Our experts select the best products and services to make smart decisions about your money (Here's how). In some cases, we receive a commission fromour partners; however, our opinions are our own. The terms and conditions apply to the offers listed on this page.
- Chapter 7 Bankruptcy is the liquidation of a debtor's assets that are not necessary to pay creditors.
- Chapters 11 and 13 are more expensive and longer than Chapter 7, but you can keep your assets.
- Chapter 7 bankruptcy will significantly lower your credit score and will stay on your credit report for 10 years.
Most debt problems can be solved with a little finesse and perhapsdebt forgivenessoption e.gdebt consolidationor evendebt settlementprogram. However, at the bottom of Pandora's box of debt relief options is bankruptcy. Six of themtypes of bankruptcy, Chapter 7 deals with the most drastic debts.
You can think of bankruptcy in Chapter 7 as losing in Monopoly, where all your assets go to the player you owe money to and you leave the game. Although drastic and complicated, it gives you a clean slate after the process is complete, at the cost of most of your belongings and credit.
What is a Chapter 7 bankruptcy?
Chapter 7 bankruptcy is part of the U.S. Bankruptcy Code that gives the debtor, the indebted person, the ability to discharge their debts. However, this comes at a price. According to Jonathan Carson, CEO of a bankruptcy services firmStrict, "Chapter 7. Bankruptcy is the liquidation of the debtor's assets." This is why it is sometimes called liquidation bankruptcy.
Businesses and individuals can use Chapter 7 bankruptcy to get out of debt by eliminating most unsecured debt and selling non-released assets to pay creditors, explains Wayne Mortenson, a bankruptcy attorney at the firmMortenson Law Firms. A business undergoing a Chapter 7 bankruptcy process closes at the conclusion of the proceedings.
What debts can you pay in Chapter 7 bankruptcy?
Secured and unsecured debts are treated differently in Chapter 7 bankruptcy.
The secured debt is secured by collateral. These debts cannot be paid off under Chapter 7. An example of secured debt is a home purchased with a mortgage or car loan. "What you owe for your home is secured by the home's value," he explainsMiriam Galston, a law professor at the George Washington University School of Law who teaches bankruptcy.
Galston argues that during Chapter 7 proceedings, secured creditors can seize property in which they have a secured interest to recover money owed to them by the debtor. The remainder of the debt is considered unsecured if, after the sale, the debtor still owes the creditor. All remaining proceeds are distributed to unsecured creditors.
Unsecured debts are not secured. Many of these debts can be discharged during Chapter 7 bankruptcy, including credit card debt, medical bills, and personal loans. In exchange for debt forgiveness, the debtor must sell many of their non-core non-core assets, such as luxury cars, collectibles, or vacation homes. However, not all unsecured debts can be discharged under Chapter 7. "Taxes, student loans and alimony obligations generally go unpaid in bankruptcy," says Mortenson.
With regard to businesses, “there is no way to write off debts because, by law, the debtor's business must be liquidated and cease to exist,” explains Galston.
Read more:The best debt management services.
What Happens During a Chapter 7 Bankruptcy?
In Chapter 7 bankruptcy, a court-appointed trustee takes control of the debtor's assets. "The trustee oversees and manages the liquidation of the debtor's assets, and the proceeds are used to pay creditors," explains Carson.
However, people who file for Chapter 7 bankruptcy do not have to sell everything they own or lose all their savings.
Certain properties are exempt from liquidation if the court administrator deems it necessary. "Exempt assets typically include necessities such as clothing, household items and personal vehicles, but this can vary from state to state," says Mortenson. Namely, in most states there are limits on the value of exempt assets. For example, an old sofa would probably be excluded from sale, but a high-end designer sofa would probably be liquidated. An older mid-range car might be considered the exception, but a newer luxury car would likely be eliminated.
Assets likely to be liquidated include holiday homes or rentals, other cars, valuable musical instruments not needed at work, coin and stamp collections, family heirlooms, artwork, expensive jewelry, and savings outside of retirement accounts.
The treatment of single-family homes in Chapter 7 bankruptcy varies from state to state. "In most states, but not all, the debtor's home is exempt up to a certain amount," says Galston. "If the state household exemption is $50,000, the borrower can't actually keep the home, but they get the first $50,000 of the sale proceeds after the secured creditor receives their share of the proceeds because the exemptions don't invalidate insurance interest," he explains. .
How is a Chapter 7 bankruptcy different from other forms of bankruptcy?
Carson explains that a Chapter 7 bankruptcy filing focuses on liquidating a debtor's assets to pay creditors, which can take several months. This differs from other forms of bankruptcy, such as Chapter 11 and Chapter 13, which require formal repayment plans and can take years. Debtors may also keep their assets while paying off their debts under chapters 11 and 13 of bankruptcy proceedings, although they have the right to sell.
In a Chapter 7 bankruptcy, the trustee takes control of the assets and manages the process. This also applies to Chapter 13 bankruptcy. However, unlike Chapter 7, which is available to businesses and individuals, Chapter 13 is only available to individuals. In Chapter 11 bankruptcy, the trustee does not participate in the proceedings and the debtor retains control of his or her assets.
Who Should Consider Chapter 7 Bankruptcy?
"If a debtor does not have significant assets or the means to pay off creditors, they would likely choose to file for Chapter 7 bankruptcy to liquidate their assets and pay off their debts,” says Carson. The cost of filing for bankruptcy is also a factor Filing Chapter 7 bankruptcy is less expensive than other forms, in part because it takes much less time and therefore lower legal fees.
However, Chapter 7 bankruptcy is not an option for all debtors. Anyone wishing to file for Chapter 7 bankruptcy must first pass a means test. The asset test aims to prevent abuses of the bankruptcy system and eliminate those who can afford to repay part of their debt.
The average test consists of two parts. The first part checks whether the borrower's income is below or above the median income in his state. If the debtor's income is below the median income in their state, they will usually be able to file for Chapter 7 bankruptcy. However, if it is higher, they move on to the second stage.
In the second step, monthly expenses for necessities such as food, housing, medical care and transportation are subtracted from the borrower's monthly income. The more money left at the end of each month, the less likely the debtor will qualify for Chapter 7 bankruptcy. Individual debtors who fail the Chapter 7 means test often file for Chapter 13 bankruptcy instead .
Carson explains that filing for Chapter 13 bankruptcy is more appealing to some debtors than Chapter 7 because it allows them to keep control of their assets. At the same time, they commit themselves to a formal creditor repayment plan. "Typically, an individual chooses to file for Chapter 13 bankruptcy if they have significant assets they would like to keep, such as a home," says Carson.
How to File Chapter 7 Bankruptcy
To file for Chapter 7 bankruptcy, a debtor files a Chapter 7 petition with the United States Bankruptcy Court, Carson explains. The process is the same for both individuals and companies. The Chapter 7 bankruptcy filing fee is $338. Debtors must also pay a $15 trusteeship fee to cover the costs of serving as a court-appointed administrator overseeing the liquidation of the estate.
A person with debt that consists mainly of consumer credit has additional application requirements. They must provide a certificate ofcredit counselingand a copy of Adebt repayment plandeveloped in credit counseling. They must also provide evidence of employee payments received 60 days prior to the application, if any, and a monthly net income statement showing the expected increase in income or expenses after the application is submitted.
Because filing for Chapter 7 bankruptcy is complex, "it's common practice for a debtor to hire a lawyer or law firm to provide legal advice, file a case, and help manage the process," says Carson.
How does Chapter 7 bankruptcy affect your credit score?
Your account has been declared bankruptcredit reportsin the category of public records. Although credit bureaus have also included tax liens and money judgments in this category, as of 2018, bankruptcies are the only form of public record that still appears on your credit report.
Bankruptcy will significantly affect your credit score, taking it down more than 200 points if you have a very good orexcellent credit score. The lower your credit score at the time of bankruptcy, the less impact it will have, although it will still be a much greater loss to you than if you hadcriminalityon your credit report.
You will feel this influence for years. According to Carson, when a person files for Chapter 7 bankruptcy, the bankruptcy information stays on the record for seven to ten years. "Companies that apply for Chapter 7 assistance go out of business and close their businesses," he says.
Chapter 7 Bankruptcy FAQs
What are the benefits of Chapter 7 bankruptcy?
“Chapter 7 bankruptcy is usually a quicker and less expensive process than other forms of bankruptcy,” says Mortenson. Filing fees are lower in Chapter 7 bankruptcy than in other forms of bankruptcy. Because it is a faster process, legal fees may be lower. Whereas Chapter 7 bankruptcy proceedings usually end in a few months, Chapter 11 and 13 bankruptcy proceedings usually take years.
What are the Disadvantages of Chapter 7 Bankruptcy?
Filing for Chapter 7 bankruptcy has serious consequences for your credit score. "This can have a significant impact on the borrower's creditworthiness and ability to obtain credit in the future," says Mortenson. Companies that file for Chapter 7 bankruptcy are completely closed, while Chapter 11 bankruptcies typically allow companies to continue operating while paying off their debts.
How long does a Chapter 7 bankruptcy last?
Chapter 7 proceedings typically take four to six months, from the filing of the application to the repayment of the debt.
Jamie Davis Smith is a mother of four, an attorney, disability advocate, and avid photographer based in Washington, DC.
A Chapter 7 bankruptcy wipes out mortgages, car loans, and other secured debts. But if you don't continue to pay as agreed, the lender will take back the home, car, or other collateralized property using the lender's lien rights.What do you lose when you file Chapter 7? ›
A Chapter 7 bankruptcy wipes out mortgages, car loans, and other secured debts. But if you don't continue to pay as agreed, the lender will take back the home, car, or other collateralized property using the lender's lien rights.How does Chapter 7 bankruptcy hurt you? ›
Chapter 7 doesn't have a repayment plan and eliminates most unsecured debts, meaning the creditors can't recoup what they advanced. One of the cons of filing chapter 7 bankruptcy is that it will negatively affect your FICO score for 10 years.What is the downside of Chapter 7? ›
Certain debts will remain on your account when you file for Chapter 7 bankruptcy. You will still be responsible for alimony and child support. Tax liens, student loans, and personal injury debts caused by intoxicated drivers are still on the docket, as well.Is bankruptcy better 7 or 13? ›
In many cases, Chapter 7 bankruptcy is a better fit than Chapter 13 bankruptcy. For instance, not only is Chapter 7 quicker, many people prefer the following two things as well: filers keep all or most of their property, and. filers don't pay creditors through a three- to five-year Chapter 13 repayment plan.