Chapter 7 bankruptcy: What is it? Should I file? How to file?

Chapter 7 bankruptcy is a powerful legal tool in the United States that allows you to totally erase many debts, including credit card debt, medical debt, car loans, and payday loans. Experts estimate that over 39 million Americans have filed for bankruptcy.^[1] It’s more common than most people think. 

One good question to ask yourself if you’re considering Chapter 7 bankruptcy: do I have more debt than I’ll ever be able to pay back, given my current income and property? If the answer is yes, then Chapter 7 bankruptcy may be the right option. 

What is Chapter 7? How does it work?

In a Chapter 7 bankruptcy, you’ll fill out forms about what you earn, spend, own, and owe and submit these forms to the bankruptcy court. You’ll also submit recent tax returns and pay stubs, if you’re employed.

A trustee, who is an official assigned to your case, will review your forms and documents. You’ll have a brief meeting with them, where they’ll ask you basic questions about what’s in your forms.

A couple of months later, you’ll get a notice in the mail from the court making your bankruptcy discharge official. The vast majority of people who are honest, fully fill out their bankruptcy forms, and complete the required steps get their bankruptcy accepted by the court. 

What debt can and can’t be erased? 

Chapter 7 bankruptcy can erase the following common debts:

• Credit card debt
• Medical bills 
• Car loans
• Personal loans and payday loans 
• Judgments from credit cards and debt collection agencies
• Utility bills 

These debts are known as “dischargeable” debts. 

The moment someone files bankruptcy, a rule called the “automatic stay” goes into effect. This temporarily stops anyone from collecting any debts you owe them. 

Chapter 7 bankruptcy cannot erase the following types of debts:

• Child support and alimony
• Recent tax debts and other debts you owe the government like fines
• Student loans can usually not be erased

These debts are known as non-dischargeable debts. 

Secured debts are debts that are backed by property, such as a mortgage backed by a house or a car loan backed by a car. If you want to keep your property that secures a debt, you cannot erase the debt in Chapter 7 bankruptcy. Before you file, you must also make sure you’re current on your debt payments. If you’re willing to give up the property, then Chapter 7 bankruptcy can erase secured debts.

Can I keep my property if I file Chapter 7 bankruptcy? 

In 95 percent of Chapter 7 bankruptcy cases, people are able to keep all of their property.^[2] The Bankruptcy Code has rules in place rules called “exemptions” that allow you to keep several types of property, such as cash, clothes, furniture, cars, etc. up to a certain dollar amount, known as “exemption limits.” 

The specific exemptions you can use to keep your property depend on your state. Many states have “wildcard exemptions” that allow you to keep any property as long as it’s worth less than a certain amount. For the 19 states that permit “federal bankruptcy exemptions,” the wildcard ceiling is a little over $10,000, meaning that you can keep property that adds up to be less than about $10,000.

If your property value exceeds the exemption limit that applies, the trustee may seize the property and sell it to pay back your creditors. This is why people call Chapter 7 “liquidation bankruptcy,” although any liquidation rarely takes place. 

Property that isn’t protected by exemptions is considered “nonexempt property.” The most common forms of nonexempt property are expensive cars and homes.

Who qualifies for Chapter 7 bankruptcy? Should I file?

There is a difference between who is allowed to file and who should file. Most people who earn under the median income for their state, based on their household size, are able to file. This is because they pass the “means test,” according to bankruptcy laws. The means test takes into account your average monthly income over the last 6 months. 

If you don’t have a job or earn near the minimum wage, you will likely qualify for Chapter 7 bankruptcy. If you don’t pass the means test, you can file a Chapter 13 bankruptcy but not Chapter 7. 

Folks looking for a fresh start typically fall into one of three categories:

• Those who should file for Chapter 7 bankruptcy right now;
• Those who should wait a little bit of time and then file for Chapter 7 bankruptcy;
• Those who should not file for Chapter 7 bankruptcy.

Should I file Chapter 7 bankruptcy right now?

Some signs that you may be a good fit for filing bankruptcy now:

• You have more than $10,000 of dischargeable debt 
• Your credit score is already low (below 600)
• You don’t own expensive property 
• Keeping up with payments is making it impossible to make ends meet every month
• You’re worried about wage garnishment or being sued for your debt 
• You pass the means test because you earn under the median income in your state
• You don’t see a way of being able to pay back your debt over the next 5 years

If these apply, right now may be the right time to file for bankruptcy.

Who should wait to file?

Certain activities can complicate a Chapter 7 bankruptcy and waiting a little bit of time can help. If you’re still relying on your credit cards to make ends meet or you’ve made large purchases in the last 6 months, then it’s best to wait to file and pay off your most recent charges first.

If you paid back or transferred property to a family member or friend in the last year, then it’s best to wait to file, if you can. You have to disclose these activities in your bankruptcy paperwork and your trustee will ask you about them.

If you’re suing someone or planning to sue someone, then it’s best to hold off on filing bankruptcy until you know the final outcome of that case, if possible. People often delay Chapter 7 bankruptcy if they’re expecting a personal injury settlement. 

Also, if you owe your landlord money and you don’t plan to move, try to catch up on missed rent payments before filing. The same generally goes for car loans, if you want to keep the car.

Finally, if you expect your financial situation to get worse, then you may want to delay your filing. You can only file Chapter 7 bankruptcy once in an 8 year period, so you don’t want to file if you know that you’re going to fall into more debt.

Chapter 7 vs. Chapter 13 bankruptcy

The main difference between Chapter 7 and Chapter 13 bankruptcy is that in Chapter 13 bankruptcy, you don’t immediately erase any debts. You propose a repayment plan based on your ability to repay certain debts. The bankruptcy trustee and all creditors review the Chapter 13 plan and, if it’s acceptable to all involved, the court confirms your repayment plan, which lasts three to five years.

Most people file Chapter 13 bankruptcy instead of Chapter 7 for two reasons. First, they fail the means test due to their high income and don’t qualify for Chapter 7 bankruptcy. Second, they own a home they want to keep that’s not covered by the Chapter 7 bankruptcy exemptions. 

If you’re considering filing Chapter 13 because you don’t pass the means test, look at the reasons you aren’t passing. The lookback period for the means test is 6 months, so if you recently experienced a drop in household income, you might qualify for Chapter 7 in the near future.

How to file Chapter 7 bankruptcy

1. Collect your financial documents. If you’re employed, this usually just means getting your recent pay stubs and the last two years of your income tax returns. It’s also a good idea to get your recent bank statements and credit report.
2. Fill out the bankruptcy forms. These forms are known as your bankruptcy petition. They include questions about what you earn, spend, own, and owe. People choose to either hire a lawyer to complete these forms for them or they fill them our on their own. They’re available on the U.S. Courts website. 
3. Take a credit counseling course. This is a 60-minute course that you can do online with any qualified nonprofit credit counseling agency. You’ll get a certificate of completion that you submit to the court. 
4. File your bankruptcy forms with the bankruptcy court. You’ll do this by mail, in-person, or online if your court allows it. If you have a lawyer, they’ll file the forms for you. At this point, 80% of your work is done. But you’ll need to complete a few post-filing tasks. 
5. Mail your trustee the required documents. You’ll be assigned a trustee from the bankruptcy court. This isn’t a judge, but they still oversee your case. They’ll likely require you to email or mail them the same documents you filed with the court and may have other requests, such as bank statements. 
6. Take a financial management course. This personal finance course is like the one you take before filing and can also be done online. It lasts 60 minutes and will prepare you for life after bankruptcy. Make sure to file the certificate of completion with the court. 
7. Attend your brief meeting with your trustee, known as a “341 meeting.” Most 341 meetings last 5-10 minutes and follow a standard script of questions. During COVID-19, they’ve been happening by phone and video conference.
8. Get your discharge letter. This happens about 2-3 months after your 341 meeting if everything goes to plan. Congratulations.

How long does Chapter 7 bankruptcy take?

Most people can file their bankruptcy forms within one week if they’re organized. The 341 meeting with the trustee who oversees your case takes place about one to two months after you file. 

If all goes well, two to three months after your meeting with your trustee, you’ll get a letter in the mail that your debt is officially discharged. This means that that Chapter 7 bankruptcy from beginning to a discharge of your debts takes about 3-5 months.

How much does Chapter 7 bankruptcy cost?

The bankruptcy court requires a $338 filing fee. If you earn below 150% of the Federal Poverty Line, you may qualify for a fee waiver. People who are on social security or unemployed usually qualify for a fee waiver. You can pay the fee in installments if you make a request and the court agrees.

The two online personal finance courses each cost between $10 and $50, depending on the provider you choose. You can also qualify for a fee waiver for these courses, based on your income.

If you hire an attorney, the most expensive cost in bankruptcy is your attorney fee. It costs an average of $1,500 to hire a bankruptcy attorney for a Chapter 7 case.

What’s life after bankruptcy like? How long is Chapter 7 bankruptcy on your credit report?

Most people who file Chapter 7 bankruptcy feel a sense of relief that all of their credit card and medical debt, along with other dischargeable debt, is totally gone. Many people see their credit scores improve if they had credit scores in the sub-600 range. 

The bankruptcy process often creates a new sense of confidence, where people feel more comfortable with their financial affairs than when they began. Part of the reason is the two required personal finance courses. Chapter 7 bankruptcy also forces you to reflect on your financial situation. 

People who file Chapter 7 bankruptcy usually get more serious about budgeting, saving, and rebuilding their credit, using tools like credit builder loans and secured credit cards. 

Chapter 7 bankruptcy stays on your credit report for 10 years, but many people who file see their credit improve and are able to get approved for a mortgage within a few years if they make good financial decisions post-bankruptcy.

Conclusion

Whether you should file for Chapter 7 bankruptcy depends on your financial situation and what other debt relief options are available to you. It’s also important to consider the timing of filing. Taking a credit counseling course or getting a free evaluation from Firebaugh & Andrews at 734-722-2999