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A decade after bankruptcy reform was passed, it seems a new group of Americans has emerged: the permanently insolvent.

Too Poor for Bankruptcy

When bankruptcy reform was enacted a decade ago, and the cost of filing for bankruptcy quadrupled, consumers were left in a new lurch: being too poor to file for bankruptcy. “The reform has generated a substitution, from formal bankruptcy to insolvency,” said Stefania Albanesi. She is the lead author of “Insolvency After the 2005 Bankruptcy Reform,” a new study released by economists at the Federal Reserve Bank of New York and Columbia University.

Jump in Price of Bankruptcy

The study looked at the rise in the cost of filing for bankruptcy. For Chapter 7 bankruptcy, which is the most common form of bankruptcy filed, the price increased from $600 to $2,500 just two years after the 2005 law was enacted. And for the more complicated form of personal bankruptcy, Chapter 13, the price rose from $1,600 to $3,500. These new costs became largely out of reach for consumers who need to discharge their debts through the bankruptcy process.

Can’t Get Bankruptcy Protection

If you’re unable to file for bankruptcy (because you can’t afford to) you can’t discharge your debts. With bankruptcy protection, debt collectors are forced to stop harassing you and/or garnishing wages. In Chapter 7 protection you are able to discharge most if not all of your debts (things like student loans cannot be discharged). So, though you are broke, you are able to start again. While your credit takes a hit, you are able to start over again and apply for credit cards, auto loans, a mortgage and other forms of credit.

Not being able to discharge these debts leaves you in insolvency, unable to discharge debts and thus, unable to start again. Insolvency often leads to foreclosure due to the inability to protect your home as it would be under bankruptcy protection.

“In bankruptcy, debts are discharged,” Albanesi said, “whereas in insolvency, debts remain.”

Source: Nasdaq, Study: Law creates many too broke to file for bankruptcy, February 24, 2015

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