What is Chapter 7 bankruptcy?

If you have serious debt problems, Chapter 7 bankruptcy could be a powerful tool for resetting your finances and clearing up debt—if you qualify. However, it’s not the only solution, and it’s not always the best solution. Bankruptcy is just one of several options for getting rid of debt—others include debt consolidation or debt resolution. 

Before heading to the courthouse, here are a few basics about Chapter 7 bankruptcy that can help you determine whether it’s right for your situation.

You might be at a low point right now, but you can get through this. ‌Especially once you have the information you need. You’re already taking the right steps by learning about your choices for dealing with a rough financial patch. 

What is Chapter 7 bankruptcy? 

Chapter 7 is known as the “clean slate” bankruptcy. In a nutshell, Chapter 7 bankruptcy allows you to wipe out debt by giving up assets to a bankruptcy court. A bankruptcy trustee appointed by the court sells the assets and turns the money over to your creditors. Any remaining debt balances are wiped out (this is called “discharged”).

There are five important things to know:

• Not everyone can file Chapter 7. Your income must fall under certain limits depending on your state and the number of people in your household.

• The court won’t take everything you own. You can keep some of your property (things you can keep are called bankruptcy exemptions). The type and value of the things you get to keep depend on the law in your state.

• You can’t get rid of every type of debt in bankruptcy. Some debts, like taxes, student loans, and child support can be difficult or impossible to wipe out. 

• You have to list all of your debts when you file. You can’t decide to include some creditors but not others.

• Amounts wiped out in bankruptcy aren't taxable.

How does Chapter 7 bankruptcy work?

Before filing for Chapter 7 bankruptcy, you’ll need to complete pre-bankruptcy counseling with an approved credit counselor. This person looks at your income and debts to decide if you need to file Chapter 7 or if a payment plan might work better for you. You don’t have to go along with the plan your counselor creates. At the end of your session, you get a certificate of completion. You’ll attach that to your bankruptcy filing.

Next, you’ll file your request for bankruptcy (called a petition), attaching a few lists (called schedules), including:

• All creditors—the type of debt and amounts you owe

• Your income—how often you get it, how much you get, and who pays you

• All of your assets

• Your monthly living expenses like food, clothing, shelter, utilities, taxes, transportation, insurance, health care, etc.

• Any exempt property that you want to keep (such as a modest vehicle or tools you need for your profession)

You’ll pay filing fees totaling $335 when you submit your petition. 

Filing bankruptcy stops most creditors from trying to collect money from you. This is called an automatic stay. The automatic stay doesn’t apply to child support or to all evictions. It also doesn’t apply to criminal restitution (court-ordered reimbursement to ‌victims or the state for financial losses that are the result of a crime you committed).

A bankruptcy trustee is a person the court appoints to manage your bankruptcy. In 21-40 days after filing, the trustee schedules a meeting with you and your creditors. It’s a meeting—but think of it as your court date. You have to show up and provide any information or documents the trustee requests. Next, the trustee takes your non-exempt assets, sells them, and pays your creditors. 

The bankruptcy trustee decides who gets paid and how much they get. Priority claims like back child support can't be wiped out and are paid first. Non-priority claims like credit card balances are only paid if there is money available. 

At the end of the process, a bankruptcy judge will issue an order of discharge, which is a document you can use to prove that your debts are cleared. This may be the only time you see the judge, as most of Chapter 7 is administrative and handled by the trustee.

Chapter 7 bankruptcy is public and can appear on your credit report for up to ten years.

Who is eligible to file for Chapter 7 bankruptcy?

Not everyone qualifies. You can't file if:

• You had a bankruptcy case that was thrown out because you didn't go to court or do what the court told you‌ to do.

• You stopped your bankruptcy filing after creditors asked the court to take back property that they had a right to.

• You haven’t attended pre-bankruptcy credit counseling within the last 180 days.

Next, you have to pass a bankruptcy means test. The means test compares your average monthly income to the median income for your state. If your income is below the median, you automatically pass the means test. You can file Chapter 7. However, if your income is above the median, you’ll have to complete another step.

In the next step, you’ll figure out your disposable income (money left over after necessities). The court will subtract allowable expenses from your income. Allowable expenses include things like rent, utilities, food, transportation, insurance, and health care. The U.S. Bankruptcy Trustee Program provides a list. You may have to provide proof of what you spend.

If your disposable income is too low to repay at least 25% of your unsecured debt over five years, you pass the means test. You can file Chapter 7 bankruptcy. 

Otherwise, the court may require you to file Chapter 13 instead. Chapter 13 bankruptcy is a repayment plan that can wipe out some of your debt after three or five years of payments. If you are only eligible for Chapter 13, you may also want to consider debt resolution as an alternative solution to your debt.

What debts can be wiped out in Chapter 7 bankruptcy?

In Chapter 7 bankruptcy, you can get rid of most unsecured debts, like:

• Credit cards

• Store cards

• Personal loans

• Private loans

• Cell phone bills

• Utility bills

• Medical bills

• Debts you owe as the result of judgments against you

Debts that can’t be discharged include:

• Many tax debts, including income taxes and property taxes

• Debts you didn’t include in the bankruptcy filing

• Child support and alimony

• Government fines and penalties

• Student loans, unless you can demonstrate that repaying them would cause you undue hardship

• Loans you owe to tax-advantaged retirement plans like 401(k)s or IRAs

• Outstanding condominium or cooperative fees 

• Debts for hurting people on purpose, damaging their property, or injuring someone while driving under the influence

If a debt is related to fraud or bad actions, creditors can ask the court to prevent it from being erased. If they don't, you can wipe out these debts too.

What about secured loans in Chapter 7?

A debt is secured if you pledge something of value (collateral) as a guarantee that you’ll repay the loan. For instance, car loans are secured, and the car is the collateral. In a Chapter 7 bankruptcy case, you usually have three options for secured debts. 

1. Walk away from the property. If you can’t or don’t want to keep making payments, you can return the collateral (for instance, the car or house) to the creditor. 

2. Reaffirm the debt. This means you keep the property, continue making payments, and remain personally liable for the debt. 

3. Redeem the collateral. You may be able to keep the collateral by paying its fair market value in a lump sum to the creditor. 

It’s important that you continue making payments even after the bankruptcy filing if you want to keep the collateral.

What do you have to give up in bankruptcy?

What you have to give up in a Chapter 7 bankruptcy depends on where you live. Each state has its own list of property you can protect (exempt property). Exempt property may include home equity, retirement savings, a modest car, tools you need for work, and household goods. Many states also give a “wildcard” exemption you can use to protect property that would otherwise be up for grabs. 

Exemptions vary among states, so where you live matters a lot. 

Is Chapter 7 bankruptcy right for you?

The decision to file Chapter 7 bankruptcy depends on several factors, including the amount of property you’d lose vs the amount of debt you can discharge.

Here are some factors that could tip the balance in favor of Chapter 7:

• You have a lot of unsecured debt. Filing fees and attorney fees make bankruptcy expensive for smaller amounts. 

• You have few or no non-exempt assets. If you don’t own much or anything, the possibility of losing assets might not apply to you. On the other hand, if you have a lot of assets, it can be better to sell some and pay your debts rather than file bankruptcy. You may be able to negotiate lower payoff amounts with your creditors.

• You must be eligible and able to pass a means test, or you can’t file for Chapter 7.

Bankruptcy laws are complicated, and mistakes can be costly. If you’re considering bankruptcy, talk to an attorney. Many bankruptcy attorneys offer free consultations to help you decide if you want to work with them and to find out if filing will accomplish your goal.