When you’re facing overwhelming debt, bankruptcy can often help—especially with credit card balances, medical bills, and personal loans. A Chapter 7 bankruptcy gets rid of debt quickly, which most people prefer over a Chapter 13 bankruptcy (that approach requires a three- to five-year repayment plan). (For a basic description of a Chapter 13 bankruptcy, see Chapter 13 Wage Earner Bankruptcy Basics.)
In a Chapter 7 bankruptcy, you can “exempt,” or keep, a certain amount of property, such as an inexpensive car, your household furnishings, and other belongings. The bankruptcy trustee (the person who facilitates your bankruptcy) will sell your nonexempt property—the property you can’t keep—and use the proceeds to pay your creditors. Not everyone qualifies for a Chapter 7 bankruptcy, however. To discharge your debts in Chapter 7, you must first meet the income requirements set by your state.
Do I Qualify to File for Chapter 7 Bankruptcy?
Determining whether you’re eligible requires that you pass something known as the “means test.” Under the means test, if your average gross income for the six months prior to filing is less than the median income of your state, you automatically qualify. If your income exceeds the median, you might still be eligible because the second step of the test allows you to deduct certain expenses, such as income taxes, health care premiums, and childcare costs, from your gross income.
To find your state’s median income, visit the U.S. Trustee website. In the box titled, “Data Required for Completing the 122A Forms and the 122C Forms,” select the most recent date. Click the “Median Family Income Based on State/Territory and Family Size” link to access the median income chart.
Can I Keep My Property?
Yes—at least some of it. The amount you can keep, or “exempt,” depends on your state’s exemption laws. Most states allow you to protect essential household goods, such as kitchenware, furniture, bedding, an inexpensive car, and some jewelry. Other types of exempt property include:
- your residence
- retirement funds, such as 401k accounts
- Social Security, veteran’s benefits, and disability benefits, and
- trade or professional tools.
While many people can keep all of their possessions, your nonexempt property becomes part of the bankruptcy estate and is sold for the benefit of your creditors. Many people end up keeping all of their possessions because they do not own any nonexempt items. But those who own a mix of exempt and nonexempt items will find that the latter will become part of their “bankruptcy estate,” which the trustee will sell for the benefit of their creditors. Common types of nonexempt property include:
- homes with more equity than can be exempted
- timeshares and rental property
- boats, recreational vehicles, and motorcycles
- artwork and collectibles
- non-retirement investment accounts, and
- stock or other ownership interests in a business, LLC, or corporation.
Of course, most people don’t want to lose any property, including nonexempt things. But from a practical standpoint, losing a treasured but nonexempt item can make sense if the total amount of debt wiped out will be significantly greater than the value of that item.
Example 1. Harry had $80,000 in credit card debt and could exempt all of his property except a classic 1964 Austin-Healey valued at $7,800. Harry decided to file for bankruptcy because even after relinquishing the car, he still netted $72,200 in debt savings.
But what happens if you don’t want to give up your property? There is a solution: You can buy it from the bankruptcy trustee—and usually at a discount. Sometimes the trustee will even let you pay for it in payments.
Example 2. Even though Harry knew filing for bankruptcy was the right thing to do, the Austin-Healey was the first car he ever bought, and after keeping it in pristine condition for years, he couldn’t bear to part with it. He didn’t have to. The trustee didn’t care who bought the Austin-Healy as long as the bankruptcy estate received the sale proceeds. So he deducted 20%—the amount it would cost him to sell the car—and sold it to Harry for $6,240. On top of that, the trustee gave Harry ten months to pay for it.
To find your state’s exemptions, check your local bankruptcy website or call the court clerk.
What Debts Are Discharged?
Chapter 7 bankruptcy wipes out, or “discharges,” almost all unsecured, nonpriority debts, including credit card debt, medical bills, personal loans, many lawsuit judgments, income taxes over three years old (though it’s rare), and past-due utility bills. Not all debts are wiped out, however. For instance, the following are not dischargeable:
- secured debt (a mortgage or car payment)
- priority unsecured debt (most income taxes, delinquent family support payments, and penalties and fines owed to the government), and
- student loans.
To find out more about the debt that survives bankruptcy, see Nondischargeable Debts: Debts You Can’t Discharge in Bankruptcy.
The Bankruptcy Process
The bankruptcy process begins when the debtor files a petition that discloses information about income and property, debts, and prior transactions. If you plan to retain a lawyer, take paycheck stubs and tax returns with you to your attorney meeting. The documents will help the attorney qualify you for Chapter 7 treatment and identify potential issues.
The automatic stay stops creditor calls.
As soon as you file, the court automatically issues an order called a “stay.” Once the automatic stay is in place, your creditors cannot contact you or attempt to collect from you. The calls come to a halt.
The trustee questions you at the “341” meeting of creditors.
About one month after you file, you’ll go to the "341 Meeting of Creditors"—the one court appearance you’re required to attend. Seven days beforehand, you must give the trustee a large group of documents, called the “541 documents.” Specifically, you’ll provide:
- tax returns
- paycheck stubs
- car titles
- mortgage statements
- banking, investment, and retirement statements
- profit and loss statements (if you own a business), and
- your marital settlement agreement (if you are divorcing or recently divorced).
At the 341 meeting, you’ll prove your identity by presenting a picture I.D. card—typically your driver’s license—and your Social Security card. The trustee will ask you a standard series of questions, including whether everything in your bankruptcy petition is true and correct; whether you need to make any changes; whether anyone owes you any money; and any other questions raised by your petition answers. Creditors can attend, but rarely show up, and most meetings last less than five minutes.
When Do I Get the Discharge?
The court will mail your discharge notice 60 days after your 341 meeting. If your case is a “no asset” case—meaning your creditors get nothing—you’ll receive a dismissal shortly thereafter. By comparison, asset cases remain open until all assets are distributed, which can take several months or more, depending on the complexity of the case. For example, the trustee might have to wait for a buyer to purchase a hard-to-sell piece of property, or for your attorney to settle a bad faith lawsuit against your insurance company.
Questions for Your Attorney
- Is filing for Chapter 7 bankruptcy a good choice or would a Chapter 13 bankruptcy make more sense?
- How long will the bankruptcy affect my credit?
- Will I have a difficult time getting a job, or renting a house, after my case is over?