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Declaring bankruptcy is a major decision that can have long-term negative effects on your finances and credit. It's also a complicated legal process that may require you to do a fair amount of research before deciding your path forward, and if it's even the best option for you.
If you do ultimately decide to file, one of the first big decisions you'll make is whether to file Chapter 7 or Chapter 13 bankruptcy. These chapter names refer to sections of the U.S. Bankruptcy Code where it's outlined how, exactly, your debt is taken care of in each process. The choice (or necessity) to file one or the other determines whether you'll be put on a debt repayment plan or if your debts will be settled with the property you own. If you find yourself at a crossroads, start here to get a grasp on what's ahead.
How Does Bankruptcy Work?
Bankruptcy is a method to eliminate or at least reduce your debt when bills pile up beyond your ability to repay them. It should be viewed as a last resort to be considered only when all other potential courses of action to get back on track have been exhausted.
Individuals filing for bankruptcy mostly use either Chapter 7 or Chapter 13. The biggest difference between the two is what happens to your property:
- Chapter 7, which is known as liquidation bankruptcy, involves selling some or all of your property to pay off your debts. This is often the choice if you don't own a home and have a limited income.
- Chapter 13, also known as a reorganization bankruptcy, gives you the chance to keep your property (including secured assets like your home and car) if you successfully complete a court-mandated repayment plan that lasts between three and five years.
Depending on where you live and your marital status, some of your property may be exempt from being sold when you file Chapter 7 because of state-specific and federal exemptions. With exemptions, whether they be your home equity, retirement accounts or even personal possessions such as jewelry, you receive the allowed exemption amounts, and the rest of the proceeds will be used to pay off debts. You can read more about potential exemptions, and check out this chart for a quick rundown on the two types:
|Chapter 7||Chapter 13|
|Type of bankruptcy||Liquidation||Reorganization|
|Who can file?||Individuals and business entities||Individuals only (including sole proprietors)|
|Eligibility restrictions||Disposable income must be low enough to pass the Chapter 7 means test||Cannot have more than $419,275 of unsecured debt or $1,257,850 of secured debt (as of 2021)|
|How long does it take to receive a discharge?||Typically three to five months||Upon completion of all plan payments (usually three to five years)|
|What happens to property in bankruptcy?||Trustee can sell all nonexempt property to pay creditors||Debtors keep all property but must pay unsecured creditors an amount equal to value of nonexempt assets|
|Allows removing unsecured junior liens from real property through lien stripping?||No||Yes (if requirements are satisfied)|
|Allows reducing the principal loan balance on secured debts through a loan cramdown?||No||Yes (if requirements are satisfied)|
|Benefits||Allows debtors to quickly discharge most debts and get a fresh start||Allows debtors to keep their property and catch up on missed mortgage, car and nondischargeable priority debt payments|
|Drawbacks||Trustee can sell nonexempt property; does not provide a way to catch up on missed payments to avoid foreclosure or repossession||Must make monthly payments to the trustee for three to five years; may have to pay back a portion of general unsecured debts|
What Are the Eligibility Rules for Bankruptcy?
The main difference in eligibility comes down to your income. Chapter 7 requires you to have either a below-median level income for your state or to pass a means test to determine whether you can reasonably be expected to repay your debts with your disposable income (that's the income you have left over after paying for the essentials).
If you don't qualify for Chapter 7, you'll have to look at Chapter 13 bankruptcy instead. For this route, you'd have a regular income, unsecured debts under $419,275 and secured debts that total no more than $1,257,850 (as of 2021).
Will I Need to Repay All of My Debts in Chapter 7 and Chapter 13 Bankruptcy?
This depends on each type of debt involved. With both filings, your unsecured debts (ones not backed by collateral, like medical and credit card bills) are discharged—meaning you won't have to pay them.
With Chapter 7, those types of debts are wiped out with your filing's court approval, which can take a few months. Under Chapter 13, you need to continue making payments on those balances throughout your court-instructed repayment plan; afterwards, the unsecured debts may be discharged.
However, certain debts might not be wiped out by either Chapter 7 or Chapter 13 bankruptcy, including:
- Tax debts or government fees
- Auto loans
- Child support or alimony
- Student loans
Some of those secured loans may be reduced with Chapter 13 bankruptcy to make repayment easier with a "cramdown," in which your court-approved repayment plan decreases the balance you owe. For instance, you could secure a reduced balance on your car loan based on the vehicle's depreciated value. With Chapter 7, there's a potential to discharge secured debt like car loans, if you give up the property involved (in this case, the car).
How Does Filing Bankruptcy Impact Credit?
Your credit may not be in tip-top shape by the time you consider filing for bankruptcy, since high balances and missed payments are the top factors affecting your credit score. Still, the presence of a bankruptcy on your credit report will severely impact your credit scores and creditworthiness the entire time it is on your report. That impact will lessen as time passes, however. Chapter 7 bankruptcy remains on your report for up to 10 years, and Chapter 13 stays there for up to seven years.
It's not an ideal credit situation, of course, but you can use the time to manage your debts wisely and make consistent on-time payments. Like with any damage to your creditworthiness, it's possible to rebuild your credit with some focus and patience—along with using the debt relief provided by the bankruptcy to get back on track financially.
How Do I Apply for Bankruptcy?
The unfortunate reality of bankruptcy is that it will cost some money—more if you hire legal help, which you probably should (more on that below). All filings have to go through U.S. bankruptcy courts, where the cost to file is $335 for Chapter 7 and $310 for Chapter 13. However, you can ask the court to either waive your fee or let you pay with monthly installments. You'll also have to take debtor education courses if you file on your own.
And that's just the beginning. There's a list of documents you'll need to take care of, as well as the specific repayment proposal you need to submit for Chapter 13. That proposal gets reviewed by a court-appointed trustee, who contacts your creditors before approving your submission. Overall, neither filing is an easy process to handle on your own, and even minor mistakes on your end could be a setback for your case.
So, whether you file for Chapter 7 or Chapter 13 bankruptcy, it's typically a good idea to hire a lawyer to help you petition. A bankruptcy attorney's price depends on the nature and complexity of your filing, with Chapter 13 filings on the pricier end, but the price tag doesn't necessarily mean a lawyer is out of the question for you. Discuss payment plans with potential attorneys, check out local pro-bono (free) lawyers and legal aid offices, or use an online tool like Upsolve to cover your bases when it comes to bankruptcy.
The Bottom Line
Bankruptcy can sound scary, but it might be a necessary step to realign your finances and move forward without debt piling ever higher upon you. No matter what, reach out for help with professional advice and stay informed on your rights and options—your situation is never hopeless. Before and after you file bankruptcy, it's important to keep a close eye on your credit. Experian's free credit monitoring can alert you to score changes, including improvements that might come in the future once your bankruptcy is in the rear-view mirror.