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Bankruptcy

What Is Chapter 7 Bankruptcy?

Chapter 7 bankruptcy, also known as a straight or liquidation bankruptcy, is a type of bankruptcy that can clear away many types of unsecured debts. If you're far behind on your bills and don't have the means to afford monthly payments and living expenses, filing Chapter 7 bankruptcy could be a last resort to help you reset your finances. However, you may have to give up some of your possessions, and it will have a long-lasting negative impact on your creditworthiness.

How Does Chapter 7 Bankruptcy Work?

When you file for Chapter 7 bankruptcy, the court places an automatic temporary stay on your current debts. This stops creditors from collecting payments, garnishing your wages, foreclosing on your home, repossessing property, evicting you or turning off your utilities. The court will take legal possession of your property and appoint a bankruptcy trustee to your case.

The trustee's job is to review your finances and assets and oversee your Chapter 7 bankruptcy. They will sell certain property the bankruptcy won't let you keep (nonexempt property) and use the proceeds to repay your creditors. The trustee will also arrange and run a meeting between you and your creditors—called a creditor meeting—where you'll go to a courthouse and answer questions about your filing.

The list of property you don't have to sell or turn over to creditors (exempt property), and the total value that you can exempt, varies by state. Some states let you choose between their exemption list and the federal exemptions. But most Chapter 7 bankruptcy cases are "no asset" cases, meaning all of the person's property is either exempt or there's a valid lien against the property.

At the end of the process, approximately four to six months from your initial filing, the court will discharge your remaining debts (meaning you don't need to pay them anymore). However, some types of debts generally aren't dischargeable through bankruptcy, including child support, alimony, court fees, some tax debts and most student loans.

What's the Difference Between Chapter 7 and Chapter 13 Bankruptcy?

Chapter 7 and Chapter 13 are the two common types of bankruptcy that affect consumers. Either could help when you don't have the means to pay all your bills, but there are important differences between the two.

A Chapter 7 bankruptcy can wipe out certain debts within several months, but a court-appointed trustee can sell your nonexempt property to pay your creditors. You also must have a low income to qualify.

A Chapter 13 bankruptcy allows you to keep your stuff and get on a more affordable repayment plan with your creditors. You'll need to have enough income to afford the payments and be below the maximum total debt limits (currently nearly $400,000 for unsecured debts and $1 million-plus for secured debts).

A court will approve the Chapter 13 repayment plan, which usually lasts three to five years, and your trustee will collect your payments and disburse them to your creditors. Once you finish the plan, the remainder of the unsecured debts is discharged.

Who Qualifies For Chapter 7 Bankruptcy

There are a few requirements you'll need to meet to file for a Chapter 7 bankruptcy:

  • You generally must complete an individual or group credit counseling course from an approved credit counseling agency within 180 days before filing.
  • Either the average of your monthly income during the previous six months must be less than the median income for the same-sized household in your state or you must pass a means test, which determines if your disposable income is high enough to make partial payments to unsecured creditors. If you don't pass the means test, you may still be able to file a Chapter 13 bankruptcy.
  • You can't have filed a Chapter 7 bankruptcy during the past eight years.
  • You can't have filed a Chapter 13 bankruptcy during the past six years.
  • If you tried to file a Chapter 7 or 13 bankruptcy and your case was dismissed, you have to wait at least 181 days before trying again.
  • You may be eligible to file, but a court could dismiss your case if it determines you're trying to defraud your creditors. For example, if you take out a loan or use credit cards with the intent of then declaring bankruptcy to avoid repaying the debt.

What Debts Are Discharged in Chapter 7 Bankruptcy?

A Chapter 7 bankruptcy will generally discharge your unsecured debts, such as credit card debt, medical bills and unsecured personal loans. The court will discharge these debts at the end of the process, generally about four to six months after you start.

Some types of unsecured debts usually aren't discharged through a Chapter 7 bankruptcy, including:

  • Child support
  • Alimony
  • Student loans
  • Some tax debt
  • Homeowners association fees
  • Court fees and penalties
  • Personal injury debts you owe due to an accident while you were intoxicated
  • Unsecured debts that you intentionally left off your filing

Your creditor could also object and keep certain debts from getting discharged. For example, a credit card company could object to the debt from recent luxury goods purchases or cash advances, and the court may decide you still need to repay this portion of the credit card's balance.

Additionally, a Chapter 7 bankruptcy may discharge the debt you owe on secured loans. Secured loans are those backed by collateral, such as your home for a mortgage, or when a creditor has a lien on your property. However, even if the debt is discharged, the creditor may still have the right to foreclose on or repossess your property.

What Do You Lose and What Can You Keep in Chapter 7 Bankruptcy?

If you file for Chapter 7 bankruptcy, you may lose your nonexempt belongings, property that has a lien on it and property you offered as collateral for a loan.

Examples of exempt property based on current federal limits for an individual include:

  • A homestead exemption of $25,150
  • Up to $4,000 on a vehicle
  • Up to $1,700 in jewelry
  • Up to $13,400 in personal property, such as books, household items, and clothes (there's a $625 per-item limit)
  • Funds in tax-exempt retirement accounts, such as a 401(k) or 403(b) accounts, and up to $1,362,800 in combined savings in IRAs and Roth IRAs
  • Public benefits, such as Social Security, veterans benefits and unemployment
  • Up to $2,525 in books and tools of trade
  • Alimony and child support
  • Certain insurance benefits
  • An additional $1,325 in property of your choice, plus up to $12,575 of unused funds from your homestead exemption

Double these amounts if you're married and file a joint tax return. Keep in mind that states may have different exemptions and limits that you can (or must) use when filing bankruptcy. For example, the homestead exemption for a single homeowner living in California starts at $75,000, but is unlimited in some other states.

A trustee can't take property when its value is less than the exempt amount, which means you may be able to keep your home and vehicle.

For example, if your house is worth $400,000 and you still owe the lender $350,000, you have $50,000 worth of equity in the home. If your state has a homestead exemption higher than the $50,000 of equity you have, then the trustee can't take your home. But if your homestead exemption is $25,150, the trustee could take and sell your home, pay off your mortgage, give you the $25,150 exempt amount and use any remaining funds to repay other creditors.

A similar scenario could play out with other forms of secured debts, such as an auto loan. However, just because the trustee can't take and sell these assets doesn't mean you'll get to keep them in the long run.

When you're behind on your payments, your creditors can still foreclose on your home or repossess your vehicle once you complete the bankruptcy process. If you want to keep possessions that are securing your debts, you may have to continue making payments on the loan (if you're not already behind) or pay the full price to purchase the item.

How Long Does Filing a Chapter 7 Bankruptcy Take?

Generally, the entire Chapter 7 process from the initial credit counseling to the point when the court discharges your remaining debts takes about four to six months.

Your case could take longer, however, such as when the trustee asks you to submit additional documents or if they have to sell your property to repay creditors. Or, perhaps you want to try to get your student loans discharged in bankruptcy. It's possible, but difficult, and can require a lengthy trial.

How Long Does a Chapter 7 Bankruptcy Stay on Your Credit Report?

A Chapter 7 bankruptcy is a major derogatory mark that can hurt your credit for years to come. The Chapter 7 bankruptcy record can stay on your credit reports for up to 10 years from the filing date, and a completed Chapter 13 bankruptcy can remain on your credit report for seven years from the filing date.

The accounts that were included in your bankruptcy may fall off your credit report earlier, as most negative marks get removed after seven years.

How to File for Chapter 7 Bankruptcy

You can choose to file for Chapter 7 bankruptcy on your own or hire an attorney to help. Some legal aid centers and nonprofit credit counseling agencies may also be able to offer you free assistance. Once you determine that you're eligible, the process will be largely the same:

  1. Attend counseling: It starts with an individual or group credit counseling course from an approved credit counseling agency, which may take place online or over the phone. You must do this within 180 days of filing, although there are sometimes exceptions during emergencies or if there aren't enough approved agencies offering the service.
  2. File your forms: On your bankruptcy forms you'll list your property, exemptions, creditors, income, recent transactions and other financial information. If you have secured debts, you'll need to decide whether you want to pay off the debt, continue making payments or surrender the property to the creditor. There's a fee to file the forms, although you can also request a fee waiver based on your income.
  3. Send verification documents to the trustee: Once the court accepts your filing, you'll need to send documents to the bankruptcy trustee who will verify your bankruptcy forms. These could include recent bank statements, tax returns, paychecks and business documents.
  4. Creditor meeting: Attend the creditor meeting with the trustee and answer questions about your paperwork and situation. The meeting is often brief, and your creditors may choose not to attend.
  5. Attend budget counseling: Within 60 days of the creditor meeting, you must complete a second course from a counseling agency. Don't forget to submit your certificate of completion to the court, or the court may close your case.
  6. Wait for the discharge notice: Once the court receives your certificate of completion, and often within 60 to 75 days of the creditor meeting, it can discharge your debts. During this time, you might have to give the trustee your nonexempt property, but don't sell or give anything to anyone else you have the trustee's permission.

Life After Bankruptcy

Filing bankruptcy can be financially, physically and emotionally draining. However, it may be your best option when bills keep piling up and you don't have the means to pay your creditors. It's also possible to recover from bankruptcy and rebuild your finances and credit, but it will take time.