Your Full Guide to Chapter 7 Bankruptcy
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From debt consolidation loans to debt settlement, there are many debt-relief options to consider if you find yourself behind on monthly payments on your debts or are unable to afford living expenses. In a situation like this, a Chapter 7 bankruptcy may help because it can discharge some of your debts; think of it as hitting the reset button on your finances. And while a Chapter 7 filing may put an end to your financial ailments, it is accompanied by long-term repercussions, including a negative effect on your credit score.
Related: The Best Apps for Debt Repayment
In this article
What is Chapter 7 bankruptcy?
A Chapter 7 bankruptcy is also known as "liquidation bankruptcy" or "straight bankruptcy." It is the most common type of bankruptcy filed in the U.S. According to the American Bankruptcy Institute, about 52% of all bankruptcy filings between September 5 and September 11, 2022, were Chapter 7 filings.
But why is Chapter 7 also referred to as a liquidation? That's because a court-appointed bankruptcy trustee will sell your non-exempt assets and use those funds to repay creditors. Unsecured priority debts are paid first in Chapter 7 cases, and you can keep assets deemed exempt under bankruptcy laws. Federal and state laws govern exempt properties, and you choose either when filing for bankruptcy.
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Chapter 7 eligibility
Before filing for Chapter 7, you'll have to go through and pass a means test, which is meant to determine your eligibility by comparing your disposable income
with living expenses. After considering expenses and debt payments, your monthly income over five years shouldn't be less than 25% of the nonpriority unsecured debt, or $9,075, whichever is greater, or $15,150.
In addition, you won't be allowed to file for bankruptcy if a previous bankruptcy petition was dismissed during the preceding 180 days because you failed to appear before the court or comply with court orders, among other things. Credit counseling sessions and debtor education courses are also mandatory. If you don't attend a counseling session from an approved agency within 180 days before filing, you won't be eligible to file for bankruptcy. If a debt management plan was made during the credit counseling session, it must be filed with the court.
How does Chapter 7 bankruptcy work?
The process starts once a petition is filed with the bankruptcy court serving your area of residence. This filing must include:
- Schedules of assets and liabilities.
- How much you earn and your expenses.
- A statement of financial affairs typically contains financial records, information on any prior bankruptcy, recent or current debts, and monthly living expenses.
- A schedule of contracts still in effect and any unexpired leases.
People who have primarily accrued consumer debts have a few extra hoops to jump through and must file:
- A certificate of their credit counseling session and a copy of any debt repayment plan developed.
- Like a paystub, proof of payment from employers is received 60 days before the filing.
- A statement of monthly net income.
- A record of any interest in federal- or state-qualified education or tuition accounts.
Once a bankruptcy has been filed in court, an automatic stay is also placed. This suspends any legal actions from debtors, meaning they will not be able to contact you and fight for payment as they will be moving into bankruptcy court for further proceedings.
Up to 40 days after the filing is made, the case trustee will set up a meeting of creditors. In this meeting, you'll be under oath and have to answer questions about your financial affairs. Also, during this meeting, the potential consequence of a bankruptcy filing will be discussed, including its effect on your credit score. Chapter 7 doesn't entail attending confirmation hearings.
What does a bankruptcy case trustee do?
A case trustee's primary job is to gather and liquidate the debtor's nonexempt assets and pay creditors. It's important to note that the case trustee is impartial, meaning they cannot make financial moves perceived to be in one party's favor. When you file a Chapter 7 petition, it creates an estate that becomes the owner of all your assets. The Bankruptcy Code governs which creditor gets paid first; each class (as defined in bankruptcy laws) has to be paid in full before the following lower class is paid. In total, creditors are categorized into six classes of claims.
That said, most Chapter 7 cases involving individuals are no-asset cases, meaning the debtor's assets are exempt or subject to valid liens. In such a case, no distribution will be made to unsecured creditors.
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What types of debts are discharged in Chapter 7?
Discharging certain debts is one of the primary purposes of filing for bankruptcy. In general, unsecured debts are discharged in Chapter 7, which means any personal loans you haven't been able to make payments on, credit card debt, medical bills and past-due utility bills are wiped away. In addition, if any of the loans have a co-signer, their obligation doesn't change even as your debt is discharged.
While unsecured debts are discharged in most cases, there are grounds when a court might not grant a discharge. These include:
- A failure to produce financial records or failure to explain the loss of assets.
- Committing a bankruptcy crime like perjury.
- A failure to obey an order of the bankruptcy court.
- Fraudulently transferring or concealing property.
But bankruptcy doesn't make all of your debts go away. Secured debts, child support obligations, alimony, certain taxes, court fees, penalties, and personal injury debt you owe due to an accident are examples of nondischargeable debts. It is widely believed that student loans cannot be discharged either; however, that's not the whole truth. While student loans can be discharged, you'll have a higher bar to clear and jump through a few extra hoops.
The bankruptcy court's discharge order comes relatively early in the process unless a creditor objects to discharge certain debts. For example, your credit card company may object to discharging the debt you accrued to purchase luxury goods. If this happens, the court will decide whether to grant or deny the motion.
How long does Chapter 7 bankruptcy stay on your credit report?
You get major negative marks on your credit report for filing Chapter 7 bankruptcy, and this filing seriously damages a debtor's creditworthiness. If you're looking to file Chapter 7, know that it takes 10 years to fall off your credit report, calculated from the filing date. According to Credit.com, if your FICO score is 700 or higher, it may fall by at least 200 points. But bankruptcy stops having a big influence on your future credit needs after a few years, and lenders may be willing to look past it if you have since demonstrated that you're a responsible borrower.
In addition, bankruptcy laws state that you can't receive a Chapter 7 discharge within eight years of a previous such discharge. And if you've received a discharge under Chapter 13 or Chapter 12 (meant for family farmers and fishermen), then you must wait six years to get a debt discharge under Chapter 7.
Related: How to Remove A Bankruptcy from Your Credit Report | How to Recover from Bankruptcy
How much does it cost to file a Chapter 7 petition?
News flash: It does cost money to file for bankruptcy. The court will charge you a $245 case filing fee, a miscellaneous administrative fee of $75, and a $15 trustee surcharge. The court may dismiss the case if you fail to pay up. Can't afford to pay these in one go? You may be able to pay them in four installments, and under certain circumstances, the court may even waive the fees.
On top of all this, you'll also have to shell out for a bankruptcy lawyer, which could charge a fixed fee per hour. According to Alllaw.com, a bankruptcy attorney typically charges $1,000 to $3,500 for a Chapter 7 petition. A new lawyer may charge you less than an experienced attorney; if your case isn't complex, you don't need to hire an experienced lawyer.
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How long does a Chapter 7 bankruptcy take?
In most cases, a Chapter 7 bankruptcy process can take between four and six months to complete. But the bankruptcy discharge associated with the filing comes much earlier — about 90 days or so. If the case trustee determines you don't have any assets they can sell, the case may get wrapped up in a few weeks.
But a few developments can greatly change the duration of the case. For example, if you have assets that can be sold for the benefit of the creditors, but if the trustee hasn't filed a report of no distribution, your case cannot be deemed closed. Ultimately, the timeline can vary greatly because it depends on when the trustee completes their work.
Differences between Chapter 7 and Chapter 13 bankruptcy
Bankruptcy type | Purpose | Who can file | Timeline |
Chapter 7 | Liquidation of assets, debt discharge | Individuals and business entities | Four to six months |
Chapter 13 | Reorganzation of finances | Individuals | Three to five years |
Pros and cons of filing for Chapter 7 bankruptcy
Pros
- Your debts are discharged: This is a big reason why so many people file for Chapter 7. Filers can get unsecured debts like credit card debt and personal loans discharged. It also stops foreclosure attempts.
- Automatic stay: When you file for bankruptcy, an automatic stay is triggered, stopping all creditors from any collection efforts. That means you won't receive any wage garnishment or jail time threats.
- A clean slate: Bankruptcy gives you a chance to start anew. With your unsecured debts discharged, you can begin to make better financial decisions to avoid another trip to bankruptcy courts.
Cons
- The cost: You can expect to pay upward of $300 to file for a Chapter 7 petition. This excludes any fees charged by your attorney, which could increase the total cost by at least $1,000.
- Affects your credit score: A Chapter 7 filing remains on your credit report for 10 years, meaning lenders may not look favorably to your financial mishaps when you apply for a new loan in the future.
- Not all debts are discharged: A Chapter 7 filing doesn't make all your debts go away! You'll still have to pay alimony, child support and certain taxes during the bankruptcy proceedings.
Alternatives to Chapter 7 bankruptcy
- Debt consolidation loan: You can take out a debt consolidation loan and pay off all your debts. This means you don't have to keep track of multiple due dates and may even secure a better interest rate.
- Debt settlement: Debt settlement entails negotiating with creditors to pay less than what you owe. You can enlist the service of a debt relief company.
- Balance transfer cards: Sinking in credit card debt? Many lenders offer a balance transfer card with 0% APR for a certain time period. Like a debt consolidation loan, you can use a balance transfer card to pay off debt on multiple cards, leaving you with debt on only one card.
- Debt management plans: You can contact a nonprofit credit counseling agency, which will help you develop a debt management plan after considering your income, expenses, and current debts.
- Chapter 13 bankruptcy: Unlike Chapter 7, where your properties may be sold, Chapter 13 is more of a reorganization of your finances. Instead of a debt dischargement, you'll be put on a three- to five-year plan to repay your creditors.
Related: Is Chapter 13 an Option After Chapter 7?
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The bottom line
If I were writing this article in the 16th century, it wouldn't have been a guide about Chapter 7, what it entails, or any alternatives. Instead, the focus would have been on how to avoid debtors' prison or the gallows because that's what filing for bankruptcy meant in those times. But modern bankruptcy laws aren't meant to punish you; they intend to give you a second chance (a clean slate, if you will). Chapter 7 bankruptcy allows you to eliminate most of your unsecured debts so you can begin to rebuild your credit score and get a fresh start on your finances. This type of bankruptcy may not be the solution to all of your debt issues, but it may prove useful for at least some of them.
Before you go down this road, it's better to consider alternatives to bankruptcy. But if your mind is made up, be sure to engage a competent bankruptcy attorney.
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Writer
Jasir Jawaid is Joy Wallet's Assistant Editor. He has more than 13 years of experience as a journalist covering Wall Street, equities, financial policy and regulation, and cryptocurrency and blockchain.
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