What is Chapter 7 Bankruptcy?
Chapter 7 bankruptcy is sometimes called a "straight" bankruptcy or "liquidation" bankruptcy. It cancels many types of debt, but filers may have to let the bankruptcy court sell their property to pay creditors.
How Is Chapter 7 Different from Chapter 13 Bankruptcy?
Chapter 13 bankruptcy is also called a "reorganization" bankruptcy. Chapter 13 bankruptcy does not require filers to relinquish property, but the debtor will have to adhere to a court-ordered plan, using income to repay some or all outstanding debt. Chapter 7 allows debtors to keep income but may liquidate property to satisfy creditors. Chapter 7 can be completed in a few short months, while Chapter 13 can take 3 to 5 years, depending on available income and assets. Chapter 7 bankruptcy filing is cheaper and easier than Chapter 13.
What Can Chapter 7 Bankruptcy Accomplish?
Filing brings creditors' actions to a halt, called an "automatic stay." This prevents creditors from garnishing wages, going after bank accounts, repossessing assets like cars or houses, or cutting off utilities. For those in danger of being evicted, foreclosed on, or losing needed utilities, the automatic stay can provide breathing room and a chance to find solutions. In addition, filers can save up some money as they may be allowed to live in their home rent-free for several months. Chapter 7 cancels all debts secured by the home, including mortgages and home equity loans. However, the creditors will be allowed to take the property and sell it to satisfy the debts.
Chapter 7 bankruptcy filing can be an expedient solution for those with lots of unsecured debt, disastrous medical bills, or other insurmountable extraordinary expenses and limited income. Borrowers who owe more on their home than it is worth can walk away with no deficiency obligation, meaning they won't have to pay the lender the difference between what is owed and what the property fetches in a foreclosure sale. It can provide a clean start, although the damage to credit ratings is substantial.
What Can't Chapter 7 Bankruptcy Accomplish?
Certain actions like tax liens or IRS property seizures won't be affected by bankruptcy filings, nor will child or spousal support lawsuits or criminal proceedings. In addition, automatic stays are not forever. Creditors can request that a stay be lifted--if, for example, the home is slated for foreclosure sale and notices have been filed. In cases like this, the court may well lift the stay and allow the lender to proceed. Chapter 7 filing will discharge neither student loans nor most tax or support obligations. It won't prevent home foreclosures or car repossessions. Though the debts may be wiped away, the creditors are allowed to repossess the assets. Filers who want to stop a mortgage foreclosure and force the creditor to accept a restructured payment will have to file under Chapter 13.
Who Is Allowed to File for Chapter 7 Bankruptcy Protection?
Debtors are allowed to file for Chapter 7 unless they:
- Fail a "means" test. Filers must not earn more than the median income for a same-size family in their state. Should their income exceed this limit, they may still be eligible to file if disposable income (determined by working through a painstaking worksheet and extensive set of rules) is less than $100 a month. If not, debtors may have to file under Chapter 13 and repay at least some of their debts.
- Have obtained a Chapter 7 bankruptcy discharge in the last 8 years or a Chapter 13 discharge in the last 6 years.
- Have defrauded their creditors by hiding assets by transferring them to friends or relatives, running up debts knowing that there was no way to repay them, concealing property or cash from a spouse in a divorce action, or lying to creditors about income or assets.
- Had a bankruptcy discharged in the last 180 days because of court order violations, fraudulent or abusive filings, or because a dismissal was requested after a creditor asked for relief from an automatic stay.
What Option Is Best?
The decision to file for bankruptcy protection is a serious one. Opting for the wrong procedure or filing when it won't provide much help can be expensive and financially disastrous. A bankruptcy attorney can advise which option is more appropriate--or determine whether bankruptcy is a good solution at all. Troubled debtors can find good advice and make the most of available solutions to debt problems.