Is Credit Counseling Prior To Filing For Chapter 7 Bankruptcy Protection Effective?
The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 changed the way Americans file for bankruptcy. The Act made it much harder to file for Chapter 7 bankruptcy protection. The bill was passed and signed in response to lenders' complaints that consumers were taking advantage of the ability to file for bankruptcy by avoiding payments they were capable of making. The Act sought to correct this perceived abuse of the bankruptcy system by instituting a means test and including a provision for all debtors seeking to file for Chapter 7 bankruptcy protection to attend mandatory credit counseling at an approved agency.
Due to the damage that filing for Chapter 7 or Chapter 13 bankruptcy protection does to a consumer's credit report, the provision to attend mandatory credit counseling applies to debtors seeking either chapter of protection. Credit counseling, as dire as the phrase may appear, actually means the debtor simply sitting down with an advisor and going over their finances together.
The aim of credit counseling is to determine whether or not they truly need to file for bankruptcy or whether an informal debt repayment plan would suffice instead. In this way, the 'abuses' of the system would be prevented by pointing out to consumers the fact that they do not have to file for bankruptcy in order to save their homes and finances.
Unfortunately, the effect was to stimulate record numbers of bankruptcies in the two weeks between the bill being passed by Congress and signed into law by President Bush. Over five hundred thousand people filed for Chapter 7 bankruptcy protection during that period. Compared to the previous year's volume for those two weeks, this represented an increase of over one thousand percent.
Why did this happen? If the new bankruptcy law was meant to prevent the abuse of the bankruptcy system, it certainly did so, because no bankruptcies were filed to nearly the same degree, thanks to the credit counseling requirement and the means test. Unfortunately, the new law had some unpleasant consequences. Since people suddenly found themselves not able to file for bankruptcy, they started to default on their mortgages. This is the result of a common financial pattern: when mortgage borrowers who have additional consumer debt are faced with the threat of not being able to keep up their mortgage payments, they typically file for bankruptcy to handle the other consumer debt so they can continue to pay their mortgage off.
When bankruptcy was denied, they started to default en masse because they simply could not pay their debts. This reveals the one great flaw of mandatory credit counseling: it only works with people who have short-term debt obligations. There are some individuals whose circumstances prevent them from ever being able to repay their debts. For these people, no amount of credit counseling will change the fact that they do not have the money to pay their creditors. This answers the question of this article firmly in the negative. Credit counseling, even mandatory credit counseling, is not effective at all.
