Chapter 7 Bankruptcy: What it Is and How to File

What Is Chapter 7 Bankruptcy?

You should understand bankruptcy clearly because it is a serious business. In the U.S. bankruptcy code, Chapter 7 governs the process of asset liquidation. When nonexempt assets are liquidated, a bankruptcy trustee pays creditors; the remaining debt has then been discharged after the proceeds are exhausted. 

The debtor must have not filed a Chapter 7 bankruptcy in the preceding eight years and must pass a means test to be eligible to file Chapter 7. This process is also called “straight” or “liquidation” bankruptcy.

Do You Qualify For Chapter 7 Bankruptcy?

Chapter 7 bankruptcy requires that you:

  • You must pass the means test, which examines your income, assets and expenses.
  • Must not have filed a Chapter 7 bankruptcy in the past eight years or a Chapter 13 bankruptcy in the past six years.
  • In the last 180 days, you could not have filed a bankruptcy petition (Chapter 7 or 13) that was dismissed due to your failure to appear in court or comply with court orders, or because your creditors sought court relief to recover property they had a lien on.

How To File Chapter 7 Bankruptcy

The absolute priority rule establishes the order of payment of debts in a Chapter 7 bankruptcy. Under this rule, unsecured debts are divided into classes or categories, with each class receiving priority for payment. Secured debts reduce the risk of loans, such as a mortgage, by being backed by collateral.

Unsecured debts are given priority for payment. Tax debts, child support payments, and personal injury claims against the debtor are examples of unsecured senior debts. Securing the debt comes next. The final step is to use the funds remaining after the assets are liquidated to pay off non-priority, unsecured debts. If there are insufficient funds to pay all of the non-priority, unsecured debts, the debts are paid on a pro-rata basis.

Below are the steps to file for Chapter 7 bankruptcy:

Step 1: Counseling and Forms

Before commencing Chapter 7 bankruptcy proceedings, petitioners must undergo debt counseling within six months of filing. If there is no approved counseling center in your county, you may skip this step. Other exceptions may apply depending on the situation.

To initiate a Chapter 7 proceeding, a petitioner must complete several forms, including a motion to the court. Information on the forms includes the debtor’s finances, creditors, assets, income and expenses. Once the petition is filed, an automatic stay prevents creditors from collecting debts. The income garnishment also ends as soon as the petition is filed.

Trustee Appointment and Meeting of Creditors

The bankruptcy court shall appoint an impartial trustee to supervise the entire bankruptcy proceedings. As part of the asset review process, the trustee will determine which assets can be liquidated to pay creditors. The trustee then schedules meetings with creditors to confirm the validity of the petition and finances. The “creditors’ meeting” is an opportunity for creditors to ask questions of the trustee and the debtor.

Debt Repayment

The debtor’s personal assets and finances shall be verified by the bankruptcy trustee. Assets that are exempt from bankruptcy or that are necessary to maintain the standard of living are retained by the debtor. The rest is seized and liquidated to pay creditors. States have different exemptions for assets. In many cases, a debtor can keep his or her primary home, personal belongings, and car. All other property is liquidated by the trustee.

Discharge of Remaining Debt

In a Chapter 7 bankruptcy, most debts are discharged. Debt discharge releases the debtor from any personal liability. After a Chapter 7 deficit is discharged, the creditor cannot seek reimbursement from the debtor in the future. 

Bankruptcy does not discharge obligations related to alimony, child support, some government debts, income taxes, or federal student loans. Forgiveness of tax debts and student loans is very limited under the law. There are 19 categories of debt that cannot be forgiven under the United States Bankruptcy Code. After the meeting of creditors, claimants usually receive a discharge about two months later.

Serious Ramifications

Debtors should be aware of the negative consequences of bankruptcy and therefore decide whether it is the right course for them. Creditors may attempt to collect debts after discharge, even if they are not entitled to do so (therefore, keep bankruptcy documents, as duplicates are very expensive). 

A bankruptcy petition will appear on credit reports for ten years from the date of the petition, seriously affecting the debtor’s ability to obtain credit. In addition, a Chapter 7 discharge cannot be obtained within eight years of a prior Chapter 7 discharge. If you have gone through Chapter 7, you can be extra prudent financially.

Is Chapter 7 bankruptcy right for you?

Make sure you understand the difference between a Chapter 7 bankruptcy and a Chapter 13 bankruptcy. A Chapter 7 bankruptcy is appropriate when:

  • You do not own many assets.
  • More than half of your income is used to pay off problem debts.
  • Chapter 7 can discharge or forgive your problem debts. Medical bills, credit card debt, and payday loans are examples of such debts.
  • Even if you took extreme measures, it would take five years or more to pay off your debt.

Taxes, child support, and student loans are among the debts that cannot be discharged in a bankruptcy proceeding. If you can discharge other types of debts, you may still be able to file for bankruptcy if you have enough money left over to pay the debts that cannot be discharged.

Chapter 13 bankruptcy, the other common form of bankruptcy for consumers, may be better if you have more assets or secured debts and can repay some or all of your debts.

In addition to debt-relief options, a debt counseling agency can help you create a debt management plan. Debt counseling agencies and many bankruptcy attorneys offer a free initial consultation before you make a decision.

How To Rebuild Credit After Bankruptcy

Following bankruptcy, you will need to pay attention to your financial life, particularly your credit, but having many debts resolved is a good start.

To rebuild after bankruptcy, follow these two steps:

  • Create a financial plan: Create a budget, set financial goals, and consider enlisting the free assistance of a nonprofit credit counselor.
  • Restore your credit: Pay your bills on time, keep your credit balances low, and dispute errors on your credit reports.

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