Chapter 7 Bankruptcy Defined – Should You File for Debt Discharge?

There might come a time in your life when filing for bankruptcy is in your best interest, financially speaking. You could be in over your head in debt and not sure of another way out. Filing for bankruptcy gives you the chance to press “reset” on your financial situation and to move on toward better things.

Bankruptcy comes in several different forms, and the best option for you depends on your specific situation. Chapter 7 bankruptcy is designed for people with a lot of debt and not a lot of income. If you know you just can’t repay what you owe, Chapter 7 might be the option for you.

What Is Chapter 7 Bankruptcy?

When you think of bankruptcy, you likely think of Chapter 7. Sometimes called a liquidation bankruptcy, Chapter 7 involves the sale of nonexempt assets, such as your second car, second home, and valuable family heirlooms. 

In addition to selling these assets, the bankruptcy court liquidates any savings or investments accounts you have. The proceeds from these activities go to repay your creditors. If the value of your assets isn’t enough to pay off all your debts, the remaining amount gets discharged or released. It’s canceled, and you won’t have to pay it. 

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Filing for Chapter 7 bankruptcy can give you nearly immediate relief, as the starting the process puts an automatic stay on your debts. Once the stay is in place, your creditors can’t take action against you, such as garnishing your wages or repossessing your property.

If everything goes well, the Chapter 7 bankruptcy process is typically over and done in six months.

Chapter 7 vs. Chapter 13 Bankruptcy

Chapter 7 isn’t the only bankruptcy option out there. As an individual, you can also file for Chapter 13 bankruptcy. There are notable differences between the two and one might be the better option for one person but not another.

Payment Plan

During a Chapter 13 bankruptcy, you enter into a repayment plan with your creditors. Usually, it takes a few years for you to pay off your debts under the plan. Chapter 13 is also called a reorganization bankruptcy.

Under Chapter 7, there’s no payment plan. Once your assets are liquidated and the debts fully or partially paid, the process is over. Even if you don’t have enough nonexempt assets to sell, you can still wipe out your unsecured debts through the discharge process.

Income Requirement

Another big difference between Chapter 7 and Chapter 13 is the income requirement. To be eligible for Chapter 7, you need to pass a means test. Your income can’t be more than the median income in your state or your expenses need to be large enough that you don’t have enough disposable income to repay your debts.

What Happens to Your Assets

Chapter 13 bankruptcy typically lets you hold on to your assets, if you have them. You can keep your house and primary vehicle, as long as you can continue to make payments on those debts. If you do want to sell an asset during Chapter 13, you need to get permission from the bankruptcy court first. 

Chapter 7 lets you keep your home and vehicle, if you have them, but requires you to sell more of your possessions.

Chapter 7 vs. Chapter 11 Bankruptcy

Chapter 11 is another bankruptcy option. It has some similarities to Chapter 13, as it allows you to reorganize your debts and work out a payment plan with your creditors. Usually, businesses file Chapter 11, although the option is open to individuals too. If your debt is too high to qualify for Chapter 13 or you don’t have stable income, Chapter 11 might be for you.

Businesses can also file Chapter 7 bankruptcy but not Chapter 13. 

Businesses file Chapter 11 with the expectation that they will continue to operate during and after the process. By contrast, Chapter 7 ends with the business’s assets being liquidated and the company ceasing to exist. 

Should You File for Chapter 7 Bankruptcy?

Chapter 7 bankruptcy isn’t the right choice for everyone. It’s very much a last resort, and you should first try to avoid bankruptcy altogether. But if you’ve exhausted all other options and are truly in over your head with debt, Chapter 7 can give you a fresh start. 

There are a few signs that filing for bankruptcy is the right option for you.

  • You Can’t Afford to Pay Your Debts Each Month. Are your debts overwhelming? For example, does more than half of your monthly income go toward debt? Are you unable to pay your debts each month after covering your living expenses, such as food and rent? If so, bankruptcy might be the path to take.
  • You Have Unsecured, Dischargeable Debts. Bankruptcy doesn’t get rid of every type of debt, such as unpaid child support, alimony, or federal student loans. But it does discharge credit card debt, personal loans, and other types of unsecured debt. If you have secured loans, Chapter 13 might be a better choice.
  • You Don’t Have a Lot of Assets. If you have a lot of assets, such as multiple vehicles, a second home, or beloved family heirlooms, you can lose them when you file Chapter 7. 
  • You Don’t Have a High Income. To qualify for Chapter 7 bankruptcy, your monthly income needs to be below the median income in your state. If you’re a higher earner, Chapter 13 or Chapter 11 might be more appropriate.
  • You’re Ready to Make a Change. Bankruptcy is a big step and it can be life changing for many people. But it’s not going to solve all of your problems, particularly if you don’t make changes in other areas of your financial affairs. If you’re ready to make a budget, stick to that budget, and avoid excessive debt when possible, Chapter 7 can give you a new start.

Eligibility for Chapter 7 Bankruptcy

Chapter 7 bankruptcy has stricter income requirements than Chapter 13. Some other eligibility requirements may prevent you from qualifying as well.  

  • You Need to Pass a Means Test. If your income is too high, you can’t file Chapter 7. You can pass the means test in one of two ways. If your monthly income is lower than the median in your state, you pass automatically. If your income is above the median, you can pass the means test if your disposable income — what’s left after you pay for necessary expenses — is low enough to meet the threshold. This threshold varies by state.
  • You Need to Complete Credit Counseling. You have to complete a credit counseling course no more than 180 days before you file.
  • You Can’t Have Had Another Bankruptcy Case Dismissed Within 180 Days. If you tried to file for bankruptcy within the past six months, and your bankruptcy case was dismissed for noncompliance, you can’t file for again.
  • You Can’t Have Had Another Completed Bankruptcy Within Six to Eight Years. If you previously completed Chapter 7 bankruptcy within the past eight years or completed Chapter 13 bankruptcy within the past six years, you can’t file again.

The Chapter 7 Bankruptcy Process

While Chapter 7 is quicker than Chapter 13, it’s not exactly a fast process. Preparing for Chapter 7 starts with completing credit counseling and may involve finding an attorney to help you choose between Chapter 7 and Chapter 13.

Here’s what to expect from the Chapter 7 bankruptcy process.

1.  Credit Counseling Course

During the bankruptcy process, you have to undergo credit counseling twice. The first part should be before you file, but not more than 180 days in advance. You can find an approved credit counselor through the U.S. Justice Department.

A key component of the pre-filing credit counseling program is helping you determine whether bankruptcy is the right choice for you. Your counselor might point you in the direction of resources you didn’t know existed or help you create a debt management plan

Alternatively, completing the credit counseling program could convince you that Chapter 7 is the best course of action.

2. Filing

After you’ve finished the credit counseling program and have decided to move forward, the next step is to file for bankruptcy. You’ll need to file a bankruptcy petition with your local bankruptcy court

Along with your petition, you’ll also need to present the court with several other bankruptcy forms:

  • A list of your assets and liabilities (debts).
  • Your current income and expenses.
  • A statement of financial affairs, which describes your income sources, payments you’ve made in the past, gifts you’ve received, and losses you’ve had. 
  • A list of your leases and contracts, if you have any (such as your apartment lease or an internet services contract).
  • Your most recent tax return.
  • A certificate of completion from your credit counseling course.
  • A statement of monthly income and any expected increase in expenses or income after you file.

When you file, you also need to pay several fees. There’s a $245 filing fee, a $15 trustee surcharge, and a $75 miscellaneous fee — all of which are subject to change over time. An installment plan might be available. If your income is 150% of the poverty level or less, the fees can be waived.

If you have any exempt property, such as a house or wedding ring, you’ll need to submit a list of it to the court when you file. 

3. Trustee Steps In

The court will appoint a bankruptcy trustee to act on behalf of your estate during the bankruptcy proceedings. The trustee comes from the Department of Justice and is responsible for carrying out your bankruptcy case based on the rules. 

In the case of a Chapter 7 bankruptcy, the trustee will arrange for the sale of your nonexempt assets, if you have any. They’ll then use the proceeds of the sales to pay off your debts in order of priority. 

Priority debts include tax debt, child support, and alimony. Nonpriority debts include your medical bills, credit card debts, and personal loans. 

Depending on how much your assets were worth, there might not be enough to pay both priority and nonpriority debts. In that case, the bankruptcy discharge will clear away the non-priority debts. If you still owe your priority creditors, you’ll have to pay them after the bankruptcy is over.

Secured debts are handled a bit differently in Chapter 7. The lender can claim the collateral on the debt. Alternatively, you can reaffirm it and make a plan to pay off the debt. You’ll keep the collateral and will still be responsible for the debt after the bankruptcy is over.

4. Creditor Meeting

The creditor meeting takes place after you’ve filed for bankruptcy and the trustee has been appointed. The trustee usually arranges the meeting. 

It’s a chance for your creditors to ask you questions about your debt and bankruptcy.  The trustee will most likely also ask you questions about your bankruptcy and debt during the meeting.

The meeting of creditors takes place 21 to 40 days after you file your bankruptcy petition.

5. Budget Counseling Course

The second part of credit counseling comes almost at the end of the bankruptcy process. You’ll need to complete a pre-discharge counseling program. 

While the first part of credit counseling focused on determining whether bankruptcy was right for you, the second part focuses on helping you carve out a path forward. Think of it as a crash course in financial literacy.

You’ll learn about making a budget, managing your income and expenses, and credit scores in the course. 

You need to complete the program within 60 days of the creditor meeting. You can find a list of approved credit counseling agencies through the Department of Justice. You can use the agency you used for pre-bankruptcy credit counseling as long as they are on the approved list for debtor education. 

Note that you can’t schedule your pre-bankruptcy and debtor education sessions simultaneously. The pre-discharge session needs to be separate.

6. Discharge

Within six months of filing, you should receive a discharge from your bankruptcy. You’ll receive a copy of the discharge in the mail. Your trustee, creditors, and any attorneys involved will also get a copy. 

If you don’t get a copy, contact the clerk of your local bankruptcy court to see what’s going on. They can send you a new copy, but there’ll likely be a fee. You can also try searching for a copy of your discharge on the court’s PACER system.

The discharge means the process is over and you’re no longer responsible for certain debts. 

Remember that a bankruptcy discharge doesn’t necessarily mean all of your debts are gone. If you have priority debts or reaffirmed secured debts, you’ll still need to pay them after the discharge.

Final Word

While Chapter 7 bankruptcy can help you move past debt, there are some drawbacks to it that are worth considering. The bankruptcy will stay on your credit report for 10 years and can cause your score to drop substantially. The hit to your credit score can make it more difficult to get credit in the near future.

It’s also important to understand that Chapter 7 won’t won’t discharge all debts and isn’t necessarily the magic get-out-of-debt free card it’s sometimes depicted as.

But if you’re having trouble affording your living expenses while buried under a mountain of debt, Chapter 7 can be that lifeline that helps you get out. If you’re considering bankruptcy, talk to an attorney and a credit counselor at a nonprofit organization so that you have a full understanding of what your options are.

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