During the peak of the financial crisis that started in 2007, bankruptcy was considerably more common than it is today. During the 12-month period that ended in September 2010, a shocking number of bankruptcies — 1.6 million — were filed.
In the year that ended March 31, 2018, annual bankruptcy filings totaled 779,828. That’s a 1.8 percent drop from the year prior, noting an ongoing decline in bankruptcies since 2010.
Fewer bankruptcies is good news for consumers and the economy, but not everyone is so lucky. Due to financial issues such as job loss, divorce, and chronic overspending, many consumers still opt for bankruptcy as a solution to their money problems.
This guide was created to help explain the different types of bankruptcy, how the process works and the type of consumer who would benefit most from the debt resolution that bankruptcy provides. If you’re considering bankruptcy to get your finances back on track, keep reading to learn more.
What is bankruptcy?
Bankruptcy is a process that helps consumers liquidate assets to pay off their debts when they can no longer manage them on their own. The process is outlined in Article 1, Section 8 of the U.S. Constitution. The Bankruptcy Code, which was enacted by Congress in 1978, is the uniform federal law that governs all bankruptcy cases in the U.S.
Besides consumer bankruptcy, bankruptcy laws also protect businesses that are struggling financially. The types of bankruptcy available to consumers, Chapter 7 and Chapter 13, help debtors resolve delinquent debts and shore up their finances, although they work in different ways.
While bankruptcy can result in the loss of personal property and assets through liquidation, it is often the best choice for consumers:
- After a Chapter 7 bankruptcy, consumers are often able to enjoy a fresh start that is free from unsecured debts that previously plagued their finances.
- After a Chapter 13 bankruptcy, consumers are typically able to begin repaying a percentage of what they owe and get back on track financially.
When should you file for bankruptcy?
While many consumers struggle to pay unsecured debts, bankruptcy is a solution intended for the most extreme cases — cases where families cannot get out of debt any other way. If a debtor has the financial means to repay their debts and gain a fresh start on their own, bankruptcy attorneys would likely counsel them on other options, such as meeting with a credit counselor and starting a debt management plan.
Yet there are plenty of cases when bankruptcy is the best option despite its consequences. For the most part, it makes sense to file for bankruptcy under the following circumstances:
- You cannot pay down your debt on your own and you continue falling further and further behind. “It makes sense to file bankruptcy when you can no longer keep up with your bills,” said Leslie H. Tayne, a debt resolution attorney and founder of Tayne Law Group, based in Melville, N.Y. “If commercial creditors are breathing down your neck or if you are in danger of losing your home, it may then make sense to file bankruptcy.”
- You have no real property and want to discharge your debts. While Chapter 13 bankruptcy requires you to reorganize your debts and pay them off, Chapter 7 bankruptcy allows you to discharge debts completely. For that reason, bankruptcy attorney Barry J. Roy of Rabinowitz, Lubetkin & Tully LLC in Livingston, N.J., said Chapter 7 makes sense when you don’t have many assets but desire to discharge your unsecured debts.
- You are struggling with unsecured debts and don’t want to lose your home. Roy said Chapter 13 makes sense for consumers who need some help with their debts but have considerable equity in their homes they want to protect.
According to Kim Cole, community engagement manager at credit counseling agency Navicore Solutions, bankruptcy can make sense when life circumstances cause people’s finances to spiral out of control. Very often, she said, her company works with consumers who have racked up insurmountable amounts of medical debt that they couldn’t pay off if they tried. Other times, bankruptcy is the result of job loss or another unintended loss of income.
Insurmountable amounts of credit card debt can also be helped with bankruptcy, particularly when the consumer has so much debt that they cannot keep up with the payments and keep a roof over their head.
On the flip side, there are plenty of times it doesn’t make sense to file bankruptcy. For example:
- Your debt doesn’t qualify for bankruptcy. Not all types of debt qualify for bankruptcy, which is why it’s not a solution for everyone. Cole said her company receives many inquiries about student loan debt because many people don’t realize student loan debt is not dischargeable in bankruptcy. Other types of debt that do not qualify for bankruptcy include alimony, child support, most taxes and debts resulting from fraud.
- You have too many assets. Chapter 7 bankruptcy has a means test you must pass to qualify. If you earn too much, you may not be eligible. Chapter 13 bankruptcy also has a limit on the amount of assets you can have to qualify.
- You can afford to pay down your debts. Cole said some families are better off with a debt management plan and credit counseling, provided they have the financial means to repay debt on their own.
- The root cause of your debts hasn’t been settled. Florida consumer protection lawyer Donald E. Petersen said consumers should not file bankruptcy until the root cause of their financial distress is solved. “If a consumer has severe health problems and is incurring medical bills that they are unable to pay, do not file bankruptcy until after the course of treatment is complete,” he said. “Similarly, consumers who are unable to pay their bills because they are unemployed or underemployed should not file bankruptcy until their employment status has stabilized at compensation that they can live on without accumulating additional debts in order to meet ordinary living expenses.”
Chapter 7 vs. Chapter 13: What’s the difference?
The two most common types of bankruptcy — Chapter 7 and Chapter 13 — work differently to help consumers recover from too much debt. The charts below outline how each process works and why these two types of bankruptcy are geared at different consumers:
|Chapter 7||Chapter 13|
Length of process
If you filed for Chapter 7 bankruptcy today, your meeting of creditors would be filed in three to four weeks. At this meeting, you will meet with your trustee.
Chapter 13 bankruptcy is more complicated than Chapter 7 bankruptcy since it requires you to restructure your debts. This type of bankruptcy requires you to make a court-approved repayment plan to show how you will pay off your debt within the next three to five years.
With Chapter 7 bankruptcy, the courts levy several charges — a $245 case filing fee, a $75 miscellaneous administrative fee and a $15 trustee surcharge. You will also have to cover the costs of court-required credit counseling before and after you file, which will cost $50 to $100 per session.
With Chapter 13 bankruptcy, the courts levy several charges — a $235 case filing fee and a $75 miscellaneous administrative fee. You will also have to cover the costs of court-required credit counseling before and after you file, which will cost $50 to $100 per session.
Types of debt forgiven
When you file for Chapter 7 bankruptcy, you have what is called “pre-filing debt” and “post-filing debt.” Pre-filing debt is debt you racked up before you filed for bankruptcy, whereas post-filing debt is debt you racked up since you filed. With Chapter 7 bankruptcy, only eligible pre-filing debt can be included.
Chapter 13 bankruptcy allows you to restructure your debts and catch up on late payments for secured assets. With that in mind, some of the debts that can be forgiven may only be partially forgiven through the Chapter 13 bankruptcy process.
To qualify for Chapter 7 bankruptcy, you must have little disposable income. A means test is applied that compares your income to the median income in your state. If your average monthly income for the six-month period leading up to your bankruptcy filing is less than the median income for the same household size in your state, you automatically qualify.
To be eligible for Chapter 13 bankruptcy, you must reside in or own property in the U.S., have a regular income and have unsecured debts of less than $394,725. You must also have secured debts of less than $1,184,200.
Roy said Chapter 7 bankruptcy is the “absolute worst thing you can do to your credit score.” But he also notes that if your debts are considerable enough and your income is so low that you cannot keep up, it could still be the best option for you.
Chapter 13 bankruptcy stays on your credit report for seven years. You may also see your credit score drop up to 200 points once you file.
What happens to your assets
Each state has a set of exemptions that apply in Chapter 7 bankruptcy. This set of exemptions and limits determines which assets you can keep once your bankruptcy has been completed.
With Chapter 13 bankruptcy, you are able to keep all your property. But you will need to restructure your debts and make payments toward some of the amounts you owe.
What happens to your debts
With Chapter 7 bankruptcy, most of your unsecured debts will be forgiven and discharged. But note that many debts — such as student loans, child support or alimony — do not qualify.
With Chapter 13 bankruptcy, your debts are restructured and a payment plan is conceived. The payment plan may offer some relief of your debts, meaning you may not have to pay back 100% of what you owe.
Which type of bankruptcy is right for me?
Both types of bankruptcy can be helpful for consumers struggling with debt, but the eligibility requirements for Chapter 7 bankruptcy make it so you will likely need to file Chapter 13 bankruptcy if your income is too high or you have significant assets.
With that in mind, here are some examples of when each type of bankruptcy might be best.
Chapter 7 may be best if …
- Your income is low enough to qualify. Roy said that if someone has modest or low earnings and significant credit card debt they can never pay off, Chapter 7 bankruptcy can make sense. “It depends on their financial situation, income and debts,” he said.
- You do not have significant assets or equity to protect. “People file Chapter 7 bankruptcy because they have no real property and want to discharge their debts,” Roy said.
Chapter 13 may be best if …
- You have significant assets you want to keep. “You’re going to file a Chapter 13 if you have equity in real or personal property you want to keep,” Roy said. “Usually people file Chapter 13 because they want to continue living in their own home.”
- You have enough income to repay some or all of your debts. Because Chapter 13 restructures most of your debts instead of discharging them, you need adequate income to be able to repay some of your debts.
How to file Chapter 7 bankruptcy
If you decide Chapter 7 bankruptcy is your best option, here are the steps you’ll take along the way.
Step 1: Gather all bills and financial information.
You’ll need documentation of your debts, your tax returns and your monthly bills before you move on to the next step.
Step 2: Receive mandatory credit counseling.
If you are a candidate for Chapter 7 bankruptcy, you will need to complete mandatory pre-filing credit counseling with an approved credit counseling agency. During this step, a credit counselor will go over your income, debts and regular bills to determine your best options, including alternatives to bankruptcy. The cost of this type of credit counseling session is typically $50 to $100.
Step 3: You will need to meet with a bankruptcy attorney.
Tayne recommends doing some research on attorney options ahead of time, including reading reviews and meeting with more than one to find the best one for you. Once you meet with an attorney, they will go over your financial information and debts and advise you on your next best steps.
Step 4: File for bankruptcy with your attorney.
Once you have completed credit counseling, you can start your bankruptcy case with your attorney. This involves filing a packet of forms with the local bankruptcy court. Required forms include the bankruptcy petition, forms for your financial information, a list of your income and expenses, and proof you have passed the Chapter 7 means test. You will also list your property exemptions based on limits in your state.
With Chapter 7 bankruptcy, you need to pay several charges upfront — a $245 case filing fee, a $75 miscellaneous administrative fee and a $15 trustee surcharge. You will also need to negotiate attorney fees and payment, which can vary widely depending on your unique case details and where you live.
Once you have taken this step to file for bankruptcy and your case is ongoing, creditors can no longer take collections actions against you.
Step 5: Your trustee works on your behalf.
Once your Chapter 7 bankruptcy is underway, a trustee takes over your case and begins reviewing your paperwork.
Step 6: You will have a meeting of creditors, also called a “341 meeting.”
After you begin the initial bankruptcy proceedings, you’ll receive a notice from the court about your meeting of creditors. You will need to be present at this meeting to answer questions from the trustee and any creditors who may be present at the meeting.
Step 7: You are determined eligible for Chapter 7 bankruptcy.
If the trustee deems you are eligible for Chapter 7 bankruptcy, you can move forward with Chapter 7 bankruptcy protection. If you are deemed ineligible for Chapter 7 bankruptcy due to your income or income-to-expenses ratio, you may have the option to file for Chapter 13 bankruptcy instead.
Step 8: Your trustee deals with nonexempt property, and you must also deal with secured debts.
If you have assets or property that is above the exempted amounts in your state, the trustee is charged with deciding which assets to seize and sell. Monies resulting from the sale of this property will be used by the trustee to satisfy some of your creditors.
If you have debts backed by collateral — such as an auto loan that is secured by a car — you must give it back, pay the creditor what it’s worth or reaffirm the debt. Reaffirming your debts is a process where you agree that you still owe an amount after your bankruptcy case is over.
Step 9: Take a credit counseling course.
Once your Chapter 7 bankruptcy case has been filed (but not discharged), you must complete a second credit counseling education course. This course may cost $50 to $100.
Step 10: Bankruptcy is over.
Once you file for Chapter 7 bankruptcy, it can take three to six months to receive your discharge. Your bankruptcy case will be closed now.
How to file Chapter 13 bankruptcy
Step 1: Gather all bills and financial information.
Pull together a packet of documentation that includes information on all your debts, your tax returns and your monthly bills.
Step 2: Receive mandatory credit counseling.
If you are a candidate for Chapter 13 bankruptcy, you will need to complete mandatory pre-filing credit counseling with an approved credit counseling agency. The cost of this type of credit counseling session is typically $50 to $100. During this meeting, a credit counselor will go over your finances, including your debts and your income, to counsel you on your options.
Step 3: You will need to meet with a bankruptcy attorney.
Conduct some research on attorneys ahead of time. Read reviews online and consider meeting with more than one attorney in your area. Your bankruptcy attorney will help put together the forms required to file Chapter 13. This includes a bankruptcy petition, debt and income schedules, and a Chapter 13 repayment plan you have worked on with your attorney to create.
You will also need to pay several court fees at this time, including a $235 case filing fee and a $75 miscellaneous administrative fee. Attorney fees are additional and may vary. Since Chapter 13 bankruptcy is so complex, it can cost up to $5,000 or more for attorney assistance.
Step 4: Get matched to a court-appointed trustee.
Your bankruptcy trustee will oversee your case and review your debt repayment plan. They will also collect payments on this plan once it’s underway, along with distributing funds to your creditors.
Step 5: Receive an automatic stay.
Once your bankruptcy is underway, an automatic stay will be in effect. This process stops creditors from pursuing collections actions against you.
Step 6: Begin your repayment plan.
Begin making monthly payments on your debt repayment plan within a month after you file for Chapter 13 bankruptcy.
Step 7: Attend a meeting of creditors.
You will receive notice about your meeting of creditors (or “341 hearing”) around a month after you file for bankruptcy. During this meeting, your trustee and any creditors that are represented will ask you questions about your income, your debts, and your monthly expenses.
Step 8: Attend a confirmation hearing for your bankruptcy.
Either you, your attorney or both of you will need to attend a court confirmation hearing. During this hearing, any objections from creditors or your trustee will be mentioned. Ideally, you will leave your confirmation hearing with your debt repayment plan and bankruptcy confirmed.
Step 9: File proofs of claim or object them.
During the Chapter 13 bankruptcy process, your creditors file proofs of claim that list debts owed with the goal of getting paid. You can either object proofs of claim that may be inaccurate or file proofs of claim so that you can pay a debt as part of your case.
Step 10: Begin debt repayment and meet with a credit counselor again.
Once your Chapter 13 bankruptcy is underway, you will make debt payments to your trustee according to your plan. You will also need to complete your second meeting with a credit counseling agency at an average cost of $50 to $100.
Step 11: Your bankruptcy case ends.
Most Chapter 13 bankruptcy cases take three to five years from start to finish. During that time, you will continue making debt payments until your plan is complete. At that time, the court will grant a discharge of your Chapter 13 bankruptcy.
Life after bankruptcy: 3 tips to recover
Bankruptcy may be a drastic solution to debt and income issues, but it is often the only way for consumers to get a fresh start. Roy implores you to consider what bankruptcy could mean to someone who is truly struggling.
“If you walked in here and told me you had $60,000 in credit card debt and you were only making minimum payments half the time and only make $20,000 per year, there’s no way you’re ever going to be able to pay off that debt,” he said.
The best thing you can do is file bankruptcy and discharge your debts so you can get a fresh start. “Otherwise, you’re just going to linger in credit card debt hell for years,” he said. “Better off to bite the bullet and file for bankruptcy so you can move on.”
Still, that “moving on” part can be difficult for consumers. Here are some tips that can help you recover from bankruptcy and get on better financial footing:
1. Listen closely to advice offered in your credit counseling sessions.
When you meet with a credit counselor before and after you file bankruptcy, you will receive counseling on how to improve your finances in the future. Take these lessons to heart and find ways to lower your expenses so that you are less likely to get in financial trouble in the future.
2. Strive to build a lifestyle without credit or debt.
Try to build a lifestyle that is less reliant on credit and debt. Believe it or not, many card issuers will grant you a credit card within months after your bankruptcy is discharged. It is up to you to fight off the temptation to borrow so that you can avoid getting back into debt.
3. Start using a monthly budget.
Try writing down all your monthly bills and expenses and estimating variable categories, such as food and entertainment. Set limits on how much you can spend and make sure you’re designating some of your monthly income toward savings and investments. Building up a reasonable emergency fund can also help you avoid debt in the future.
Frequently asked questions (FAQs)
These frequently asked questions and answers can help you learn more about filing Chapter 7 and Chapter 13 bankruptcy.
Filing for Chapter 7 or Chapter 13 bankruptcy can cause immediate damage to your credit score, often resulting in a loss of up to 200 points. But your credit score may have already been damaged due to late payments and other financial issues leading up to your bankruptcy filing.
Chapter 7 bankruptcy stays on your credit report for up to 10 years, while Chapter 13 bankruptcy stays on your credit report for up to seven years. Both types of bankruptcy will cause damage to your credit score.
Chapter 13 bankruptcy requires a $235 case filing fee and a $75 miscellaneous administrative fee, plus attorney costs. Chapter 7 bankruptcy comes with a $245 case filing fee, a $75 miscellaneous administrative fee and a $15 trustee charge, as well as attorney charges. With both types of bankruptcy, you are also required to pay for two credit counseling sessions that cost $50 to $100 each.
Both Chapter 7 and Chapter 13 bankruptcy can allow you to keep your house if requirements are satisfied. Chapter 13 bankruptcy is especially popular with homeowners who have considerably equity since it allows them to stay in their home and continue making payments while they pay off all, or a portion of, their other debts through a repayment plan..
Both Chapter 7 and Chapter 13 bankruptcy require you to go through credit counseling before and after you file. These sessions cost between $50 and $100 depending on the credit counseling agency with which you work, and they are mandatory.
You must reside in or own property in the U.S., have a regular income and have unsecured debts of less than $394,725 to qualify for Chapter 13 bankruptcy. You must also have secured debts of less than $1,184,200. You must not have had a bankruptcy case dismissed in court for 180 days before filing.
If your average monthly income for the six-month period leading up to your bankruptcy filing is less than the median income for the same-size household in your state, you automatically qualify. If your income is above the median, you must pass an additional means test that compares your income to specific monthly expenses to prove you have little to no disposable income.