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Filing for Bankruptcy May Stave Off Disaster

Consumers with little hope of paying off debt are turning to bankruptcy as a solution.

Thirty percent more Americans filed for bankruptcy in the year through June compared with the previous 12 months. Filing for bankruptcy can hurt financially, but for some, it offers a much-needed path out of financial disaster. Before you decide whether to file for bankruptcy, here are a few points to consider.

A Little History

In 2005, Congress passed laws making it more difficult for consumers to file for bankruptcy under Chapter 7, which allows consumers to erase most of their debts. Prior to that, a judge decided Chapter 7 eligibility on a case-by-case basis. Ineligible consumers had to settle for a Chapter 13 bankruptcy, in which they are required to pay back a portion of their debts based on a payment plan.

The new laws introduced a standardized "means test" based on the median income of your state of residency. If your income is below the median income, you are eligible for Chapter 7. If your income is above the median, your eligibility depends on a complex calculation of disposable income. (Use this online calculator to get an idea of your eligibility.)

But while the new laws make the process of filing for bankruptcy more complicated and costly, they don't really change who qualifies, according to Henry Sommer, president of the National Association of Consumer Bankruptcy Attorneys, or NACBA. "Almost everybody who was eligible before 2005 is still eligible now," says Sommer. "The new laws really only affected 0.5% of the cases, but many people don't realize that."

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