Chapter 7 Bankruptcy: Pros and Cons and What Happens After
10 MIN READ
Published August 31, 2023 | Updated September 08, 2023
Bankruptcy is a valuable legal remedy and tool that gives individuals facing particularly difficult financial hardship the opportunity to start over. Chapter 7 and Chapter 13 are the primary bankruptcy options for individuals. Chapter 7 bankruptcy, in particular, can wipe off most of your unsecured debts, but you may have to liquidate your assets. This comprehensive guide outlines the Chapter 7 bankruptcy process, eligibility criteria, and the pros and cons to consider before initiating a filing.
What is Chapter 7 Bankruptcy?
Chapter 7 bankruptcy is known as liquidation bankruptcy because it involves liquidating your property to satisfy your outstanding debts. If you have a lot of unsecured debts and no other options are right for you, this may be a viable solution for dealing with your debts. Once you complete the bankruptcy proceedings, you’ll emerge on the other side with a clean financial slate. You’ll still need to pay your secured debts, but with most of your unsecured debts out of the picture, it may be easier for you to manage your obligations going forward.
Pros and Cons of Filing for Chapter 7
Filing for Chapter 7 bankruptcy is a serious and significant decision, so you certainly should not take it lightly. You should carefully consider all the potential advantages and consequences before you decide to proceed. The pros and cons listed here will help you make an informed decision whether to pursue Chapter 7 bankruptcy:
- Once you file for Chapter 7 bankruptcy, an immediate and automatic stay is triggered, which will ensure that your lenders stop collection attempts and legal actions like wage garnishment. This means that you won’t have to request a separate stay of proceedings, instead, this stay of collection actions will be implemented automatically the moment you file your bankruptcy documents with the court.
- Chapter 7 offers the opportunity for a fresh financial start.
- You may be able to retain certain exempt assets.
- The negative impact on your credit score after your bankruptcy is discharged will diminish over time.
- Most of your unsecured debts will be wiped out.
- Credit Report Impact: Chapter 7 bankruptcy will stay on your credit report for ten years, or more. The hangover effects of a Chapter 7 bankruptcy have been known to persist on a consumer’s credit reports for as long as 11-13 years, depending on how long your former creditors continue to report old, negative information to your credit files.
- Credit Challenges: For several years after your bankruptcy is closed, it will be difficult for you to rent an apartment due to poor credit. You may also have trouble buying a car, or getting any new credit. If you do get new credit, the interest rates you may qualify for may be very high.
- Asset Loss: You may lose non-exempt assets such as real estate, jewelry, and vehicles.
- Ongoing Obligations: Chapter 7 bankruptcy may not eliminate all of your secured debts, such as auto loans and mortgages. You may still need to make payments for those.
- Exclusions: Chapter 7 bankruptcy will also not eliminate child support, alimony, student loan debt, or tax liens or past due tax debt.
Difference Between Chapter 7 Bankruptcy and Chapter 13 Bankruptcy
Understanding the main differences between Chapter 7 and Chapter 13 bankruptcy will help you decide which option may be right for you, depending on the types of debt you have. Here are the key differences between the two that you should be aware of.
Chapter 7 bankruptcy can wipe out dischargeable debts within a few months, but you’ll need to liquidate your non-exempt property. You’ll also need to have a very low income to pass the means test and qualify for it.
Chapter 13 bankruptcy is known as a reorganization bankruptcy, where you can retain your assets, but you’ll have to stick to a court-approved repayment plan for three to five years. At the end of the plan, the court will discharge the rest of your debt. Your monthly income also needs to be high enough to afford those payments, plus your normal living expenses. It allows you to catch up with secured debts so you can avoid foreclosures and repossessions.
Are You Eligible For Chapter 7 Bankruptcy?
You must meet a few qualification requirements before you can file for Chapter 7 bankruptcy.
You’ll need to pass the means test to qualify for Chapter 7 bankruptcy. This is an essential part of the process. The means test looks at your income over the last six months to determine if your disposable income is low enough to qualify for Chapter 7. If you do not meet the means test, you can still file for Chapter 13 bankruptcy.
To complete the means test, you’ll need to provide information about all sources of income for you and your spouse, if filing jointly, in the last six calendar months. You’ll also need to provide a list of your living expenses, such as clothing, food, utilities, health care, transportation, and taxes. The amount you earn must be less than your state’s median income for similar-sized households to pass the test.
You must complete the mandatory credit counseling course before you file for bankruptcy. The counseling sessions must be provided through a court-approved credit counseling agency.
No Recent Bankruptcies
You cannot have filed Chapter 7 bankruptcy in the last eight years. You also cannot have filed a Chapter 13 bankruptcy in the last six years. If you had filed for bankruptcy, but the court dismissed your case, you’ll need to wait at least 180 days before you file again.
Bankruptcy eligibility is contingent on refraining from fraudulent actions aimed at exploiting the bankruptcy system to the disadvantage of your lenders. Even if you are eligible to file for bankruptcy, if the court determines that you knowingly and intentionally took out a recent credit card or loan with the intent of filing for bankruptcy to have the loan discharged, the court may summarily dismiss your bankruptcy case.
How to File for Chapter 7 Bankruptcy
Filing for bankruptcy involves a meticulous process and substantial paperwork which must be filed at certain predetermined times, which is why it’s best to work with a qualified bankruptcy lawyer to help make this process as stress-free as possible. Here’s the process you’ll need to follow to successfully file your chapter 7 bankruptcy case.
1. Find a Bankruptcy Lawyer
Start the process by finding a bankruptcy attorney you’ll be comfortable working with. Talk to the attorney about your financial situation so they can help you determine if you should file for bankruptcy and which type of bankruptcy may be right for you. They can also explain bankruptcy laws, the impact on your assets, and other important things you need to know about.
United States Bankruptcy Court employees are not permitted to provide you with any legal advice or help in completing the necessary forms. But if you’re unable to afford legal services, you may qualify for low-cost or pro bono legal representation.
2. Complete a Credit Counseling Course
You’ll need to attend mandatory bankruptcy counseling before you can file your petition. Choose a nonprofit counseling agency from the U.S. Court’s approved list and attend individual or group sessions. You’ll need a completion certificate to file, along with your bankruptcy petition.
3. Gather Necessary Documents
When you file a Chapter 7 bankruptcy petition, you’ll need to submit relevant documents so the court can determine if you’re eligible. Make a list of all your debts, including credit card debt, student loans, car loans, personal loans, and more. Along with that, you may have to submit the following documents.
- Bank statements for the last six months, at minimum
- Tax returns for the last two years
- Pay stubs for the last two years
- Appraisals for any real estate or other fixed assets you own
- Registration copies for any vehicles you own
4. Complete the Bankruptcy Forms
The next step is to complete your bankruptcy forms. Your lawyer can help you complete these forms based on the information you provide him/her. You’ll need to list your property, creditors, income, exemptions, and other financial information on the forms. You’ll also need to decide if you want to pay off your secured debts, surrender the property, or continue making monthly payments on them.
5. File the Bankruptcy Petition
Once you have filled out the right forms and have the necessary documents on hand, the next step is to file the bankruptcy petition. When you file the petition, you’ll need to pay a filing fee of $338 for Chapter 7 bankruptcy.
6. Attend the Meeting of Creditors
If the court accepts your petition, your bankruptcy trustee will set up a meeting of your creditors, called the 341 meeting. You’ll need to attend this meeting, but your creditors may choose to opt out. The goal of this meeting is for the trustee to verify your information, learn more about your case, and for your creditors to ask any questions they may have.
7. Complete a Debtor Education Course
After the meeting of creditors, you’ll have 60 days to complete a debtor education course from an approved counseling agency. This is a mandatory requirement, and you’ll need to submit a certification of completion to the bankruptcy court in a timely manner. Otherwise, the court may close the case.
What Happens After You File for Bankruptcy
Bankruptcy may seem intimidating, but knowing what happens during and after you file for bankruptcy can ease your mind. Once you follow the steps listed above and file your petition, here’s what you can expect.
Immediately after you file your petition for Chapter 7, you’ll receive protection from your creditors. This is known as an automatic stay. Your lenders can no longer continue collection actions, by phone, letter, Email, or in-person. They can’t call you or try to collect the amount you owe, once your bankruptcy petition is being considered by the court. Wage garnishments will also stop once the automatic stay takes effect.
The bankruptcy trustee then begins to liquidate non-exempt property to pay your creditors’ claims. If you want to keep a non-exempt property, you’ll be required to pay the value of that asset to the trustee. Chapter 7 bankruptcy exemptions vary by federal and state laws, but typical exemptions include:
- Retirement accounts
- Pension and retirement income benefits from sources like Social Security, regular monthly income from fixed and variable annuities, and public/private pensions.
- Many household goods
- Some home equity
- Some amount of your vehicle’s value
- Tools you may use in your trade, profession, or small business
- Some public and insurance benefits
Discharge of Debts
Once you complete allyour bankruptcy obligations, the court will discharge your remaining debts. You may still have to complete a few steps listed in the court order even after the final discharge of your debts. A bankruptcy discharge is the release of a debtor from the personal liability of debt repayment. It prevents creditors from taking any further collection actions.
Chapter 7 bankruptcy will discharge most of your unsecured debts, but you still may be required to pay your secured debts. You’ll also be responsible for paying nondischargeable debts like tax liens/past due tax debts, child support, and alimony.
Your credit will need some time, attention and work after bankruptcy, but you’ll be starting off again on the right foot since you won’t have most of your unsecured debts. Learn as much as you can about using credit responsibly and cultivate good money management habits to start rebuilding your credit.
- Avoid applying for loans and credit cards on a frequent basis, for the first 3-4 years following your bankruptcy’s closure. Hard credit inquiries can further damage your credit score, so try to limit your new credit applications to no more than 1-2 new credit lines or loan applications per year, during those first few years following your bankruptcy.
- Start budgeting so you can ensure you are accounting for all your bills. Use computer expense tracking software or a similar budgeting application on your phone.
- Monitor your bank account every week to ensure you’re not spending any more than you need to.
- Set up autopay for your bills so you don’t miss any payments.
- Apply for a secured credit card and pay off the balance at the end of the month to rebuild your credit.
- Apply for a credit builder loan or see if you can become an authorized user on someone else’s credit card to improve your credit score.
Filing for Chapter 7 bankruptcy may seem daunting, but in some situations, it may be a necessary task to help you start over. With the right knowledge and the help of a bankruptcy lawyer, you can determine if this is the right option for you or if you should consider other debt relief methods like debt settlement first. Once you resolve your debts, focus on building your income, budgeting, and managing consumer debt responsibly so you can avoid bankruptcy in the future.