How Bankruptcy Works

­The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, which took effect on October 17, 2005, was designed to curb fraud and also to aid individuals seeking debt relief. One important change demands that all debtors must now get credit counseling before filing for bankruptcy and additional budget management and debt counseling before debts can be discharged. The counseling agency must be approved by the United States Trustee's office.

Under the new law, some people who have high incomes will no longer be allowed to file under Chapter 7. Instead, they'll have to pay back at least some of their debts through Chapter 13. Those filing under Chapter 13 have to hand over an amount of their income dictated by the IRS. That amount is based on the current monthly income previously calculated. The use of the current monthly income method means that some debtors may be forced to give up more income than they have, and that some Chapter 13 plans may not work.

Lawyers must also now attest to the accuracy of the information passed to them by their clients. While this requirement may help ensure that debtors submit accurate information, it could also result in lawyers spending more time on cases and consequently, bigger legal bills.

For Chapter 7 filers, property is more vulnerable to being seized by creditors under the new law. Property is now valued at the amount it would cost to replace it rather than what it could be sold for at an emergency fire sale. Some property may be exempt from seizure, but those seeking protection under Chapter 7 must now have lived in a state for two years to be eligible for exemption. To use your new state's homestead exemption (which determines how much equity you can keep in your home), you must have lived in the state for 40 months. Exemptions often vary significantly from state to state, so it's important to examine the options available in your state (or in your old state if you recently moved) if you are considering filing for bankruptcy.