The year 2005 was witness to one of the most significant overhauls of the personal bankruptcy in more than half a century. The new laws enacted by Congress and signed by the President will make it much more difficult for many consumers to walk away from credit card debt, overdue bills and other debts.

This overhaul of the bankruptcy system was designed to cut down on the perceived abuse of the system by people who could afford to pay the money they owed but chose to file bankruptcy instead. These new laws, however, are likely to affect more than just those who were out to cheat the system. It is important for every consumer, no matter what their current financial situation, to understand the new bankruptcy laws and how they could potentially be affected.

The two types of bankruptcy filing

There are two distinct types of bankruptcy filing, Chapter 7 and Chapter 13. When an individual files for Chapter 7 bankruptcy protection, all of his or her assets (minus any assets exempted by the state) are liquidated, with the proceeds being used to pay the creditors. The remaining debts are cancelled under a Chapter 7 filing, providing the individual with a fresh start.

A Chapter 13 filing is somewhat more complicated, with the bankruptcy filer being put on a payment plan which can last up to five years. Any debts which have not been repaid by the end of the plan term are cancelled.

The intent of the new law

The intent of the new, more restrictive bankruptcy filling law is to force more consumers into the more restrictive Chapter 13 bankruptcy filing, thus forcing more consumers to pay back a greater percentage of what they owe.

Perhaps the biggest change in the new bankruptcy law is the qualifying test. Under the new bankruptcy law, each individuals income will be subjected to a two part means test. The first means test uses a formula to exempt expenses like rent, food and other necessities in order to determine if the debtor is able to pay back at least 25% of the non-priority unsecured debt. This unsecured debt includes things like credit cards.

The second part of the means test compares the income of the bankruptcy filer to the median income level for the state. Those who are determined to be able to afford to pay back 25% of their debt, and whose income falls above the median for the state will be required to use the Chapter 13 bankruptcy filing, while those who fail the means test will be permitted to file under the more generous Chapter 7 rules.