Chapter 7 bankruptcy, also called liquidation bankruptcy, is the most common form of bankruptcy in the US. It is designed for people who do not have enough income to pay their debts.
When you file for Chapter 7 bankruptcy your debtors must stop all collection efforts. The court will appoint a Trustee, who will sell your assets and use the proceeds to pay your creditors. You may be able to keep some exempt assets. After the liquidation of your assets remaining debts may be discharged, and you will no longer have to pay them.
Chapter 7 bankruptcy can relieve you of many forms of debt, but you may lose assets and your credit may take some time to recover. It may be some time before you are able to apply for a mortgage or other forms of credit.
How Does Chapter 7 Bankruptcy Work
A Chapter 7 Bankruptcy is a legal proceeding that follows a set sequence of events that can span up to six months. These events include
- Attending a credit counseling session with an approved counselor. This session will help you decide whether bankruptcy is the right option for you.
- Qualifying for Chapter 7 bankruptcy. This may involve a means test, which will examine your income and expenses to determine whether you have enough income to pay some of your debts. If the court believes that you have enough income to pay some of your debts, you may have to file for Chapter 13 bankruptcy.
- Working with a court-appointed Trustee to oversee the process.
- Attending a meeting between you and your creditors, called the 341 meeting of creditors, scheduled by your trust. Your finances will be examined to assure that the information that you have provided to the court is correct.
Assessing your assets for liquidation. Any non-exempt assets will be sold, and the proceeds will be distributed to your creditors. If you have no or few assets, your creditors may not be paid anything.
Some unsecured debts, including credit card debt, unsecured loans, rent and utility bill arrears and medical debt may be discharged once your assets are liquidated. When debt is discharged it can no longer be collected and you do not have to pay it.
A Chapter 7 bankruptcy usually takes 90 to 100 days to conclude.
It is important to remember that some debts cannot be discharged by Chapter 7 bankruptcy, including:
- Child Support
- Most Tax Debts
- Student Loans
- Homeowners Association Fees
- Court Fees and Penalties
- Personal Injury Debts Caused by an Accident That Occurred When You Were Intoxicated
- Debts that you Intentionally Omitted From Your Filing
If your financial problems are caused by debts of these types, Chapter 7 bankruptcy will not help you.
Creditors also have rights during a bankruptcy, and they may challenge a debt’s discharge, especially if they believe you obtained the debt by fraudulent means.
When to Consider Chapter 7 Bankruptcy
Bankruptcy is not intended to be an easy way out of debt. It is meant to be the last resort for debtors who are completely unable to pay what they owe.
If you are facing any of the following conditions, it may be time to consider bankruptcy:
- You have tried negotiating with creditors and working with a credit counselor but still face your debt issues without any relief in sight.
- Your debts are more than 40% of your annual income.
- It would take 5 years or more to pay off your debts even if you devoted all disposable income to debt payment.
- You are being continuously pursued by debt collectors.
- You owe the type of debts that can be discharged by bankruptcy.
With these criteria, you are most likely a candidate for Chapter 7 bankruptcy relief.
Most of us feel an obligation to pay our debts and will do whatever it takes to pay them, even if it isn’t possible. If it isn’t possible, Chapter 7 bankruptcy is an option to consider.
Who Qualifies For Chapter 7 Bankruptcy
Chapter 7 bankruptcy is intended for debtors who do not have enough income to pay their debts. With that in mind, there are several qualifications in place to determine if you can file Chapter 7:
- If your monthly income is below the median income for your state, you will qualify for chapter 7 bankruptcy.
- If your monthly income is above the median for your state, you will have to pass a means test. If the means test reveals that your income is not sufficient to pay even some of your debt, you will be approved for Chapter 7 bankruptcy.
- If the means test determines that you have enough income to pay some of your debts, your bankruptcy will be converted to Chapter 13. You will have to set up a 3-5-year payment plan supervised by a trust.
- If the court determines that your debts were incurred using fraud, or that you incurred debt with the intention of declaring bankruptcy, your case may be dismissed.
There are several other conditions that have nothing to do with your financial situation, but serve to curtail abuse of the bankruptcy system:
- You cannot file for Chapter 7 bankruptcy if you have had a bankruptcy petition dismissed in the last 180 days.
- You cannot file for Chapter 7 bankruptcy if you have filed for Chapter 7 bankruptcy during the past 8 years or filed for Chapter 13 bankruptcy during the last six years.
- You must have attended a credit counseling session with an approved counselor no more than 180 days before your filing.
If you meet these conditions, you will probably be eligible for Chapter 7 bankruptcy.
How to File for Chapter 7 Bankruptcy
Bankruptcy is a complex legal proceeding and most petitioners retain an attorney to assist them. If you can’t afford a lawyer, you have several options.
- Negotiate reduced attorney’s fees.
- Seek help from a free legal clinic or legal aid society.
- Find a pro bono attorney.
- Represent yourself. This will require serious effort and research, and errors may damage your case.
You will need to file a bankruptcy petition with the bankruptcy court that serves your area. You will need to submit other documents with the petition.
- A list of all creditors and the amount and type of their claims.
- The source, amount, and frequency of your income.
- A list of all your property.
- A detailed list of your living expenses.
- A list of property exempt from liquidation.
- Tax returns for the current tax year as well as returns filed during the case.
- A certificate of credit counseling.
- A copy of any debt repayment plan developed during credit counseling.
- Evidence of any payment from employers in the last 60 days.
- A statement of monthly net income and any expected increase in income or expenses.
- A record of any interest in federal or state education or tuition accounts.
It is extremely important to file accurate and complete information. If you attempt to conceal assets or income or deliberately distort your filing your case could be dismissed and there could be other penalties.
A husband and wife may file for bankruptcy jointly or separately. If they file jointly, they must submit the same documents that individual debtors use.
There are fees for filing a Chapter 7 bankruptcy, including a $245 case filing fee, a $75 administrative fee, and a $15 Trustee surcharge fee. The court may waive the filing fees if the debtor’s income is less than 150% of the State’s poverty threshold. These fees are imposed by the federal court system. You will also have to pay for the required credit counseling.
Between 21 and 40 days after your filing, your bankruptcy trustee will hold a meeting of creditors to begin the bankruptcy process.
90 to 100 days after the process begins, in most cases, your remaining eligible unsecured debts will be discharged. You are no longer responsible for paying discharged debts.
What Assets Will I Lose and What Can I Keep?
If you file for Chapter 7 bankruptcy you may lose some assets, including non-exempt personal possessions and property that is collateral for a loan.
Some assets may be exempt from liquidation. If an asset is fully exempt, you can keep it. If an asset is partially exempt, you may be able to keep part of the proceeds of the liquidation.
Many types of property can be exempt, often up to a specific value. Bankruptcy rules allow for these exemptions. These are federal exemptions and there may be variations in some states. Look up your state’s exemption rules to be sure.
- Homestead exemption of $25,150.
- Vehicle exemption of $4000.
- Jewelry exemption of $1,700.
- Personal property up to $13,400 can be exempt, with a maximum of $625 per item.
- Tax-exempt retirement accounts are exempt up to $1,362,000 in IRAs and Roth IRAs.
- Books and tools of trade are exempt up to $2,525.
- Alimony and child support are exempt.
- Some insurance benefits may be exempt.
- Property of your choice up to $1,325.
- Up to $12,575 of your homestead exemption may be applied to other property if not used for a homestead.
These amounts are doubled for married couples filing jointly.
Properties cannot be liquidated if their value is less than the exempt amount. The value of a homestead or a vehicle is based on your equity – the total amount you have paid to date – not the full value of the asset. If your equity is lower than the exempt amount the asset cannot be liquidated.
An exempt asset that is retained by the debtor can still be foreclosed or repossessed after bankruptcy if it has been used to secure a specific debt. If you wish to retain the asset, you will have to continue making payments on it. These debts will not be discharged, and the assets will still be subject to foreclosure or repossession after your mortgage.
How Will Chapter 7 Bankruptcy Affect My Credit?
A Chapter 7 bankruptcy can remain on your credit report for 10 years and can have a serious impact on your credit. The impact will be reduced over time, especially if you improve your financial record after your bankruptcy.
The individual accounts that were involved in your bankruptcy will drop off your credit report 7 years after they went into delinquency.
By the time you file for bankruptcy your credit may already be seriously damaged. If your credit is already in trouble the additional damage may be minor. If your credit was good before bankruptcy the damage is likely to be greater.
You will have to wait 2 years after your bankruptcy discharge to apply for a mortgage, or one year if your bankruptcy was due to factors beyond your control (like medical debt) and you have managed your finances responsibly since your bankruptcy.
Pros and Cons of Chapter 7 Bankruptcy
Chapter 7 Bankruptcy can give you significant advantages.
- Most debt collectors can no longer harass you or garnish your wages.
- The discharge of your debts will leave more money for basic necessities.
- You may be able to prevent a water, gas, or electricity shutoff.
- You may be able to recover a driver’s license suspended for non-payment of tickets or fines.
- You may be able to stop foreclosure, repossession, or eviction, at least temporarily.
Chapter 7 bankruptcy also comes with potential disadvantages.
- Your credit will be affected.
- You may lose assets and property.
- Some debts will not be erased.
- If you have co-signers on loans, they will be liable for your debts.
- Bankruptcy can be expensive.
- You can only file once every 8 years.
You will have to weigh the advantages and disadvantages and determine whether bankruptcy is appropriate for you.
Can I Recover From Chapter 7 Bankruptcy?
Bankruptcy may seem like the end of your financial life. It’s not. It’s intended to give you a fresh start. To take advantage of that fresh start you will need to take charge of your financial life and take active steps toward recovery.
- Check your credit report 90 days after your bankruptcy is discharged. Make sure all included debts are listed as discharged and have no balance.
- If any debts were excluded from your bankruptcy, such as a mortgage, make sure they are not listed as discharged, and that your payments are being recorded.
- Don’t make the same mistakes over again. Examine how you got to bankruptcy and learn from the past.
- Consider credit counseling to help you build a realistic long-term budget and financial plan.
- Watch out for credit repair companies that promise to rebuild your credit. Many of them are scams.
- Begin rebuilding your credit. A secured credit card is a great start. Look into credit builder loans from your bank or credit union.
Recovering from bankruptcy takes time and effort, but it can be done. Many Americans have gone through Chapter 7 bankruptcy, rebuilt their credit, and bought homes.
The Bottom Line
Chapter 7 bankruptcy is not easy, and it’s not meant to be. It’s not a decision to take lightly. In case where you truly don’t have the capacity to pay your debts, though, it can provide relief from debt collection efforts and a fresh financial start.