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January, 2006 - Changes in Bankruptcy Laws and Credit Card Payments

With the new bankruptcy law in force this fall and credit card companies virtually doubling their minimum payments within the next few months, a major shift in American personal finance has arrived. The new bankruptcy legislation was signed into law in April 2005 and took effect on October seventeenth. This new law makes it significantly harder to discharge debt through bankruptcies and will benefit credit card companies by significantly reducing losses they experience due to bankruptcies. In a related move, prompted by a 2003 directive, credit card companies in America are raising their minimums, ostensibly to improve a borrower's ability to payback their balances more quickly and encourage more prudent use of credit cards. With two such important changes happening simultaneously there will undoubtedly be some negative long and short term effects and perhaps even some benefits.

Bankruptcy laws enable individuals who have created too much debt to either decrease their debts and re-organize the remaining balance into a more manageable monthly payment, known as a chapter 13 bankruptcy; or to entirely discharge all their debts and give the individual a fresh financial start, known as chapter 7 bankruptcy. In both cases the aim is to allow these individuals to regain a financially viable footing, by enabling them to keep their home and car and start again. These individuals also pay a penalty for claiming bankruptcy as their credit reports are clearly marked for up to ten years with a record of the bankruptcy. The stigma attached to borrowers with bankruptcies limits their ability to borrow and increases their cost to do so for years to come. These long term consequences mean that declaring bankruptcy is far from a free ride for people in debt.

On the corporate side, lenders have long argued that past bankruptcy laws were too lax and slanted in favor of debtors, granting unwarranted bankruptcy protection that allowed debtors to abuse the system. New bankruptcy laws are specifically aimed at preventing bankruptcy abuse. These laws will clearly bring benefits to corporations, recapturing much of what was once lost through looser bankruptcy protection laws. Since the goal of this law is to re-balance a system deemed to be full of loopholes it seems that small business owners who are owed money and large credit card and financing corporations stand to gain the lion's share of the benefit.

The new bankruptcy laws in action force individuals seeking bankruptcies to run a much more stringent gauntlet to qualify for bankruptcy than ever before, preventing significantly more people from obtaining bankruptcies and forcing many more than before to payback monies owed on a chapter 13 repayment plan. Thus far there has been no great public outcry from individuals who feel that the new laws are unfair, but the law is still quite new. Opponents of the new law feel that the law may prevent individuals with extenuating circumstances, such as losing jobs, or severe illness, from obtaining protection they genuinely deserve. There may soon be stories of financial ruin emerging ever more frequently now that these laws have tightened. Especially, because many people are about to experience a big surprise that's about to make the transition to new stricter bankruptcy laws a reality for them.

Starting in January 2006 the major credit card companies have been directed to raise their minimum payments to approximately twice their former levels. Up until now most credit card minimum payments were 2- 2.5% of the balance owed, so a $5,000 balance would cost about $100-$125 per month. At this rate such a debt could take over twenty years to pay back. With the new minimums in force this same $5,000 balance is going to cost $200 each month. The extra principal will be applied to lower the balances owed faster. But, for the millions of American's who are already carrying too much debt and barely making ends meet there may be a crisis this winter, as they find themselves paying nearly twice what they're used to paying to their credit cards. Normally, such a dramatic change in payments would be enough to push many consumers over the edge towards bankruptcy. However, with the tighter laws in place, it would seem that many will find themselves between a rock and a hard place, unable to handle the increased minimums on the financed debts and unable to qualify to discharge the debts through bankruptcy.

It's quite likely that even in a mortgage market with significantly increased rates during the last year that many of these financial refugees will need to find shelter by refinancing their homes and taking second mortgages. It seems that this winter and spring a mortgage boom could be in the offing to rectify many American's finances. While many who hold high credit card balances will benefit from using the equity in their homes to stabilize their finances, others who do not own homes, and may not qualify for bankruptcies may have hard times ahead.

Unquestionably, the old 2% credit card minimums that spread out paybacks on purchases over twenty years or more are clearly bad for the long term financial health of consumers, in the short term the cure may seem worse than the disease. While raising credit cards minimums seems a responsible idea on the whole, which will force consumers to spend more judiciously, the implementation of these increases in a matter of months, as opposed to a gradual increase, may have unintended consequences and will likely make for a much rougher transition. In an economy largely fueled by consumer spending such changes could have a negative effect on the economy in 2006, even if the intent is to promote better financial habits among Americans.