The Maze of Debt Relief Options

In 2001 and 2002, Wes Wannemacher charged $3,200 on a new Chase credit card to pay for expenses related to his wedding. Over the next six years, he paid about $6,300 dollars toward that debt, yet in February 2007 he still owed $4,400.

How could he pay nearly double his original debt and still owe more than $4,000?

As he explained in testimony before the Senate Permanent Subcommittee on Investigations, Wannemacher was socked with $4,900 in interest charges, $1,100 in late fees, and 47 over-limit fees totaling $1,500, despite going over his $3,000 credit limit by a total of $200 on just three occasions.

Credit cards have become a fixture of U.S. economic life, with the average American household owning five different cards. While the credit card industry has provided many consumers with easy access to credit, it has also created enormous problems and contributed to record levels of personal bankruptcy filings.

The number of bankruptcy cases filed in federal courts rose 12.8 percent in the 12-month period ending March 31, 2006, according to statistics released by the Administrative Office of the U.S. Courts. Bankruptcy cases totaled 1,794,795 for that period, compared to 1,590,975 bankruptcy cases filed in the 12-month period ending March 2005.

But what exactly is bankruptcy?

Bankruptcy is a federal court process designed to help consumers and businesses eliminate their debts or repay them under the protection of the bankruptcy court. Bankruptcies can generally be described as "liquidations" or "reorganizations."

Chapter 7 bankruptcy is the liquidation variety where property is sold (liquidated) to pay off as much of your debt as possible, while leaving you with enough property to make a fresh start.

Chapter 13 is the most common type of "reorganization" bankruptcy for consumers where you repay your debts over a period of years.

Both kinds of bankruptcy have numerous rules, and exceptions to those rules, about what kinds of debts are covered, who can file, and what property you can and cannot keep.

There are several key changes to the new bankruptcy law, called the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA). The three major changes to the law that will affect the most people are the ticket in, the means test, and the ticket out.

The "ticket in" is simple a credit counseling session that the person wishing to file bankruptcy must attend. You must attend this credit counseling session six months prior to applying for bankruptcy.

The bankruptcy court determines whether or not you can qualify for chapter 7 bankruptcy. Under the new law, your income will be tested by a two-part "means test". The first test is a formula that exempts certain expenses (rent, food, etc.) to determine if you can afford to pay 25 percent of your unsecured debt, such as credit card bills. Next, your income will be compared to your state's average income.

The court will not allow you to file chapter 7 bankruptcy if your income is above average for your state and you are able to pay 25 percent of your unsecured debt. Under the new bankruptcy law, the court may allow you to file under chapter 13, though.

If your income falls below your state's average but you are able to pay 25 percent of your unsecured debt, you may be able to file chapter 7, but the bankruptcy court will still have the authority to require you to file chapter 13 instead if the court believes you would be abusing the system by filing under chapter 7.

The "ticket out" for the new bankruptcy law is attending a financial education class from an approved provider before your bankruptcy can be finalized. The United States Trustees Office approves the class providers.

Also under the new law, the court will apply living standards derived by the IRS to determine what is reasonable to pay for food, rent, and other expenses to determine how much you have available to pay on your debts.

So, your life will be dictated by standards that may be unrealistic for your family by the state standards and the laws lobbied for by the credit card companies. Not to mention the long term damage a bankruptcy does to your credit rating and future lend ability. So bankruptcy should only be considered as a last ditch effort of debt relief, left only for the desperate.