Chapter 7 Bankruptcy: Understanding the Basics
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Bankruptcy laws were designed to give people in dire financial situations a chance to start over. Whether your troubles stem from bad decisions or just bad luck, bankruptcy can help you resolve your debt and get back on stable financial footing.
While stories of big companies declaring bankruptcy tend to make the news, individual bankruptcies are far more common. In 2017, there were just 23,157 business bankruptcy filings, compared to 765,863 non-business bankruptcies, according to the Administrative Office of the U.S. Courts. Of those, Chapter 7 is by far the most common, making up more than 60 percent of all non-business bankruptcy filings in 2017.
Note: If you are dealing with an insurmountable amount of debt and feel like bankruptcy is your only option, click below to see if you qualify for other debt relief options.
What is chapter 7 bankruptcy?
If you’re facing financial troubles and considering declaring bankruptcy, you likely have some questions about what type of filing is right for you and the effect it will have on your credit score and assets. Chapter 7 bankruptcy is named for Chapter 7 of the Bankruptcy Code. In Chapter 7, the debtor’s assets are liquidated, or sold to pay off creditors which in return allows you to start over with a clean slate.
Other forms of bankruptcy, such as Chapter 13, typically allow the debtor to keep their property and work out a plan to repay creditors, but Chapter 7 does not. This guide will explain who is eligible to file Chapter 7, and how that will affect you now and in the future.
To qualify for Chapter 7, an individual must pass a means test, which is done using an official form.
James Shenwick, personal and business bankruptcy attorney with Shenwick & Associates in New York, NY, says completing the means test calculations is very complicated and virtually impossible to do without a software program, so you should seek help from an experienced bankruptcy attorney before you attempt to complete the form on your home.
The form requires you to provide your income and expenses, then make calculations using the information entered. Some of that information, such as your current monthly income, will come from your own records. Other information will come from the IRS and the Census Bureau but are available through the U.S. Department of Justice.
The means test is designed to determine whether you have the means to repay a portion of your debts. If the calculation determines you can, then you don’t qualify for Chapter 7 bankruptcy. If the calculation determines you don’t have the means to repay your debts, you may consider filing for Chapter 7.
The forms needed to complete the means test and the instructions for completing them are available for download through the U.S. Courts website. They include:
- Form-122A-1, Chapter 7 Statement of Your Current Monthly Income
- Form 122A-2, Chapter 7 Means Test Calculation
- Form 122A-1Supp, Statement of Exemption from Presumption of Abuse Under §707(b)(2)
Which debts can be forgiven in chapter 7 bankruptcy?
After Chapter 7 bankruptcy, many of your debts will be discharged, or wiped out, at the end of your case. However, this isn’t true of all debts. The discharge of debt is established by federal law. Some debts cannot be discharged in bankruptcy, so you will still owe them after your other debts have been discharged.
Officially, any debts that you did not list on your bankruptcy paperwork can remain after you’ve declared Chapter 7 bankruptcy, but Shenwick says, in practice, that doesn’t usually happen.
There are two types of Chapter 7 bankruptcies: asset (where the debtor owns assets that can be sold and the proceeds distributed to creditors) and no asset (where the debtor doesn’t own any nonexempt property, cash or valuables).
“If a creditor is omitted and it’s a no-asset case, the debt will be discharged. If it’s an asset case, the paperwork can be reopened, and the omitted debt can be added,” Shenwick says.
Debts that CAN be discharged in a Chapter 7 bankruptcy include:
- Credit card debt
- Medical bills
- Lawsuit judgments
- Most debts arising from car accidents
- Obligations under leases and contracts
- Personal loans
- Promissory notes
Debts that CANNOT be discharged in bankruptcy include:
- Child support and alimony
- Fines, penalties, and restitution you owe for breaking the law
- Certain tax debts
- Debts arising out of someone’s death or injury as a result of your intoxicated driving
And finally, some debts can be discharged in a Chapter 7 bankruptcy unless a creditor objects and convinces the court that they should not be discharged.
- Debts arising from fraud
- Debts for luxury purchases or cash advances made within a period of time prior to filing
- Debts arising from willful and malicious acts
- Debts arising from embezzlement, theft or breach of fiduciary duty
Shenwick says, in his experience, less than one in ten debts are objected to by creditors in court.
“It’s rare for the creditor or the trustee to object,” Shenwick says. “The presumption in bankruptcy is that the person is entitled to a discharge. The goal is a fresh start, so as many debts as can be wiped out should be discharged.”
What assets will I lose?
Chapter 7 bankruptcy requires the debtor to sell certain assets and use the proceeds to pay their debts. But some assets are exempt under federal and state bankruptcy laws, meaning the individual is allowed to keep the assets.
The home is often the asset most people considering Chapter 7 bankruptcy are concerned with losing. Most states allow homeowners to protect a certain amount of the equity in their home from creditors. This is called the homestead exemption. The federal homestead exemption is currently $23,675, or double that amount for a married couple jointly owning a home.
So if you own a home worth $300,000 with a mortgage of $285,000, your equity of $15,000 would be fully protected by the federal homestead exemption. That’s because the $23,675 exemption amount is larger than and covers the entire amount of the $15,000 equity. However, in some states, the state homestead exemption is much lower than the federal one, and not all states allow their residents to use the federal exemption amounts. So it’s a good idea to consult with an experienced bankruptcy attorney in your area to find out which set of exemptions apply.
Federal bankruptcy law permits each state to adopt its own exemption laws in place of the federal exemption. In some states, the debtor has the option to choose between the federal and state exemption lists and select the one most beneficial in their circumstances.
Exemptions may enable you to keep your home, one car, clothing, household items and even some proceeds from the sale of your property. Keep in mind that exemptions are not automatic. For an asset to qualify for an exemption, you must list the item on the exemption form and specify the amount of the exemption you’re claiming.
The amount of exemption you are entitled to claim for different assets may also vary by state.
For example, in California, you can claim a $2,300 exemption for a motor vehicle. If your vehicle is worth less than $2,300, you can keep your vehicle. If your vehicle is worth $5,000, the bankruptcy trustee will likely sell your car, pay you $2,300 for the exemption, and use the remainder of the proceeds to pay off your creditors.
How does Chapter 7 bankruptcy affect my credit and for how long?
Bankruptcy will no doubt hurt your credit score, but the extent of its impact depends on over overall credit profile.
According to our research, 43% of people with a bankruptcy on their credit file have a credit score of 640 or higher within a year of the bankruptcy. Within two years of bankruptcy, 65% have a credit score above 640.
In reality, if you are in a position where your debts are so overwhelming that you need to file bankruptcy, chances are your score is already pretty low to begin with. And because of that, your score may not see a huge drop at all. However, if you have good credit, you can definitely expect to see a significant dip. .”
Expect a Chapter 7 bankruptcy to remain on your credit report for up to 10 years from the date filed. But the negative impact of the bankruptcy on your credit score will lessen over time, meaning a bankruptcy that is only one year old will have a more significant impact than one that happened eight years ago.
Is Chapter 7 Bankruptcy right for me?
Mark Billion, CEO of BankruptcyAnywhere.com, a software program that helps people act as their own attorney for a bankruptcy filing, says Chapter 7 may make sense for people who:
- Make less than 50% of the median income level in their state. “Those who make more than 50% of the median income for their state have to explain to the Court why they deserve to file,” Billion says.
- Are current on their rent/mortgage and car payment. “If you are not trying to catch up on secured debt (the technical term for loans secured by your home or car) a Chapter 7 should be your best bet. It eliminates payday loans, credit cards, medical bills, personal loans, and pretty much everything else.”
- Have little or no disposable income.
- Have not successfully filed Chapter 7 during the previous eight years.
|Pros & Cons of Chapter 7 Bankruptcy|
|A fresh financial start||Will remain on your credit report for up to 10 years|
|You may be able to keep certain exempt assets||May impact your ability to get credit, buy a home, buy a car, rent an apartment, or even get a job for quite some time|
|Collection efforts by your debtors must stop as soon as you file|
If you don’t meet the means test for Chapter 7, and you have income, but either through bad luck or bad decisions got in over your head in debt, Chapter 13 may be a better option. Chapter 13 bankruptcy helps you work out a court-approved payment plan to help you pay off your debts over a period of three to five years. Once the payment plan is completed, any remaining debts are discharged.
If Chapter 13 is a viable option, it may be preferable. A Chapter 13 bankruptcy may be removed from your credit report after seven years (as opposed to 10 years with Chapter 7). Also, some creditors look more favorably on Chapter 13 bankruptcies since you’re paying more of your debts off than you would under Chapter 7.
Chapter 13 vs. Chapter 7
|Chapter 13 Bankruptcy vs. Chapter 7 Bankruptcy|
|Set up a plan to repay all or part of your debts while keeping your home, vehicle, and other personal property||Liquidate all non-exempt assets and use the proceeds to pay creditors|
|For debtors with a stable monthly income and the ability to make payments under the proposed plan||For low-income debtors with little or no assets|
|Cannot have more than $394,725 of unsecured debt or $1,184,200 of secured debt||No upper limit on debt|
|Receive discharge of eligible remaining debts after completion of repayment plan (usually three to five years)||Receive discharge of remaining eligible debts typically within three to five months|
|Allows the debtor to catch up on missed payments and avoid foreclosure or repossession||May not provide a way for the debtor to avoid foreclosure or repossession (depends on state law)|
|Remains on your credit report for up to seven years||Remains on your credit report for up to 10 years|
PART II: Filing for Chapter 7 Bankruptcy
Here’s an overview of the steps involved in filing for Chapter 7 bankruptcy.
Find an attorney
Many blogs and websites have bankruptcy information, but your best course of action is speaking to an experienced personal bankruptcy attorney who is familiar with the laws of your state.
Shenwick says in his experience, once a person realizes they have a problem that may lead to bankruptcy, they speak to their accountant. The accountant may know about the issue anywhere from six to 12 months before the individual consults an attorney.
“So many people say they wished they’d come to see me a year ago,” Shenwick says. “It’s the avoidance reaction – they put off what is unpleasant or uncomfortable.” Despite those fears, Shenwick says delaying the inevitable is a mistake. “Some people make their problems worse by attempting to transfer assets to friends and family – that’s a big no-no. Or they might pay the wrong creditors. If you sense you’re in trouble, speak to an attorney as soon as possible to prevent mistakes that can make matters worse.”
Shenwick recommends getting a referral from your accountant, family attorney or friend. If you can’t find someone through word of mouth, call your local bar association. They maintain a list of bankruptcy attorneys in your area.
Great ready for credit counseling
The federal Bankruptcy Code requires individuals filing for bankruptcy to get credit counseling within a 180-day period before filing a bankruptcy petition. If you are married, both spouses must attend credit counseling.
The credit counseling agency must be approved by the U.S. Trustee Program. You can find a list of approved agencies from the U.S. Department of Justice.
Petition and paperwork
Next, you’ll file a petition with the bankruptcy court in your area. In addition to the petition you will also have to submit:
- A schedule of assets and liabilities
- A schedule of current income and expenses
- A statement of financial affairs
- A schedule of contracts and unexpired leases
- Certificate of credit counseling
- A copy of any debt repayment plan developed through credit counseling
- Pay stubs (if any) for the last two months
The court is required to charge a $245 case filing fee, a $75 miscellaneous administrative fee, and a $15 trustee surcharge. In most cases, you have to pay these fees before filing, but in some cases, the court will permit you to pay in installments over the course of 120 days.
A trustee is appointed to your case
After your petition is filed, the U.S. trustee appoints an impartial case trustee to your case. It’s the trustee’s job to administer your case and liquidate any nonexempt assets.
The trustee is also required to ensure that you understand the potential consequences of bankruptcy, including its effect on your credit rating, your ability to file for bankruptcy in the future, and the financial impact of receiving a discharge of your debts.
It’s crucial to cooperate with the trustee and promptly deliver any financial records or documents the trustee requests.
Time to meet your creditors
Somewhere between 21 and 40 days after your petition is filed, the trustee will hold a meeting of creditors. During this meeting, you will be placed under oath and must answer questions posed by the trustee and your creditors. You are required to attend the meeting and answer questions about your finances and assets.
Your lawyer will prepare you for the meeting of the creditors and attend the meeting with you. In most cases, the questions will be very similar to the ones already asked by your attorney. The purpose of this meeting is simply to get you to confirm, under oath, that the written disclosures you provided in your paperwork are true and complete.
At this point, your trustee has gathered enough information for the court to make a decision on whether or not you are eligible for Chapter 7 protection. If you are eligible according to the means test, your case will proceed. If you’re not eligible, you have the option to file for Chapter 13 bankruptcy.
Nonexempt property is liquidated
If you have nonexempt assets, the trustee will determine whether they are worth seizing and selling. In some cases, you may be able to keep certain non-exempt assets if the trustee determines that selling them is not worth the effort. For instance, if you own a boat worth $3,000, but owe $2,800 on the loan you used to purchase the boat and the cost to transport and sell the boat would be $200, the trustee may determine it’s not in your creditor’s best interest to sell the boat.
The trustee also has the power to recover money or property under their “avoiding powers.” This includes the ability to reverse certain transfers made to creditors within 90 days of your petition for bankruptcy and undo certain transfers of property.
Once the trustee has sold nonexempt assets and paid out creditor claims, remaining eligible debts are discharged, and the creditors are no longer allowed to take any collection actions. In most cases, the Court issues the discharge order within 60 to 90 days of the meeting of the creditors.
Not ready for bankruptcy? Other ways to tackle a debt
Bankruptcy can give people in dire circumstances a fresh start, but it’s not a decision to be taken lightly. Bankruptcy has serious and long-term consequences. Before you file, consider some alternatives.
With debt consolidation, you can roll all unsecured debts such as credit cards, personal loans, and medical bills into one new loan with one monthly payment. In most cases, you’ll also negotiate lower interest rates or a reduced balance with your creditors, so your payments are manageable.
Debt consolidation still has a negative effect on your credit score because you aren’t paying your debts as agreed, but its impact is typically not as severe as declaring bankruptcy.
Debt settlement involves negotiating with creditors to settle your debt for less than is owed. This is most often used when you have one large debt with a single creditor, but it can be used to deal with multiple creditors.
Debt settlement still has a negative impact on your credit score because you aren’t paying the full amount owed. Also, the debt that is forgiven will be reported to the IRS and may increase your taxable income.
If you have cash in the bank or own other assets that can be sold to pay off your debt, this may be a viable alternative to declaring bankruptcy. Take into account any potential consequences. If you tap your retirement account to pay down debt, you may owe tax on the distribution as well as a ten percent penalty for early withdrawals. You could pay off one debt, only to find yourself owing the IRS.
Default on payments/Do nothing
Ignoring your debt problems won’t make them go away and may even make your situation worse. Interest and late fees will continue to accrue while you do nothing and the debt collectors may initiate a lawsuit.
If you find yourself unable to pay your bills, work with a qualified credit counselor to explore your options and possibly set up a debt management plan. If that doesn’t work, seek out an experienced bankruptcy attorney who can help you navigate the bankruptcy filing process.
Many people facing financial troubles fear they won’t be able to afford an attorney’s fees, but Shenwick says personal bankruptcy is handled on a fixed-fee basis, based on the complexity of your case, and often the attorney will adjust the fee based on the client’s ability to pay. “You’ll find that most bankruptcy attorneys are compassionate people. They do this work because they want to help people,” Shenwick says.
Life after bankruptcy
After filing a Chapter 7 bankruptcy, your credit score will be lowered, possibly by hundreds of points and the bankruptcy will remain on your credit report for the next ten years.
But this doesn’t mean you won’t be able to access credit for the next decade. “After bankruptcy, your best bet is simply to start from scratch,” Billion says. “Get a credit card (they’re typically available starting six months after settling your bankruptcy case) or failing that, a secured credit card. Use them responsibly and do not keep a balance. Assuming you don’t go back into massive debt, you can get a car loan at a decent interest rate in one year and a home loan in two years.”
It will take time to rebuild your credit score, and there’s no legal way to remove the bankruptcy from your credit report before the ten-year time frame has elapsed. But bankruptcy does give you a second chance, so don’t waste it. If you take this opportunity to learn a lesson about handling debt responsibly, over time, your credit score will begin to reflect that.