What Is Chapter 7 Bankruptcy?
Chapter 7 is known as the “liquidation bankruptcy’’ because it discharges most of your unsecured debt. That includes credit card debt, medical bills and personal loans.
It’s the quickest, simplest and most common type of bankruptcy. According to the American Bankruptcy Institute (ABI), 63% of the 774,940 bankruptcy cases filed in 2019, were Chapter 7.
An even more encouraging bankruptcy statistic: 94.3% of Chapter 7 filings had their debts discharged, meaning forgiven.
You must pass a “means test’’ to qualify for Chapter 7 filing. The means test examines financial records, including income, expenses, secured and unsecured debt to determine if your disposable income is below the median income (50% lower, 50% higher) for your state. The means test income level varies from state to state.
You might be forced to sell any non-exempt assets, though several online sites claim that 96% of Chapter 7 filings are “no asset” cases, meaning there is not enough equity or value in the property for a trustee to sell it and pay off creditors.
Generally, the Chapter 7 process can be completed in four to six months.
Debts That Can and Can’t Be Discharged in Chapter 7 Bankruptcy
Chapter 7 should dismiss most of the debts you owe, but there are some hard-and-fast debts that can’t be discharged in Chapter 7.
The list of non-dischargeable debts includes:
- Child support
- Tax liens
- Court fees and penalties
- Personal injury debts owed due to an accident while you were intoxicated
The list of items that can be discharged in a Chapter 7 bankruptcy include:
- Credit card debt
- Medical bills
- Personal loans
- Mortgage or automobile loans that you can no longer pay (but you lose possession of)
- Income tax debt
- Student loans — must prove undue hardship
- HOA fees — if you surrender your home or condo
- Any other form of unsecured debt.
When to File Chapter 7 Bankruptcy?
There are several warning signs that you should be considering Chapter 7 bankruptcy. Five strong signs that indicate filing for Chapter 7 may be the right solution include:
- Your debts total more than half your annual income.
- It would take five years (or more) to pay off your debt, even if you took extreme measures.
- Your debt creates stress in essential aspects of your life, such as relationships and your ability to sleep.
- You have little to no disposable income.
- Your monthly income is below the median level in your state.
How to File Chapter 7 Bankruptcy
The most important factor in filing Chapter 7 bankruptcy is finding an experienced bankruptcy attorney. Once you decide on an attorney, you can refer creditors to your lawyer’s office. Filing the petition will trigger an “automatic stay,’’ which means creditors can’t pursue lawsuits, garnish your wages or contact you about your debts. Here’s a potential timetable:
If you’re qualified, it will take 4-6 months to complete the bankruptcy process.
Here are the steps you must take when filing for bankruptcy:
- To start the process, the debtor must fill out a long series of forms that detail records of assets, liabilities, income, expenses and overall financial standing, plus any existing contracts or leases in the debtor’s name.
- Pre-bankruptcy credit counseling ($50) is the next required step for debtors filing under Chapter 7. These course typically are offered by nonprofit credit counseling agencies, who look at your financial situation to determine if there are other avenues (debt management, debt consolidation, debt settlement) that could resolve the issue without having to file bankruptcy.
- If it’s determined that bankruptcy is your best solution, then you, or your attorney, must take the forms you filled out in Step 1 and file a petition for bankruptcy at the local bankruptcy court.
- From there, it’s time to reach into your wallet (what’s left of it) and start paying for the process. Some of the bills you must pay include a petition filing ($335), court fees (which vary by state) and attorney fees (the national average for Chapter 7 bankruptcy is $1,250, according to the National Bankruptcy Forum). Bankruptcy involves a lot of paperwork, which becomes public record. Bankruptcy court participants are generally featured in newspapers and online, so there’s a potential loss of financial control and privacy.
- Once your case has been filed, the court will appoint a bankruptcy trustee to oversee the accuracy of the documents you filed. The trustee will want to see copies of bank statements, paycheck stubs, tax returns, etc. to verify that your documents are accurate.
- The next step is a meeting with the trustee and creditors, if any creditors decide to pursue the debts you are trying to discharge. The trustee (and possibly the creditors) may have questions about some of the documents you filed and you are required to answer. The trustee has 30 days for objecting to property the debtor wants the right to retain. Other creditors have 90 days from the meeting to file a suit alleging that their debt should not be eliminated in the bankruptcy. It’s possible the trustee will say the Chapter 7 case should have been filed as a Chapter 13.
- The next step is to make sure that if you made promises about secured debt – usually a home or automobile – you fulfilled those promises.
- Then comes a second counseling session called “debtor education.” These also are administered by nonprofit credit counseling agencies who try to teach you ways to handle debt so you don’t wind up back in court again.
- If all goes well – and in the vast majority of cases it does – the judge will discharge your qualified debts and you no longer have a legal obligation to pay them.
Once completed, your financial situation will seem like a mess. Without debts, though, you can start on the road back. Setting up a budget and applying for a secured credit card are some preliminary steps.
You will likely need to change your spending habits. Regular credit counseling or help from a financial planner could be a smart approach. It’s also very important to pay all your bills on time and never use credit cards or loans as an extension of your income. It’s common sense time. Live within (or beneath) your means. Be thankful for what you can afford. The new financial goal: Never ending up in a bankruptcy situation again.
The rebuilding process can be quite rigorous. Bankruptcy will stay on your credit report as a negative mark for up to 10 years. It’s also required that you declare your bankruptcy filing to future employers and on medical forms, along with state or government official reports.
So, it’s something to consider, primarily because it can drastically affect your chances of getting a mortgage or a college loan.
But facing dire financial straits, bankruptcy might be your best option. You wouldn’t be alone. Bankruptcy can happen to anyone.
Preparing for Chapter 7 Bankruptcy
There’s some protocol to follow in the months before filing for bankruptcy. Failing to follow these instructions could undermine your efforts.
Don’t Pay Creditors — It seems counterintuitive and you should definitely make routine payments. But any large or unusual payments could be viewed as “preferential transfers.’’ That means one creditor has benefited unfairly over others.
No New Debt — A new creditor could claim you took out a loan or ran up the balance on a credit card without intending to pay it back. Legally, that’s fraud and it will not be forgiven.
No Unusual Transactions — Don’t stray from the routine. Don’t transfer titles of cars or homes. Don’t buy luxury goods. Don’t transfer your business or remove your name from it. They can all be classified as fraud.
Be Truthful — You are required, while filing for bankruptcy, to provide full and complete information. You must disclose any debt, assets, accounts or other financial information. Failure to comply could lead to fraud and potential criminal charges.
Don’t Touch Retirement Funds — You are generally allowed to keep retirement plans and accounts, so keep them safe while considering bankruptcy and don’t use those funds to pay down debt.
Use Common Sense — You should not file for bankruptcy if you’re about to receive a large sum of money, such as an inheritance. You could use that money to pay down your debts. Otherwise, if you’re involved in a bankruptcy process, that money could be seized by a court representative to pay your debts.
Never think you can get away with something sneaky or dishonest. Your bankruptcy lawyer is always a good resource for what you should and shouldn’t do.
Pros and Cons of Filing Chapter 7 Bankruptcy
Deciding to file for Chapter 7 bankruptcy is a big decision that shouldn’t be taken lightly. There are pros and cons, which must be weighed carefully while studying your situation.
Pros of Chapter 7
- It will prevent your lenders from aggressive collection action.
- Chapter 7 is easily understood and explained to curiosity-seekers and future lenders. Sure, they might have questions about bankruptcy and it will hurt your credit. But if you talk yourself out of Chapter 7 when it could be the right decision, consider a future of trying to explain your missed debt payments, defaults, repossessions and lawsuits. And yes, all of those will hurt your credit, too.
- You will be forced to be more disciplined financially. If you ever intend to borrow money again, you will need to be frugal and demonstrate responsibility in repaying debt. Even though you might be able to open new lines of credit anywhere from one to three years after filing for bankruptcy, the interest rates will be much higher. Demonstrating ability to pay those debts on time is the only way to get the interest rates down.
- In many states, exemptions will allow you to keep many of the things you own, including more property than you probably need. After you file, you will be able to keep any salary you earn and any property you purchase.
Cons of Chapter 7
- Your credit will take a major hit. Chapter 7 bankruptcy can remain on your credit report for up to 10 years — though if bankruptcy is a viable option, chances are your credit is already tarnished.
- You will lose all of your credit cards.
- You may lose luxury possessions, like a boat or second home, depending on how much equity you have.
- You will need to wait 2-4 years (depending on the type of loan) before you are able to get a mortgage.
- It won’t automatically relieve you of student loan debt or obligations to pay alimony and/or child support.
Chapter 7 Bankruptcy FAQs
From a practical standpoint, there are two questions that always come up for anyone considering bankruptcy and several others that apply to just about anybody filing Chapter 7.
There is no minimum or maximum amount of debt for Chapter 7 bankruptcy.
To automatically qualify for Chapter 7, your disposable income must be below the median level for your state. That number varies from state-to-state. If your disposable income exceeds the median in your state, you still may be able to qualify through a “means” test that includes looking at your income and reasonable expenses to see if you can get that number under the median income for your state.
No. In fact, you probably will retain most of your possessions. Several online sources claim that 96% of Chapter 7 filings are deemed “no asset cases” by trustees, meaning nothing the consumer owns will sell for enough to pay off creditors. So, in many cases, you won’t lose your possessions.
No. There are some debts including child support and alimony that can’t be discharged in a Chapter 7 filing.
Mainly, credit card debt and medical bills. You could have unsecured personal loans discharged, too.
If you’re going to use an attorney, you’re going to need somewhere around $2,200 to cover all your costs. If you’re going to represent yourself, figure around $800.
The major difference is time – Chapter 7 takes 4-6 months; Chapter 13 takes 3-5 years – and money. You can have most, or all your unsecured debt discharged in Chapter 7 bankruptcy. In Chapter 13, some of your debt is forgiven, but only if you meet the conditions approved by the trustee and bankruptcy judge.
Chapter 7 is, by far, the more popular form because it’s cheaper, quicker and effective at relieving responsibility for debt … if you qualify! And that’s a big if. You must pass a means test, meaning your disposable income is under the median income in your state. If you don’t qualify for Chapter 7, you can always fall back on Chapter 13.
Not if it gets you out of debt. You might be able to run from creditors for a while, but eventually the stress of that overwhelms people. Bankruptcy lets you stop running and start over again. It may take a few years for you to get loans and obtain credit again, but at least you’ll have that opportunity. Bankruptcy is meant to give people who made financial mistakes a second chance. In today’s turbulent economy, that is a good thing.
Alternatives to Filing Chapter 7 Bankruptcy
If you are wondering if you should file for bankruptcy, there are many nonprofit consumer credit counseling organizations that have the ability to negotiate more favorable terms with creditors. It’s particularly effective with credit-card companies. The repayment program will be managed expertly and fees could be avoided.
Here are some options:
Debt Management Plan — Entering into a debt management program can provide relief from interest rates, late fees and penalties from creditors. Under a DMP, which is negotiated by credit counselors, you promise to pay back the full principal over time in an efficiently managed manner.
The debt management program provides an organized monthly payment plan. It provides an opportunity to handle the debt more efficiently than trying to sort it out yourself. By keeping the payments on track, it will be good for your credit score.
Some caveats: There is generally an enrollment and maintenance fee and the DMP is never a guaranteed option. Creditors have no obligation to participate.
Debt Consolidation— This option reduces interest rates and combines all of your debts into one manageable monthly payment. Under debt consolidation, you take out a loan, which is used to consolidate and pay off all of your other debts.
Debt consolidation companies are experienced at acquiring loans and finding the lowest monthly payment. With credit-card loans, the consolidated interest rate can be significantly less than what is being charged on each of your credit cards.
A word of caution, though. Be sure to look for a dependable and experienced debt consolidation company (with at least five years of experience). Also, be wary of consolidating several unsecured loans into one secured loan. If you can’t pay back the loan, collateral items at stake typically include your home or car and you could lose one or both!
Debt Settlement — It’s a lump-sum settlement payment with creditors, although this option is generally a consideration only for people with very poor credit. It allows you to decrease the principal you owe while eventually retiring the debt.
In most cases, you will around 50%-75% of the original debt. But it’s important to determine — up front — whether the company is charging a percentage of the debt as its fee or you could find yourself paying even more. Be aware that debt settlement is damaging to your credit score. Lenders often will report the debt as “settled for less than agreed’’ or “settlement accepted’’ for seven years.
Personal Loan for Bad Credit — Yes, you can get a personal loan with bad credit, depending on your situation. You can expect high interest rates and should only consider this option if you can truly afford the monthly payment.
What to Do After Chapter 7 Bankruptcy
Push the re-start button on your financial life.
That’s the first thing anyone should do after having debts discharged in Chapter 7 bankruptcy. Hopefully, that re-start button includes a plan for reduced spending and paying all bills on time.
The easiest way to do that is to draw up a budget that realistically accounts for your income and expenses.
If you’re not good at that, call a nonprofit credit counseling agency and get some free assistance from their professional certified counselors. Helping consumers come up with an affordable monthly budget is their specialty.
They can give you the benefit of their training and experience at drawing up monthly budgets, plus tips on how to make the bottom line come out in your favor every month.
If you get in the habit of paying bills on time, you will begin to rebuild your credit, and you’ll regain favor with lenders and credit card companies. A few years of good practice and you – and your creditors – will forget this ever happened.
About The Author
Bill “No Pay” Fay has lived a meager financial existence his entire life. He started writing/bragging about it in 2012, helping birth Debt.org into existence as the site’s original “Frugal Man.” Prior to that, he spent more than 30 years covering the high finance world of college and professional sports for major publications, including the Associated Press, New York Times and Sports Illustrated. His interest in sports has waned some, but he is as passionate as ever about not reaching for his wallet. Bill can be reached at [email protected].
- United States Courts. Individual Debt Adjustment. Chapter 7. Retrieved from: http://www.uscourts.gov/federalcourts/bankruptcy/bankruptcybasics/chapter7.aspx