Money: Going Under

SHOULD YOU NEED ANOTHER REASON TO AVOID bankruptcy--a humbling process often triggered by illness, divorce or job loss--look no further than a bill about to be passed by Congress that will make it harder for middle-class families to erase medical, credit-card and other debt.

The first big change is a requirement to undergo credit counseling before filing for bankruptcy. That may seem inoffensive, but be warned: over the past few years, horror stories have emerged about credit-counseling agencies that funnel consumers into expensive debt-management plans. Last year the Senate urged the IRS and the Federal Trade Commission to step up enforcement against some outfits for abusing their nonprofit status.

Today 70% of individuals who file for bankruptcy protection do so under Chapter 7 of the bankruptcy code, which requires that most of your assets be confiscated but wipes out most debt, such as medical and credit-card bills (though you're still obligated to pay any child support, taxes and student loans). Under the new law, less debt can be erased under Chapter 7. And if your income is above the median in your state--and you can afford to pay at least $6,000 over five years--you will be forced into Chapter 13, which requires a repayment plan for all debt. (The national median income for a family of four is $65,093, with state medians ranging from $45,867 in New Mexico to $87,412 in New Jersey.)

Chapter 13 filers are given a budget with allowances for things like food and utilities but no amenities. Any income you earn above that level gets divvied among creditors for three to five years. (Under the new law, more people will be pushed into five-year plans.) And you may have to repay bigger chunks of certain types of debt, such as car loans.

The bottom line is that bankruptcy was always to be avoided--think of the emotional strain, the wrecked credit--but now even more so. Says Elizabeth Warren, a Harvard Law School professor and author of All Your Worth: The Ultimate Lifetime Money Plan: "The safety net for middle-class families just got smaller." •