Chapter 7 Bankruptcy: Pros & Cons
The first bankruptcy laws date back to 16th century England. Back then, going bankrupt could mean a trip to debtors’ prison or even the gallows. Early bankruptcy laws focused on punishing the debtor and repaying the creditor. Eventually, modern bankruptcy laws would emerge as a rehabilitation method, a form of reorganizing one’s debts and assets.
There are six chapters of bankruptcy in the U.S. However, the most common types of bankruptcy are Chapter 7 and Chapter 13. Chapter 7 bankruptcy is known as ”liquidation,”while Chapter 13 is called “reorganization.”
In Chapter 7, a bankruptcy trustee collects your nonexempt assets and uses them to pay off creditors. Certain property is exempt, which means it is protected from seizure. This should include many of the items you will need to work and live, sometimes referred to as “necessities of modern life.”
One major difference between these types of bankruptcies is that Chapter 7 discharges your debts without the need for repayment.
Pros of Chapter 7 Bankruptcy
Bankruptcy falls victim to all sorts of misinterpretations. In truth, it was designed to relieve certain debts and give individuals a fresh start. It should be seen as a way out rather than a punishment. In fact, a 2018 survey by American Bankruptcy Institute showed that 93% of Chapter 7 applicants were able to protect all their assets, including home and car, as long as they were able to make on-time payments.
So, if done properly Chapter 7 really can be a “fresh start” for someone and not a time when they lose everything.
Let’s go over some of the other pros of filing for Chapter 7 bankruptcy.
The undeniable upside to filing for Chapter 7 bankruptcy is the debt relief it provides. It has the power to lift a major burden off your shoulders in just a few months. Most unsecured debt can be discharged, including credit cards, medical bills, and personal loans.
Individuals, self-employed workers, small business owners, and corporations may all file Chapter 7 bankruptcy. Relief is available regardless of how much you owe; there is no max limit that disqualifies you. However, individuals are required, within 180 days before filing, to receive credit counseling from an approved credit counseling agency.
No Collections or Repossessions
Filing Chapter 7 Bankruptcy automatically stays collection actions. This forces creditors to stop any lawsuits, wage garnishments, and phone calls. The bankruptcy clerk will alert all creditors whose names and addresses you provide.
The Bankruptcy Code lets debtors protect most of their property. This protected property is considered exempt, which means the bankruptcy trustee cannot sell it to pay off your creditors.
Exemptions vary by state. However, most things that are considered necessary for life usually fall under exemptions. Your car, most of your household items including clothes and furniture, and a portion of your home’s equity are often considered ‘exempt’.
If you’re considering bankruptcy, you’re in a tight position and credit is hard to come by. Nobody wants to loan money to underwater borrowers. Once you file and assume the label of bankrupt, it will be even harder to qualify for any sort of credit. However, after some time, your credit score will rise again, and the more time that passes after filing, the less creditors will hold your bankruptcy against you. Eventually, with a little effort, you will be in good standing once more, but the only way to get there is by sticking out the entire bankruptcy process.
Some lines of credit are easier to get your hands on than others. For this reason, it may be wise to apply for a secured credit card, which can improve your credit score when you pay your bill on time, each month.
Quick & Cheap Processing
Though a Chapter 7 bankruptcy remains on your credit report for 10 years, the process, from initial filing to discharge, should take between four to six months. This is a good thing since the sooner your debts are cleared, the sooner you can begin the road to re-establishing good credit and healthy finances.
Here are some of the fees you will need to pay when you file:
- $245 case filing fee
- $75 miscellaneous administrative fee
- $15 trustee surcharge
Cons of Chapter 7 Bankruptcy
The consequences of bankruptcy may not be as severe as they were in the past, but it still comes with risks. Bankruptcy can wipe the slate clean, but there are measures in place to make sure the debtor is still held accountable for falling short on his or her agreement.
Here are some of the cons of filing Chapter 7 bankruptcy:
Effects on Credit
A bankruptcy will tarnish your credit report for 10 years. This will make it harder to apply for credit, which means you may have to hold off on major purchases. Buying a house, returning to school, even applying for a credit card will all become more difficult after you file. Just keep in mind these effects are temporary, though long term.
Not All Debts Are Discharged
For some, there’s just no escaping all of it. Certain debts will remain on your account when you file for Chapter 7 bankruptcy. You will still be responsible for alimony and child support. Tax liens, student loans, and personal injury debts caused by intoxicated drivers are still on the docket, as well.
Loss of Property
Uscourts.gov gives the following definition for Chapter 7 bankruptcy:
This chapter of the Bankruptcy Code provides for liquidation – the sale of a debtor’s nonexempt property and the distribution of the proceeds to creditors.
The keyword here is ”nonexempt.” Essentially, this means you will be able to keep most of what you need to get by. However, you may have to give up some property. Luxury items are the first to go. If you have a second car or vacation home, then you won’t have them for much longer.
Exemptions vary by state. For example, borrowers (who have equity) filing in Florida face little risk of losing their home thanks to the state’s homestead exemptions. Check your local laws to verify what qualifies as exempt.
There is a $245 case fee for filing federal bankruptcy, along with a few other administrative fees. However, you can pay these in as many as 4 installments. Just keep in mind, the last installment must be made 120 days after filing the petition. You may be able to have these fees waived if your income falls below 150% of the federal poverty guideline.
There is a means test required for debtors currently making over a monthly limit. If you make more than the median monthly salary of your state, then a means test is required to determine if you’re truly in a position that calls for bankruptcy. If the court finds that you make too much to file for Chapter 7, your case may be converted to Chapter 13 or dismissed.
Consult With a Professional About Your Options
There’s no reason to make this decision solo. Whether you need an expert to guide you through the whole process, or you’re simply looking for free consultation and advice on the best way forward, speaking with a bankruptcy attorney can help clear things up. These are trained professionals who focus their attention on none other than bankruptcy law. This means they can tell you if filing for bankruptcy is wise, premature or overdue.
Try not to look at bankruptcy as a punishment or something to feel ashamed of. From the modern perspective, that was never the intention.
In 1934, the Supreme Court ruled that the primary goal of bankruptcy was to offer debtors a fresh start, asserting:
“It gives to the honest but unfortunate debtor … a new opportunity in life and a clear field for future effort, unhampered by the pressure and discouragement of preexisting debt.”
About The Author
Bents Dulcio writes with a humble, field-level view on personal finance. He learned how to cut financial corners while acquiring a B.S. degree in Political Science at Florida State University. Bents has experience with student loans, affordable housing, budgeting to include an auto loan and other personal finance matters that greet all Millennials when they graduate. He has a prodigious appetite for reading, which he helps feed with writing from Scottish philosopher Adam Smith, the “Father of Capitalism.” Bents writing also has been published by JPMorgan Chase, TheSimpleDollar and Interest.com.
- N.A. (ND) Chapter 7 - Bankruptcy Basics. Retrieved from https://www.uscourts.gov/services-forms/bankruptcy/bankruptcy-basics/chapter-7-bankruptcy-basics
- N.A. (ND) A Brief History of Bankruptcy. Retrieved from https://www.bankruptcydata.com/a-history-of-bankruptcy