Filing Chapter 7 bankruptcy is a serious financial decision for individuals who have large amounts of debt they likely won’t ever be able to repay.
Though filing for Chapter 7 ultimately gives you a fresh financial start by eliminating debt, it may come with serious consequences, including negatively impacting your long-term personal credit health and the loss of valued personal possessions.
What is Chapter 7 bankruptcy?
Chapter 7 bankruptcy is liquidation bankruptcy that will discharge most of your unsecured debts.
“Among other actions, a bankruptcy court will issue a temporary stay on collection activities, so collectors will stop calling and wage garnishments will cease,” said Derek Jacques, bankruptcy attorney with The Mitten Law Firm in Southgate, MI.
Types of collection activities that may be halted temporarily include evictions, garnishments and repossessions.
“With Chapter 7, the court will take ownership of your assets, and assign a trustee to oversee the proceedings,” Jacques said. “The trustee will review your finances, debts, income, and assets.”
The court may sell non-exempt property to help pay back your creditors and also run a meeting between you and your creditors where you’ll answer questions about your filing.
Certain types of debts can be discharged In Chapter 7 bankruptcy, including credit card debt, medical bills, personal loans, most unsecured debts and certain tax debts.
However, some debts are not dischargeable in Chapter 7 bankruptcy, including most taxes, child support, and alimony, fines and penalties imposed by government agencies, debts incurred by fraud or willful injury, and most secured debts if you keep the property and pay as agreed, says Leslie Tayne, founder and head attorney at Tayne Law Group in New York, N.Y.
“Student loans are also notoriously difficult to get discharged in bankruptcy, though it’s possible if the borrower is able to prove paying the debt would cause undue hardship,” she said.
It’s also worth noting that Chapter 7 is not the same as Chapter 13 bankruptcy.
“Chapter 7 involves asset liquidation,” Jacques notes. “Chapter 13 gives you the ability to keep your things and gives you a path to repayment, basically by reorganizing your debt.”
While both forms of bankruptcy are options for those suffering from massive IOUs, you need to pass a means test to qualify for Chapter 7, which determines if your income is low enough to file for Chapter 7; if you fail the means test, you won’t qualify for it. Chapter 13 does not include a means test.
Reasons to file Chapter 7 bankruptcy
Whether or not you should file for Chapter 7 bankruptcy depends on several factors.
“If you have a large amount of unsecured debt that you cannot reasonably afford to pay off, and your income is under the required limit, you may benefit from Chapter 7 bankruptcy,” Tayne said.
One of the major deciding factors is how much debt you have.
“If you’re being called by collection companies or you’ve had your wages garnished, these are red flags indicating you may need to file bankruptcy,” Jacques notes. “To know if Chapter 7 is right for you, ask yourself this question: Can I reasonably pay back my creditors if given a plan to do so?”
If you can’t, then Chapter 7 may be the option for you.
How to file for Chapter 7 bankruptcy
The Chapter 7 Bankruptcy process can be successfully executed by taking these six key action steps.
1. Undergo credit counseling. The Chapter 7 bankruptcy process only starts after you complete a credit counseling course from an approved agency. “The course can be taken online, over the phone, or in person,” Tayne said.
2. Collect the needed documents. You’ll need to gather documentation that shows your financial information and present it to the bankruptcy court, including your income, expenses, assets, and liabilities.
3. Complete the bankruptcy forms. Once your documents are in place, you’ll need to complete the bankruptcy petition and schedules, which are the official forms you will file with the bankruptcy court. “These forms will ask for detailed information about your financial situation,” Tayne said.
4. File your paperwork. After completing the bankruptcy petition and schedules, file them with the bankruptcy court in your district. “Along with the petition, you’ll have to pay a filing fee, which varies from district to district, Tayne said.
5. Meet with creditors. After you file for bankruptcy, you will be required to attend a meeting of creditors, also known as a 341 meeting. The meeting gives your creditors the opportunity to ask you questions about your assets and liabilities.
6. Take a financial management course. Lastly, you’ll be required to complete a financial management course, which provides you with information on budgeting, money management, and how to use credit responsibly.
“It’s important to note that the laws regarding bankruptcy can vary by state and case, it is best to consult with a bankruptcy attorney to understand how the laws apply to your specific situation and help you through the process,” Tayne said.
Pros and cons of Chapter 7 bankruptcy
Chapter 7 bankruptcy has positives and negatives, depending on your personal financial situation.
Pros of Chapter 7 bankruptcy
1. A fairly short timetable. Yes, chapter 7 bankruptcy may stay on your personal record for years, but the actual bankruptcy process isn’t that long. It usually takes three-to-six months from filing Chapter 7 bankruptcy to receive debt relief.
2. You get a chance to catch your breath. Once you file for Chapter 7 bankruptcy, you get automatic relief from debtors chasing you down for payments. That’s due to the “automatic stay” provision in bankruptcy law, which prevents lenders and creditors from coming after you for payment until your bankruptcy is discharged or until your debt repayment plan is up and running.
3. You earn a fresh start. With Chapter 7 bankruptcy, your personal debt, outside of student loans, recent income tax debt, or past-due child support can be erased. Within one-to-three years, you can even get new lines of credit, albeit with some strings attached, such as higher interest rates.
4. Future wages are secure. Once you file for Chapter 7 bankruptcy, any future wages earned after the filing debt are yours to keep and you’re free to use them for any or even all living expenses.
Cons of Chapter 7 Bankruptcy
1. The cloud of bankruptcy can significantly derail your credit. Once you file Chapter 7 bankruptcy, it remains on your credit report for seven-to-10 years.
2. No credit cards, and likely, no new house. You’ll likely forfeit your credit cards and won’t be able to land a new mortgage for several years—or even more, depending on the situation.
3. Not all debts go away. Specific debts, like tax liens or alimony and child support, are not dischargeable in Chapter 7 bankruptcy.
4. Time constraints. Chapter 7 bankruptcy can only be filed once every eight years.
How to Manage Your Budget After Bankruptcy
Here are a few rules-of-thumb to consider after filing bankruptcy in order to develop good financial habits.
- Avoid unsecured debt. Watch out for unscrupulous lenders who target consumers fresh out of Chapter 7 bankruptcy. Those offers, which tend to appear in mailboxes, emails, and texts, offer credit cards or auto or personal loans with extremely high interest rates. Stay far away from such offers and keep your new financial persona debt-free.
- Build a budget that works. For consumers coming out of Chapter 7 bankruptcy, a good household budget is no luxury—it’s a necessity. Create a secure budget that includes all of your income and all of your debts. If the debts are higher than your income, start cutting back and/or boosting cashing income and focus on keeping out of debt.
- Boost your income and build an emergency fund. Generating more household income isn’t always easy, but it’s doable, and doing so will make it easier to keep debt at bay and the household budget stabilized. Try moonlighting or freelancing on the side. If you’re in a decent job, steer all raises and bonuses into your savings fund. If you receive an inheritance, plow that cash into savings as well.
- Once you’re on your feet, establish an emergency fund that’s roughly equal to three months’ worth of essential expenses. That cash comes in handy if you run into financial trouble, such as an illness, injury, or the loss of a job.
At this point, your Chapter 7 bankruptcy is over, and your eligible debts are wiped away and you can start to rebuild your credit score and financial future.
Frequently asked questions (FAQs)
The entire Chapter 7 bankruptcy process usually lasts anywhere from three-to-six months.
The discharge dissolves some or even all of your unsecured debts, depending on your personal situation.
Yes, in most cases you can file a Chapter 7 bankruptcy petition online. That usually occurs when filing a Chapter 7 bankruptcy without an attorney.
That depends on an individual’s unique personal financial situation. Typically, Chapter 13 bankruptcies are easier to get as you’ll need to pass a means test to qualify for Chapter 7 bankruptcy, which is more about asset liquidation than debt reorganization.
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