With the new bankruptcy law in effect since October 17, 2005, there is a lot of confusion with regard to the new “means test” requirement. The means test is used by the courts to determine eligibility for Chapter 7 or Chapter 13 bankruptcy. The purpose of this article is to explain in plain language how the means test works, so that consumers can get a better idea of how they will be affected under the new rules.
When most people think of bankruptcy, they think in terms of Chapter 7, where unsecured debts are normally discharged in full. Bankruptcy of any variety is a difficult ordeal at best, but at least with Chapter 7, a debtor was able to wipe out their debts in full and get a fresh start. Chapter 13, however, is another story, since the debtor must pay back a significant portion of the debt over a 3-5 year period, with 5 years being the standard under the new law.
Prior to the advent of the “Bankruptcy Abuse Prevention and Consumer Protection Act of 2005,” the most common reason for someone to file under Chapter 13 was to avoid the loss of equity in their home or other property. And while equity protection will continue to be a big reason for people to choose Chapter 13 over Chapter 7, the new rules will force many people to file under Chapter 13 even if they have NO equity. That’s because the means test will take into account the debtor’s income level.
To apply the means test, courts look at the debtor’s average income for the 6 months prior to filing and compare it to the median income for that state. For example, the median annual income for a single wage-earner in California is $42,012. If the income is below the median, then Chapter 7 remains open as an option. If the income exceeds the median, the remaining parts of the means test comes into play.
This is where it gets a little bit trickier. The next step in the calculation takes income, less living expenses (excluding payments on the debts included in the bankruptcy), and multiplies that figure times 60. This represents the amount of income available over a 5-year period for repayment of the debt obligations.
If the income available for debt repayment over that 5-year period is $10,000 or more, then Chapter 13 will be required. In other words, anyone earning above the state median, and with at least $166.67 per month of available income, will automatically be denied Chapter 7. So for example, if the court determines that you have $200 per month income above living expenses, $200 times 60 is $12,000. Since $12,000 is above $10,000, you’re stuck with Chapter 13.
What happens if you are above the median income but do NOT have at least $166.67 per month to pay toward your debts? Then the final part of the means test is applied. If the available income is less than $100 per month, then Chapter 7 again becomes an option. If the available income is between $100 and $166.66, then it is measured against the debt as a percentage, with 25% being the benchmark.
In other words, let’s say your income is above the median, your debt is $50,000, and you only have $125 of available monthly income. We take $125 times 60 months (5 years), which equals $7,500 total. Since $7,500 is less than 25% of your $50,000 debt, Chapter 7 is still a possible option for you. If your debt was only $25,000, then your $7,500 of available income would exceed 25% of your debt and you would be required to file under Chapter 13.
While most of us maintain an awareness of just what law is, and in general the reason it is necessary to standardize our conduct in civilized society, we rarely consider just what law, in point of fact, truly means in a daily perspective. What exactly is law for the typical person? How do laws affect our existence on an everyday basis? In actual fact, is the law a remote theory that we find difficult to relate to?
The Will of the People
Let’s take a look at a few of the elementary ways laws operate in the social order, along with the makeup of the law as we generally understand it. Many people think the legal system is present in order to protect their well-being, and that they’ve got no need to interact with it on a daily basis. Nevertheless, they take for granted that if their actions are questioned the law will function, the path of justice will proceed smoothly, and the will of the people will be fulfilled. It’s a naive understanding of the purpose of our laws, but undeniably the manner in which it functions in our general society on a daily basis.
For example, at the highest level, we’ve got the constitution of the United States, which establishes parameters inside which our government can take action to defend the citizens of our country. That has an vast effect on the manner in which our government and in fact our nation is run, which has an effect on all that we do every single day, and how we do it. It affects the services we’re provided, our jobs and pretty much the daily lives we lead.
Essential to our Democratic Lifestyle
The law isn’t an abstract idea that protects us whenever we require it. It is an essential component of our nation’s democratic lifestyle, it regulates our actions, and in spirit lets us act behave in accordance with our individual desires. Some people will believe our laws are excessively restrictive in some aspects; nevertheless it works quite well for the most part. Our laws serve their purpose in regulating our conduct, and if a law doesn’t work, we are able and have the right to modify it.
There has been a lot of talk about the new bankruptcy law that was passed by Congress in 2005. What exactly were the changes, and how will they affect your eligibility for bankruptcy?
The idea behind the recent bankruptcy law was to limit the abuse of the system. The new statute is supposed to help determine whether people really need to declare chapter 7, even though many lawyers and consumers disagree. Regardless of what you think about this new statute, you have to get used to it (at least until you convince your congressman to change it).
So what does the new bankruptcy law mean to you? For one thing, you’ll be required to attend credit counseling classes within 180 days before filing personal bankruptcy. You may be able to do this online or over the phone instead of attending a live class. You’ll have to produce a certificate that proves your attendance, but you may be able to get an extension from the court if you were not able to take it before filing a petition.
You have to make your tax return available to any creditor who asks for it, and you also have to get your pay stubs together for the last 60 days before you filed Chapter 7. After your successful Chapter 7 case, you’ll also have to attend the financial management class to help ensure that you do not repeat your mistakes and end up in bankruptcy court sometime in the future.
Will you still be eligible for Chapter 7? Well, one lawyer estimates that only 3% or so of people that would have been eligible previously will no longer be able to file Chapter 7. In other words, most people will still be eligible, even though they may have to go through additional hurdles.
Specifically, if your salary is greater than the median salary for your state, you will have to take a more involved test to determine whether you can afford to pay some of your debt. If you fail this test, you may be forced to declare Chapter 13 which involves a partial repayment plan.
Consumer debt relief has become increasingly popular because of the fact that the traditional method of bankruptcy filing causes a number of troubles for the consumers, the creditors and the economy as a whole. The consumers lost their credibility once they filed for bankruptcy and the failed to get any further credit from the creditors for the coming 7-10 years. This happened because of the fact that the report of bankruptcy filing continued to show up on the credit history of the consumer for that period of time. On the other hand the creditors lost their liquidity and they failed to cover their costs. They lost their financial equilibrium and reached the verge of bankruptcy. This caused a situation of disequilibrium in the economy as a whole. The economy reverted back into recession instead of coming out of the same.
It is because of this reason that the Federal govt. designed some new consumer protection laws to give ensure that the alternate consumer debt relief options gain in popularity and bankruptcy is sent to the back foot. The govt. declared tax breaks for the creditors and released billions of dollars into the economy. This money is known as the stimulus money. The govt. declared that those creditors who agree to debt settlement deals will get tax relief and can use the stimulus money to cover up the costs that they have. This is because of the fact that when the creditors agree for debt settlement deals, they lose some of the money and their profit levels go down. This means that the creditors will take more hit when they will have to pay the unaltered tax rates. To give relief from this, the govt. announced a reduction the amount of taxes.
On the other hand as the creditors agree for settlement, they lose some of the principal amount of the money that they give out to the consumers. To cover up that loss, the creditors are allowed to use the stimulus money revolving in the market. With these new laws, the creditors went to the safe side and they opened up for the debt settlement deals. This means that the consumers having credit card debts can now get debt relief due to elimination of a certain percentage of the debt. Thus the new consumer protection laws mean that the credit card debts get eliminated by a certain percentage and the consumers get back on a healthy financial track.