Debt is a familiar companion for most in the United States. And even though we expect to see collective consumer debt surpass $4 trillion this year, most consumers are able to maintain payments and manage debt effectively. Unfortunately for some consumers, such as the 12.8 million who filed bankruptcy petitions between Oct. 1, 2005 and Sept. 30, 2017, debt can become an unmanageable burden that they can’t imagine themselves escaping. Whether the financial struggle is due to unexpected life circumstances or mismanaged money, declaring Chapter 7 bankruptcy might be an option worth considering.
How Chapter 7 bankruptcy works
Bankruptcy is designed as a form of relief to debtors, allowing them to discharge or reorganize their debt. In the case of Chapter 7 bankruptcy, the goal is to liquidate any nonexempt assets and use the proceeds to pay creditors. Which assets are considered nonexempt are defined by your state, but are generally comprised of assets that are not needed in the maintenance of a home or job.
The initial step for most may be to meet with a bankruptcy lawyer to get details on the process along with an overview of the benefits and drawbacks based on your personal situation. After that, if you decide that Chapter 7 seems like the right choice, you need to get credit counseling within the six months before you file.
Assuming that the credit counseling doesn’t find an alternate option, you then file for bankruptcy, submitting the appropriate forms and information (outlined below). After filing, a trustee is appointed to the case. Within 40 days of filing, the trustee will set up a meeting of creditors, during which all the listed creditors and the trustee are able to question the debtor about their financial situation. The trustee handles the administration of the bankruptcy, determines whether there’s a presumption of abuse, liquidates assets, makes payments to creditors and submits asset reports when relevant.
Finally, about 60-90 days after the meeting of creditors, if no creditor files a complaint or objection, the bankruptcy is discharged. Once this is done, the remaining eligible debts are wiped out and the debtor is no longer responsible for maintaining payments. This is also the case in a “no asset” bankruptcy, where there are no assets to liquidate and, as a result, no payments made to creditors before discharge.
It’s understandable why a person might want to file Chapter 7, since it allows borrowers a fresh start without managing ongoing payments, but there are rigid requirements to qualify since the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) was introduced to help ward off abuse of the bankruptcy system.
Chapter 7 eligibility
Before determining whether you are eligible for Chapter 7 bankruptcy, determine whether you want to use this option at all. Chapter 7 is often referred to as a liquidation, which means that assets you own (such as a recreational or second vehicle, or tools) can be sold by the trustee in order to pay your debtors. For some consumers, that might be enough to encourage them to look at alternatives, such as Chapter 13 bankruptcy.
But if you determine that the positives of Chapter 7 outweigh the negatives for you, see if you qualify to file. There are a few simple deal-breakers that immediately disqualify you from filing Chapter 7:
- You’ve had a Chapter 7 bankruptcy discharged in the past 8 years
- You’ve had a Chapter 13 bankruptcy discharged in the past 6 years
A few more situations that could make you ineligible for Chapter 7 include:
- You’ve had a Chapter 7 or Chapter 13 bankruptcy dismissed in the past 6 months for reasons such as violating a court order
- Your debts were obtained through fraudulent means (which could include making false statements on a loan application)
- You are filing as a corporation or LLC
Your income may prove yet another obstacle between you and Chapter 7. This is determined by taking a means test. Through this test, your last six months of income is measured against the median income of your state. If your income is the same or more than the median, you must complete a second form that lists your expenses. The total allowable expenses are then compared with your income to determine whether you qualify to file for Chapter 7.
What debts are forgiven or discharged under Chapter 7?
The goal of Chapter 7 bankruptcy is to discharge a debt, but only eligible debts will be discharged. So, what’s not eligible? Some of the most common debts you can’t discharge include:
- Child support
- Certain tax debt
- Death and personal injury claims due to a DUI
- Debt obtained through fraud
- Debts not listed in the bankruptcy
- Most student loan debts
What does that leave? Dischargeable debts such as:
- Medical bills
- Consumer debt, such as credit cards
- Personal loans and promissory notes
- Some lawsuit judgments
- Lease and contract obligations
How to file Chapter 7 bankruptcy
Get a credit counseling briefing with a state-approved provider
Must be done within the 6 months before your filing
Determine which court will handle your case
Find the right court through tools online for your district
Discover what state-specific requirements are for your filing
Some states will list special forms on their website that are required by your local court
A notice required by 11 U.S.C. § 342(b)
|Forms for the initial petition|
Statement about Social Security numbers
Compensation disclosure for preparer
Form 103A (when relevant)
Request to pay fees in installments
Form 103B (when relevant)
Request to waive filing fees
Form 101A (when relevant)
Initial eviction judgment statement
Form 101B (when relevant)
Payment of eviction judgment
You will also be required to submit the certificate of completion for credit counseling and a list of all creditors
|Within 14 days of filing|
Individual debtor’s schedules
Asset and liability schedule
Property, debtors, income, leases, expenses statement
Financial affairs statement
Compensation disclosure for attorney
Chapter 7 filing intention
A statement of current monthly income for Chapter 7
The means test calculation for Chapter 7
Form 122A-1Sup (when relevant)
Statement of no presumption of abuse
Finally, you’ll be asked to submit a copy of all income (pay stubs and remittances) received in the 2 months before filing
One of the very first things a bankruptcy filer must do before filling out a single form is to get a credit counseling briefing from a provider that’s approved in the state where the bankruptcy will be filed, a step that must be taken in the six months before your filing.
Melinda Opperman, executive vice president of the nonprofit Credit.org, says that this consultation entails an in-depth review of a debtor’s budget and explores different recommendations and options, but it goes even deeper than that.
“We get to the root problem and probe,” said Opperman. “It might seem like a job loss was the reason for the hardship, but then you realize it’s [just the final straw],” she said.
From there, Opperman said the goal is to provide resources, like a comprehensive budget, to help the consumer achieve their financial goals. If the consumer has settled on declaring bankruptcy, the briefing includes a discussion of the terminology they can expect to hear through the process. The briefing can cost anywhere from $15 per household to $50 per person, depending on the provider you choose.
Another prefiling step is to find out which court you need to file in, based on your local district courts. Then, check with the local court to find out if there are any state-specific forms you need to complete. The last prefiling step is to review Form B2010, a required notice that explains the different types of bankruptcy you can file as well as the costs. For 2018, Chapter 7 had a total fee of $335 — not including lawyer fees.
Completing the initial petition
The initial steps for the initial filing include (when relevant) the following forms as well as any state-specified forms:
- Form 101: Voluntary Petition for Individuals Filing for Bankruptcy
- Form 121: Your Statement About Your Social Security Numbers
- Form 119: Bankruptcy Petition Preparer’s Notice, Declaration and Signature
- Form 2800: Disclosure of Compensation of Bankruptcy Petition Preparer
You may also need to include the following optional forms, when relevant:
- Form 103A: Application for Individuals to Pay the Filing Fee in Installments
- Form 103B: Application to Have the Chapter 7 Filing Fee Waived
- Form 101A: Initial Statement About an Eviction Judgment Against You (individuals)
- Form 101B: Statement About Payment of an Eviction Judgment Against You (individuals)
Finally, you’ll want to prepare a list or matrix of all your creditors, formatted the way your local court requires. Submit this along with the above forms and your certificate of credit counseling completion.
Within two weeks
The next and final set of forms must be submitted within the 14 days following your initial filing. These forms consist of:
- Form 106Dec: Declaration About an Individual Debtor’s Schedules
- Form 106Sum: A Summary of Your Assets and Liabilities and Certain Statistical Information (individuals)
- Forms 106A-J: Schedules to 106 listing property, debtors, income, leases, income, expenses and more
- Form 107: Your Statement of Financial Affairs for Individuals Filing for Bankruptcy (individuals)
- Form 2030: Disclosure of Compensation of Attorney For Debtor
- Form 108: Statement of Intention for Individuals Filing Under Chapter 7
- Form 122A-1: Chapter 7 Statement of Your Current Monthly Income
- Form 122A-2: Chapter 7 Means Test Calculation
- Form 122A-1Sup (when relevant): Statement of Exemption from Presumption of Abuse Under §707(b)(2)
The court will also need a copy of all pay stubs and remittances you receive during the 60 days prior to your bankruptcy. Once again, check with your local court to see how they want these submitted and whether they go to the court of the bankruptcy trustee.
Finally, while not a necessity for filing, a requirement prior to discharge is a second financial education course. “The second course focuses on things like setting financial goals, budgeting, banking, borrowing, credit reports, credit scores, re-establishing credit, homeownership and different consumer laws,” said Opperman.
When filing Chapter 7, there is no requirement to have a lawyer, but because of the length of the forms and the number of them, it could be helpful to have one working with you. Especially since you may be able to offset the expense by getting bankruptcy filing fees waived with Form 103B. Either way, since most bankruptcy lawyers offer a free initial consultation, it’s a good idea to at least meet with one and get a sense of the process.
The means test
Chapter 7 has a reputation for being difficult to qualify for. This is mostly due to the more stringent eligibility standards put in place by BAPCPA in 2005. More directly, it’s because of the means test, a nine-page form that analyzes the filer’s expenses. But it’s not always the filer’s actual out-of-pocket expenses that are measured in this test. Instead, most of the expenses are based on the number of people in the household and the IRS-issued National and Local Standards for expenses like food, clothing, and utilities. In other words, what you actually spend on clothing and food will not be a factor.
Passing or failing the means test
When you pass the means test, it shows the court that your filing for Chapter 7 is not an abuse of the bankruptcy system because you can’t afford to restructure your debt under Chapter 13. But life has a way of throwing curveballs at us, which means that just because you fail the means test today doesn’t mean you will six months from now.
Failing the means test means that you’re a good candidate for Chapter 13, but this is only true if you can maintain payments of the Chapter 13 plan for the full three to five years. If you think this isn’t the case, possibly because an unusual bonus or remittance inflated your income before taking the means test, then you may want to wait and retake the test. Or, if you are willing to deal with a higher level of judicial involvement, you can file Chapter 7 even after failing the means test by listing out what you consider to be your special circumstances.
Pros and cons of declaring Chapter 7 bankruptcy
By far, one of the biggest positive aspects of declaring Chapter 7 bankruptcy is the ability to get eligible debts discharged without further payments. Chapter 7 is also much faster than other types of bankruptcy, in some cases taking as little as four months to discharge. (Chapter 13 can take years to get discharged.) Finally, the fact that collections activities stop once a bankruptcy is filed is a positive for many stressed-out debtors.
On the negative side, the impact on your credit score is probably the first thing that comes to mind. But when you’re facing the financial difficulties that make Chapter 7 a viable solution, it’s likely your credit score is already being impacted by late payments, collection notices, and repossessions, and would continue to be if you didn’t file.
One big negative for those who own nonexempt assets is the fact that they will be liquidated to pay creditors. Also, a potential negative is that your next tax refund may be considered part of the bankruptcy estate if it was from prefiling income.
Alternatives to Chapter 7
For many, bankruptcy is a last resort to deal with out-of-control debt issues. But it’s not the only choice a consumer can make. They might also consider other debt management options such as:
- Debt management plan: After getting the credit counseling briefing and financial education course required to file bankruptcy, you may learn financial management skills you didn’t have before. These skills can help you create a more efficient budget and may help you discover the ability to better manage your debt without needing to declare bankruptcy.
- Debt consolidation loans: You may be able to undergo debt consolidation to take all your debt and transfer it to one payment at a reduced interest rate, making repayment somewhat easier to manage. If you have equity in your home, you might be able to take out an equity loan and create your own debt consolidation with lower interest than your creditors currently charge.
- Lender negotiations: Some lenders may be willing to negotiate with you to lower interest rates and remove fees if you present them with a repayment plan. If you can make a lump sum payment, you may find that some creditors will even settle the total amount due for less. But note that the amount forgiven can be taxable.
When you decide to try to create your own plan for debt resolution, Opperman suggests still taking advantage of the help that an accredited, nonprofit credit counseling agency offers. “Yes, you can do it on your own, but most of us don’t repair our own cars or cut our own hair, so why try to handle this serious of an issue on your own,” said Opperman. “You can do a self-administered [debt management] plan, but at least start by getting some pro advice,” she said.
In some situations, a Chapter 13 bankruptcy might be a better solution than a Chapter 7 or a debt management plan. Especially when your income is high and you have nonexempt assets you want to protect, but your expenses are too high to manage debt repayment on your own.
After you declare bankruptcy, what comes next?
While you may be free and clear of certain debts after declaring Chapter 7 bankruptcy, you might still have remaining debts to manage like student loans, mortgage payments, and other non-dischargeable debts. It’s going to be vital that you create a plan that enables you to maintain those payments and not take on further debt, especially since you won’t be able to file Chapter 7 again for at least eight years.
As you may already have guessed, there will be some impact on your credit as a Chapter 7 bankruptcy will show on your credit report for up to 10 years. The good news is that the influence of this will lessen over time, so much so that we have research indicating that 75% of filers saw their credit rise to 640 after five years of filing — well before the bankruptcy had disappeared from their report.
Managing your credit is extremely important after filing bankruptcy because according to Opperman, things don’t always go as planned. “Often, after a bankruptcy, your credit report is a mess because creditors stop collections and debts get charged off,” she said. “By the time [filers] look at their credit report two years later, it still looks like they owe debts that were discharged,” said Opperman. To help with this, Credit.org created “The Consumer Guide to Good Credit,” which guides consumers through the process of re-establishing good credit after bankruptcy.
While a bankruptcy filing can stop foreclosure actions, it won’t save your home if you’re behind on payments and it’s only a temporary solution. Instead, struggling homeowners who are facing foreclosure should consider filing Chapter 13, which allows them to catch up on past-due payments.
The main obstacle is the means test, which measures your income and expenses based on IRS-issued National and Local Standards for household expenses, such as utilities and food. If your current monthly income is less than the state median, or your aggregate five-year net income on the means test is less than $12,850, or 25% of your total unsecured debt (of $7,700 or more), then you may qualify.
Yes — assuming you are not behind in payments. A home is generally considered an exempt asset if you have no equity or it is under homestead exemption in your state, which means it’s not liquidated to pay creditors the way that a boat or vacation home might be.
Chapter 7 offers consumers a much-needed solution to the problem of overwhelming debt that can stem from a job loss, medical expense or other unexpected, life- and finance-altering event. While it is more difficult to qualify for Chapter 7 now than it was a decade ago, the hurdles in place are there to prevent abuse of the bankruptcy system, while still ensuring those who legitimately need Chapter 7 can still get access.
Moving forward after bankruptcy, consumers should make sure they extend their financial knowledge and exercise caution when taking on debt, to ensure they don’t end up needing bankruptcy again a few years down the road. The key to this, according to Opperman, is knowledge. “Financial knowledge is power when it comes to your money, and risk occurs when you don’t know what you’re doing with your money,” she said.