What Is Bankruptcy? Your Complete Guide to Debt Relief Options

Bankruptcy is a legal process that helps you eliminate or reorganize your debts. You get a fresh start when overwhelming debt becomes unmanageable. Chapter 7 and Chapter 13 bankruptcy are the most common types for individuals. Chapter 7 wipes out eligible debts within months. Chapter 13 requires a repayment plan but helps you catch up on mortgage or car payments.

How Does Bankruptcy Work? The Basics Explained

Bankruptcy was designed to help people and businesses get debt relief. It provides a way out for folks in tough financial situations.

Chapter 7 and Chapter 13 bankruptcy are the two most common types that individuals file. They get their names from chapters of the U.S. Bankruptcy Code. The code spells out the rules for each kind of bankruptcy.

Both types aim to eliminate or manage debt in different ways.

• Chapter 7 wipes out qualifying debts quickly, often within a few months
• Chapter 13 sets up a repayment plan lasting three to five years

Which chapter is right for you depends on your financial situation. Your income, debt type, and long-term goals all matter.

The Goal of Bankruptcy: A Fresh Start

All bankruptcy filers hope to get a bankruptcy discharge.

A bankruptcy discharge is a court order that permanently eliminates your debt obligation. You get a clean slate. The bankruptcy court will grant your discharge if you meet all legal requirements.

The order is permanent and applies to all dischargeable debts.

Dischargeable debts typically include credit card debts, medical bills, payday loans, personal loans, and past-due utility bills.

Bankruptcy won’t wipe out non-dischargeable debts like child support, alimony, or some past-due taxes.

Immediate Relief Through the Automatic Stay

You’ll get protection from the automatic stay while awaiting your discharge. It takes effect immediately when you file your bankruptcy petition.

The automatic stay protects you against all collection activities. Phone calls, letters, wage garnishment, and debt lawsuits all stop.

The automatic stay gives you breathing room while your bankruptcy case processes.

The Role of the Bankruptcy Court and Trustee

The United States Bankruptcy Court oversees your bankruptcy case. The court ensures all laws and rules are followed.

The court reviews your filing and addresses any disputes. It grants your bankruptcy discharge, which eliminates your eligible debts. You won’t need to interact directly with a judge in most personal bankruptcy cases. The court plays a key role in approving your case.

A bankruptcy trustee takes over key responsibilities after you file. The trustee reviews your paperwork to confirm accuracy. They ensure creditors are treated fairly.

In Chapter 7 cases, the trustee determines if you own any non-exempt property. Property could be sold to pay creditors, though this rarely happens.

In Chapter 13 cases, the trustee collects your monthly payments. They distribute them to your creditors according to your repayment plan. The trustee acts as the middleman so you don’t interact with creditors.

What Are the Different Types Of Bankruptcy?

There are several different types of bankruptcy. Each is designed for different situations. The most common types are named after chapters of the U.S. Bankruptcy Code:

• Chapter 7: Quickly eliminates most unsecured debts like credit card bills and medical debt, often within months
• Chapter 13: Creates a repayment plan lasting three to five years for catching up on missed payments
• Chapter 11: Designed for businesses or individuals with significant assets or debts to reorganize finances
• Chapter 12: Specifically for family farmers and fishermen with tailored repayment plans

Chapter 7 and Chapter 13 are the most common forms. We’ll examine each of those closely.

What Is Chapter 7 Bankruptcy?

Chapter 7 is by far the most popular type of personal bankruptcy. It wipes out most unsecured debts. Medical bills, personal loans, payday loans, and credit card debt all qualify. Past-due rent and utility bills are also unsecured debts.

Some people can get their federal student loans discharged through Chapter 7. An additional process called an adversary proceeding is required.

How Long Does Chapter 7 Take?

Chapter 7 bankruptcy is the quickest form of bankruptcy relief. The bankruptcy court enters the discharge order once filers complete all required steps. Certain deadlines must pass first.

The bankruptcy discharge is typically granted within three to four months of filing. Filers can take advantage of their fresh start immediately. You can begin rebuilding your credit score right away.

What Happens to Your Property in Chapter 7 Bankruptcy?

You must list everything you own when you file Chapter 7 bankruptcy. All types of property must be included, even things without much value.

In bankruptcy, these are called assets.

There are three basic kinds of assets:

• Personal property: Your stuff like furniture, clothes, electronics, and your car
• Real property: Land and anything attached to it, like a house or condo
• Intangible property: Things you can’t touch, like your bank account, tax refund, or retirement savings

Even if you don’t physically have something, it still counts as an asset. You just need a legal right to it on the day you file bankruptcy.

Listing an asset doesn’t mean you’ll lose it. Most people keep everything they own in Chapter 7 cases. Bankruptcy exemptions protect certain property from being sold by the trustee.

If everything you own is protected by exemptions, your case will be a no-asset case. Creditors won’t get any money, and you still get your debt wiped out. Ninety-five percent of Chapter 7 cases are no-asset cases where filers keep all property.

Items you’re making payments on like a car or home are still considered assets. Whether you can keep them depends on the loan status. Your ability to stay current on payments matters too. Lenders may repossess or foreclose if you stop paying, even with exemption protection.

Can You Keep Your Car and House in Chapter 7 Bankruptcy?

Mortgages and car loans are secured debts. The property backs up the loan. Lenders can reclaim the property if you fail to pay. These debts work differently in Chapter 7.

Whether you can keep your car or house depends on several factors. Property value, equity, and current payment status all matter. Most people filing Chapter 7 can keep these items if protected by exemptions.

You need to stay current on payments if you want to keep the property. Otherwise, the secured creditor can still repossess the car or foreclose. Bankruptcy wipes out your personal liability but doesn’t stop secured creditors.

Does Chapter 7 Bankruptcy Get Rid of All Debts?

Some types of debts are considered non-dischargeable. Chapter 7 won’t erase them:

• Recent income tax debt
• Alimony
• Child support
• Debt incurred from illegal acts like embezzlement or larceny

You’re protected against collection actions for these debts during bankruptcy. The automatic stay provides this protection. Once the discharge is granted, creditors can start collecting again. The IRS, state taxing authority, or a former spouse can even start or resume a wage garnishment.

What You Need To Know About Chapter 7 Bankruptcy Eligibility

Not everyone qualifies for Chapter 7 bankruptcy. You must pass the means test to be eligible. The means test ensures only those who truly can’t afford debt repayment use Chapter 7.

Here’s what you need to know about eligibility:

• Income requirements: The means test compares your income to the median income for your household size in your state. You automatically qualify if your income is below the median.
• Disposable income test: You can still qualify if your income is above the median. Show that necessary living expenses leave you with little to no disposable income. Bankruptcy law sets a strict formula for this calculation.
• Exceptions to the means test: The means test may not apply if most debts are business-related. Some individuals with military service may also be exempt.

You need to meet other basic requirements even if you pass the means test. You must complete a credit counseling course before filing. You must demonstrate that you haven’t filed another bankruptcy case recently.

Will Filing Chapter 7 Bankruptcy Hurt Your Credit?

Many people worry that filing for Chapter 7 will ruin their credit. Filing may actually help your credit improve if your score is already low. Scores below 600 especially benefit.

Your credit score already takes a hit when you’re behind on payments. Bankruptcy gives you a clean slate. Lenders may see you as less risky once you’re no longer carrying debt. You can’t file Chapter 7 again for another eight years. Lenders appreciate this peace of mind.

Studies show people who file for bankruptcy often see credit scores increase within months. Many can open new credit accounts within a year. Some recover faster than people in similar financial situations who don’t file.

Filing bankruptcy won’t instantly fix your credit. It can be a turning point though. Many people rebuild their credit with time and good financial habits. They qualify for loans, credit cards, and even mortgages again.

What Is Chapter 13 Bankruptcy?

Chapter 13 bankruptcy is sometimes called reorganization bankruptcy. It allows individuals with regular income to reorganize their debts. You pay them off over time.

Instead of wiping out debts immediately like Chapter 7, Chapter 13 creates a repayment plan. The plan lasts three to five years. You make monthly payments to a bankruptcy trustee during this time. The trustee distributes the money to your creditors.

Chapter 13 can be especially helpful if you want to catch up on missed payments. Secured debts like a mortgage or car loan qualify. You keep the property while catching up. Chapter 13 can also reduce the balance or interest rate on certain secured debts.

Any remaining eligible unsecured debts are discharged at the end of a successful payment plan. Credit card or medical bills get wiped out.

Chapter 13 takes longer than Chapter 7. It can help you protect your property and manage debts you can’t afford to pay in full.

What Are the Alternatives to Bankruptcy?

Bankruptcy isn’t the only option if you’re struggling with debt. You may have alternatives depending on your financial situation. Here are some common options:

• Debt settlement: You can negotiate directly with creditors to settle your debt for less than the full amount owed. A lump sum offer works best for the reduced balance.
• Debt management plan (DMP): A credit counseling agency can help you set up a structured repayment plan. You pay off your debts over time, often with reduced interest rates.
• Debt consolidation: You take out a new loan to combine multiple debts into one payment, ideally with a lower interest rate.

You can contact your lender if you’re struggling with a car or home loan. Ask for forbearance or a lower monthly payment during temporary financial hardship. Our partner Cambridge Credit Counseling can help you explore debt management options with lower payments.

When Should You Consider Bankruptcy?

Many people who file bankruptcy have suffered big setbacks. Divorce, job loss, or serious illness with huge medical bills are common examples. Others have simply fallen behind, then been unable to catch up. Late fees and interest increased credit card debt and other debts to unmanagable levels.

Bankruptcy makes sense when your debt exceeds what you can reasonably pay. You’re drowning in collections calls and threats of lawsuits. Your wages are being garnished or you’re about to lose your home.

You don’t have to wait until the last minute. Speaking with a bankruptcy attorney can help you understand your options. You can speak with a bankruptcy attorney for free to see if Chapter 7 or Chapter 13 is right for you.

Bankruptcy provides real relief when you need it most. You deserve a fresh financial start.