, bankruptcy filings have skyrocketed and they are climbing even faster now as consumers race to file before the new law goes into effect. Filings were up 16 percent from the previous quarter as of June 30, according to a report from the Administrative Office of the U.S. Court. Chapter 7 filings are responsible for the increase, as the new law makes it tougher to qualify to file.
Contrary to popular belief, most bankruptcy filings aren't caused by credit-card misuse. A study published in Health Affairs in February concludes that half of all bankruptcies are caused by health problems and subsequent unemployment and cancellation of health insurance. The study also reveals that most of those filing for bankruptcy aren't serial deadbeats, but middle-class consumers who own their own homes.
Credit counseling briefing
Under the new law, consumers who want to file for bankruptcy must complete a credit counseling briefing, designed to inform them of their options in dealing with their debts, six months prior to filing. The course must be at least 90 minutes long and can't cost more than $50. Accredited agencies can't turn anyone away based on their ability to pay.
The briefing can be provided through one-on-one, in-person counseling; group classes or over the phone or Internet. The U.S. Trustee Program of the Department of Justice, which administers various aspects of the new bankruptcy law, must approve the curriculum.
Topics covered in the briefing include examining the underlying causes of a consumers' financial problems; a look at their budget, in terms of their income and expenses; helping them understand the debt-to-income ratio; providing guidance as to whether a debt-management plan will help the consumer; and the consequences of filing for bankruptcy and other alternatives to bankruptcy, according to Gail Cunningham, vice president of business relations with Consumer Credit Counseling Service of Greater Dallas, an agency that has applied to provide these classes.
Because of the fee-waiver requirement, and the fact that most people considering bankruptcy don't have a lot of money to spare, a good number of these briefings will take the form of online interactive classes, says Howard Dvorkin, founder of Consolidated Credit Counseling Services in Fort Lauderdale, Fla.
If a consumer works with a credit counseling agency's counselor who believes they could benefit from a debt management plan and draws one up, that plan must be included with the consumers' bankruptcy petition, even if the consumer doesn't believe he has the ability to meet the obligations of such a plan.
The timing issue
Consumer advocates question whether this credit counseling briefing will really help consumers. "The question is whether the timing is right -- is this a good time for a consumer to receive counseling or not," Plunkett says. "When they get to this point, most consumers have already made the mental decision to seek bankruptcy because, in most cases, they learn about this provision through their bankruptcy attorney."
"So we wonder whether it is too late, because most people at this point face imminent financial calamity," he says. "Timing is everything in credit counseling. If there is early intervention, it can work, but if people get it after they have been laid off, for example, they won't have regular income and can't benefit."
Financial management
The back end of the twin requirements is a two-hour personal financial management education class that consumers must attend before a bankruptcy can be completed, or debts discharged, in industry lingo. According to the U.S Trustee's Office, the curriculum for this class must include:
- Budget development: Learning how to set short and long-term financial goals, the difference between net and gross income and classifying expenses as "fixed, variable or periodic."
- Money management: Learning to keep good financial records, how to comparison shop, differentiate between wants and needs, types of insurance and what coverage is necessary, and the difference between short- and long-term savings.
- Using credit wisely: Learning the types and sources of loans and credit; identifying potential credit problems, how to use credit appropriately and understanding credit ratings.
- Consumer information: Learning about consumer resources, consumer laws and regulations.
- This class also will have a fee, which hasn't been specified yet, although agencies can't turn away anyone because of their inability to pay. If a couple is filing for bankruptcy, each individual must take both courses and receive individual certificates, which means double fees in many cases.
Approved providers
The U.S. Trustees Program has designed procedures and applications to vet applicants who wish to provide these classes. Nonprofit credit counseling agencies and attorneys are eligible to provide the credit counseling briefing and personal financial education seminar. In addition, certified public accountants, certified financial planners and teacher certificate holders, among others, are also qualified to conduct the personal financial education seminars.
While most consumer credit counseling agencies that will provide these services are qualified as nonprofits by the IRS, Plunkett believes that some agencies shouldn't qualify because they engage in activities outside the scope of traditional nonprofits. What many consumers don't realize, Plunkett says, is that the consumer credit counseling industry was founded by companies and banks issuing credit cards and still receives a good deal of funding from that industry.
Because the credit card industry is anxious to recoup as much money as possible from consumers experiencing financial difficulties, credit counseling agencies are rewarded financially for steering consumers into debt-management plans, he says. These programs consolidate consumers' unsecured debt and may offer a sweetener in the form of a reduction in interest rates. Unfortunately, secured debt -- including mortgages and car loans -- aren't part of these plans and are usually what force consumers to consider filing for bankruptcy.
In April 2003, the Consumer Federation of America, or CFA, and the National Consumer Law Center, or NCLC, issued a report, "Credit Counseling in Crisis: the Impact on Consumers of Funding Cuts, Higher Fees and Aggressive New Market Entrants." This report charged that many consumers were being ill-served by the credit counseling industry and that for some consumers, these agencies were making their problems worse rather than better.
While some things have improved in the past two years, many problems remain, Plunkett says. "Our big fear is that this requirement may make things worse for many consumers," he says. "It's one thing for people to voluntarily seek help from an industry in turmoil, but now the federal government is forcing people into the hands of credit counseling agencies that could actually harm them."
Cunningham says that her agency is doing all they can to help consumers in financial distress. "For the first time in history, financial education is written into federal law," she says. "We're happy about that. We feel that the legislation is thorough and that the Trustees are aware of the industry and are taking steps to maintain high standards in those that are approved."
How to find the right provider
When considering bankruptcy, don't sign up with the first agency you find. Instead, follow these tips -- provided by the CFA and NCLC -- to find an agency that will help you figure out what is in your best interests:
- Shop around by phoning at least two or three agencies before deciding which one to use.
- Seek an agency that offers a wide variety of services, including face-to-face budget counseling, savings and debt management classes. Avoid agencies that provide only a debt-management program.
- Scope out all fees from both the agency and your creditors. Avoid those that charge only "voluntary" fees as there will be high pressure for you to pay them. Also avoid agencies that provide extra compensation to employees who sign up consumers for debt-management programs.
- Investigate the agencies' and the employees' credentials. Just because an agency is a member of a trade group or a nonprofit doesn't mean they are right for you. Make sure counselors are experienced and have taken classes that have lasted longer than a few weeks.
- Don't sign on for any debt-management plan until you have all the specifics in writing and your creditors have agreed to the terms. Find out exactly what type of concessions your creditors are making, how much you are expected to pay per month and how long your payments will last.
- Find out whether credit counseling will negatively affect your ability to get future credit. Credit score services don't mark consumers down for getting such counseling, but some individual creditors do.
