Personal Finance

Bankruptcy would be an easier option for consumers under Elizabeth Warren's plan

Key Points
  • While bankruptcy filings have trended downward, consumer advocates worry that some changes enacted in 2005 have dissuaded some individuals from filing.
  • There were more than 773,000 bankruptcies filed — the majority by individuals — in the 12-month period that ended June 30, 2019.
  • The number of bankruptcy filings has generally been dropping from a peak of nearly 1.6 million in 2010.
  • Medical debt is a leading cause of filing for bankruptcy, according to research released last year.

Consumers would face fewer hurdles in trying to discharge debt through bankruptcy under a new plan from one of the Democratic presidential hopefuls.

Sen. Elizabeth Warren, D-Mass., released a proposal Tuesday that aims to undo parts of a 2005 law, such as higher fees and more paperwork, that she says made it harder for individuals to file for bankruptcy. Her plan also would allow student loan debt to be discharged in bankruptcy — which currently is difficult to do — along with other changes intended to make bankruptcy more accessible to consumers.

"I'm glad to see … proposals to revise some of the most onerous rules that people have had to deal with since the 2005 law passed," said Ike Shulman, co-chair of the National Association of Consumer Bankruptcy Attorneys' legislative committee. "The current system really needs a review."

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While bankruptcy filings have trended downward, consumer advocates worry that some of the changes made in 2005 have dissuaded some individuals from filing.

There were more than 773,000 bankruptcies filed in the 12-month period that ended June 30, 2019, according to the U.S. Courts. The majority of those — about 751,000 — were from individuals; the remainder (22,000) were business filings. The number of bankruptcy filings has generally been dropping from a peak of nearly 1.6 million in 2010.

Medical debt is a leading cause of filing for bankruptcy, according to research released last year. Other culprits include unaffordable mortgages, student loans and financial instability or debt caused by overspending or divorce.

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Meanwhile, overall household debt stands at nearly $14 trillion according to the Federal Reserve Bank of New York. That includes $9.4 trillion in mortgages, $1.5 trillion in student loans, $1.3 trillion in car loans and $900 billion in credit card debt.

While student loan debt is difficult to discharge in bankruptcy — you must prove undue hardship — most other consumer debt is fair game for either eliminating or negotiating a lower payback amount, depending on the specifics of your case.

Of course, getting to the point of actually filing the paperwork with the bankruptcy court means overcoming the emotions that accompany the decision.

"No one is happy when they go to file for bankruptcy," Shulman said. "But by the time they file, they have no other alternatives."

Filing options

Under current law, there are several ways to file for bankruptcy.

Most individuals typically choose between Chapter 7 and Chapter 13. Each has filing fees of a few hundred dollars, and enlisting an attorney can add $1,200 to about $3,500, depending on where you live and the complexity of your case.

It's also worth noting that while federal law governs bankruptcy, there are some differences among states regarding what property cannot be sold to pay off creditors. For instance, in some states, wedding rings up to a certain value are protected.

Both Chapter 7 and 13 stop collection activity like calls from creditors or debt collectors, wage garnishments and, potentially, lawsuits from creditors. (Court judgments already in place are trickier to get rid of in bankruptcy.)

No one is happy when they go to file for bankruptcy. But by the time they file, they have no other alternatives.
Ike Shulman
co-chair of the National Association of Consumer Bankruptcy Attorneys' legislative committee

However, there are differences in who qualifies and how debt is treated in each option. Chapter 7 generally is for people who lack enough income to repay their debt and have little in the way of assets.

This approach quickly erases certain forms of debt, including from credit cards, medical bills and personal loans. It does not, however, necessarily stop your car from being repossessed or prevent home foreclosure, Shulman said.

It also is the most common way to file individual bankruptcy, although some people have too much income to qualify.

Basically, you are subject to a "means test" for Chapter 7. This results in some filers having too much income — an amount that varies from state to state — which forces them to file under Chapter 13. (Warren's plan would eliminate the means test.)

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Chapter 13 generally gives you three to five years to pay back certain debt and keep assets (i.e., house or car). It also prevents creditors from garnishing your wages or putting a levy on your bank account. For this filing option, your debt must be below a certain amount (about $1.68 million total).

For individuals with debt above that threshold, Chapter 11 — which is largely similar to Chapter 13 — might be the best choice. This is the least commonly used option for individuals.

Credit impact

A big downside to bankruptcy is the hit that the filer's credit report takes.

However, many people who file for bankruptcy already have tarnished credit due to delinquent accounts, Shulman said.

"They're usually doing it when they have debt in collections or other dings that already show up on their report," he said.

The information remains on a credit report for seven to 10 years, although the impact decreases over time and your score will tick upward gradually.

Regardless of the bankruptcy approach taken, filers should be prepared to provide detailed information on their financial life to the court. That includes tax returns, bank statements, pay stubs and the like.

Consumers also should keep in mind that having an initial consult with a bankruptcy attorney often is free. They also might have suggestions for handling debt that does not involve bankruptcy.

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