Chapter 7 Bankruptcy: What It Is, How to File, the Means Test & More
Chapter 7 is the most common form of personal bankruptcy, constituting about 70% of all non-business bankruptcy cases. It is also called “straight” or “liquidation” bankruptcy, requiring debtors to surrender most of their property in exchange for forgiveness, or “discharge,” of their debts. That property is liquidated, or sold for cash, and the proceeds are used to compensate the debtors’ creditors.
Fortunately for everyone worried about the fate of their home and car during chapter 7 proceedings, those items are actually part of a very long list of exempt items that are not eligible to be sold, as long as you meet certain equity and delinquency requirements.
In this comprehensive guide, you will learn even more about how the Chapter 7 bankruptcy process works, who is eligible, how much it costs and more. For the purposes of this guide, we will focus primarily on personal Chapter 7 cases. Corporations, partnerships and LLCs file a different form of Chapter 7 bankruptcy for businesses.
|Automatic Stay: This feature of Chapter 7 immediately stops most collection attempts by creditors and government agencies.||Property Loss: You will lose much of your nonexempt, or “luxury,” property, such as your second home or family heirlooms.|
|Property Retention: Most state exemptions allow you to keep many of your assets, such as your primary home and car, as well as your clothes and household furnishings. You may also keep the income you earn and property you buy after you file for Chapter 7.||Credit Damage: A record of Chapter 7 bankruptcy stays on your credit report for 10 years.|
|More Relief: The amount of debt that you can discharge through Chapter 7 is virtually unlimited.||Time Limitation: You may receive a discharge under Chapter 7 bankruptcy only once every eight (8) years from the date of your last filing. If you find yourself in a worse situation during that period, Chapter 7 won’t be an option.|
|Success Rate: Given that more than 99% of Chapter 7 cases are discharged, your Chapter 7 bankruptcy will likely be a success (so long as you follow the rules and don’t commit fraud).||Debt Survival: You may still have to pay certain debts, such as a mortgage lien, child support or alimony, once bankruptcy is over. Chapter 7 also won’t relieve you of student loan debt unless repayment would impose undue hardship on you and your dependents.|
|Time Commitment: Chapter 7 bankruptcy takes much less time (4–6 months) than Chapter 13 bankruptcy (3–5 years).|
|Cost-Effectiveness: Attorney’s fees are typically cheaper in Chapter 7 bankruptcy than in Chapter 13.|
|Credit Opportunities: Although you will lose all of your credit cards in bankruptcy, you may qualify for another credit card or loan after three years have passed since you filed for Chapter 7, albeit at unattractive terms.|
Any person who resides, conducts business or possesses property in the United States may file for Chapter 7 bankruptcy. You will qualify for Chapter 7 bankruptcy regardless of your debt load, provided that you meet certain eligibility requirements.
|Eligible for Chapter 7||NOT Eligible for Chapter 7|
|You are an individual, a sole proprietor or a general partner in a business (Chapter 7 personal bankruptcy).||You have had a bankruptcy case dismissed in the past 180 days because you failed to appear in court or to follow the court’s orders. You must wait another 180 days before you may file again.|
|You are a partnership, a corporation or other business entity (Chapter 7 business bankruptcy).||You voluntarily dismissed a prior bankruptcy case when your creditors sought relief from the automatic stay.|
|You passed an income-based Means Test.||You received a discharge from bankruptcy in the past six (6) years (for Chapters 12 or 13) or eight (8) years (for Chapter 7).|
The means test in bankruptcy is an income-based method of determining whether a filer deserves to have debts wiped out through Chapter 7 or restructured through Chapter 13. It is designed to limit eligibility for Chapter 7 liquidation to those who truly struggle to pay their debts or to operate an insolvent business.
|Required to Take the Means Test||NOT Required to Take the Means Test|
|Individual debtors with more than 50% consumer debt whose current monthly income is more than the state median for their family size.||Individuals with more than 50% consumer debt whose current monthly income is less than the state median for their family size.|
|Individual debtors, including sole proprietors and general partners, with more than 50% business, or nonconsumer, debt.|
TIP: If the majority of your debts are consumer debts, a high amount of student loans may help you bypass the Means Test and qualify for Chapter 7. Some courts, but not all, classify student loans as “nonconsumer debt.” If your total student loan debt puts your total nonconsumer debt above 50%, you will not be required to take the Means Test.
The Chapter 7 process is quite swift and straightforward compared with the requirements and multi-year timeline of Chapter 13. In general, the entire Chapter 7 process — from filing to discharge — usually takes about three (3) to six (6) months. Prior to filing your case, however, you will need to cover the following preliminary steps:
- Complete credit counseling within 180 days prior to filing your petition.
- Consult and hire a bankruptcy attorney. The complexity and stakes of chapter 7 bankruptcy make it extremely risky to represent yourself. If you’re concerned about affording an attorney, you can seek assistance from a local law clinic or contact attorneys that do pro-bono work.
- Gather the documents necessary to complete your packet of bankruptcy forms and schedules.
In most cases, Chapter 7 requires only one trip to the bankruptcy court, when you attend your 341 meeting to attest to the truthfulness and accuracy of your bankruptcy petition. The case ends shortly after you receive your discharge — unless, of course, your case is dismissed or converted to a different chapter during the process.
As you prepare to file a case under Chapter 7, keep in mind that each bankruptcy jurisdiction has different rules as well as local forms, schedules and procedures. It is extremely important that you follow all rules and attend all required meetings to avoid dismissal of your case or, worse, being charged of criminal activity such as fraud. Learn more about the Chapter 7 filing process on WalletHub.
The automatic stay is a provision of the Bankruptcy Code that stops most collections efforts from creditors, government agencies and collections agencies directed at you (and your spouse if filing jointly) while in effect. An action that is “automatically stayed” — such as a lawsuit, repossession, foreclosure or wage garnishment — cannot be enforced for a period of time, beginning when you file for bankruptcy.
If granted, the length of the automatic stay will depend on the type of collection effort in question, whether you’ve previously filed for bankruptcy and how many times you’ve done so. Generally, however, the automatic stay will last for the duration of your bankruptcy case.
Keep in mind that the automatic stay protection is not absolute: There are multiple exceptions, or actions that it does not cease. A complete list of the actions that are and are not subject to the injunction are covered in our Automatic Stay guide.
Most debts are discharged in personal Chapter 7 bankruptcy cases. In fact, the more qualifying debts you have, the more relief you will get. Below we will cover how different types of debt are treated in a Chapter 7 bankruptcy case.
These debts are wiped out through Chapter 7.
|Collection Accounts||Credit Card Debt (including late fees)||Medical Bills|
|Unsecured Loans (including personal loans from friends, relatives or employers)||Debt from Bad Checks (unless fraudulently based)||Payday Loans|
|Back Rent and Other Lease-Related Debts||Unpaid Taxes*(depending on certain criteria)||Tax Penalties|
|Utility Bills (past-due balances only)||Government Benefit Overpayments You Weren't Eligible to Receive & Didn't Return (including Social Security and Veterans Assistance loan overpayments)||Dischargeable Portion of Secured Debt (e.g., mortgage and car loans — see "Secured Debt in Chapter 7 Bankruptcy" section below)|
|Deficiency Balances Post-Repossession (i.e. balance you owe even after your property has been repossessed by the creditor)||Auto Accident Claims (unless you were convicted of a driving drunk charge)||Attorney Fees (except those you incurred for the Chapter 7 case as well as establishing child support and alimony)|
|Revolving Charge Accounts (i.e. debts carried on charge cards and credit lines)||Civil Court Judgments (unless fraudulently based)||Business Debts|
* Unpaid taxes must meet all of the following criteria: 1) The tax obligation must be federal or state income tax debt from a return filed at least two (2) years before filing for Chapter 7; 2) The tax was due at least three (3) years before filing for Chapter 7 and disclosed on a return; 3) The tax was assessed at least 240 days before filing for Chapter 7; 4) The return was filed without malicious or fraudulent intent.
These debts are NOT wiped out through Chapter 7. You must continue paying them.
|Alimony/Spousal Support/Maintenance||Child Support||Debts You Incurred After the Date of Your Chapter 7 Filing|
|Debts NOT Listed in Your Bankruptcy Petition (unless your creditor files a claim)||Debts Caused by Property Settlements in Divorce or Separation Proceedings||Debts That Were or Could Have Been Listed on a Previous Nondischarged Bankruptcy Case|
|Attorney Fees Incurred for Establishing Child Support or Alimony||Unpaid Personal Income Taxes That Became Due Within the Past Three (3) Years||Government-Issued, -Insured or -Guaranteed Loans|
|Debts You Incurred Within 90 Days Before Filing for Chapter 7 for Luxury Goods or Services Totaling More than $500 from One Creditor||Damages Awarded for Death or Personal Injury Caused By Your Unlawful Intoxicated Driving||Government-Imposed Fines, Penalties and Criminal Restitution Orders|
|Loans Used to Pay Off Nondischargeable Tax Obligations (e.g., paying your past-due IRS taxes with a credit card)||Student Loans*||Condominium or Cooperative Housing Assessments, Dues and/or Fees Assessed After Filing for Chapter 7|
|Educational Benefit Overpayments You Weren't Eligible to Receive and Didn't Return||Debts for Malicious or Reckless Failure to Fulfill Your Commitment to a Regulatory Agency||Excise & Customs Taxes|
|Debts from Fraud or Embezzlement While Acting as a Fiduciary (concerning any bank or insured credit union)||Cash Advances Totaling $750 or More That You Obtained Within 70 Days Before Filing for Chapter 7||Trust Fund Taxes|
*Generally, student loans cannot be discharged in a Chapter 7 (or Chapter 13) bankruptcy case. However, there is one exception: If you can prove to the bankruptcy court that paying your student loans would cause you and your dependents undue hardship, the court may discharge your student loans. If you do not qualify, you must continue paying on them.
Secured debts are unlike most dischargeable debts. That’s why some debtors who file for Chapter 7 bankruptcy are surprised when they later discover that their property has been foreclosed on or repossessed by creditors even after discharge. In order to avoid such an unwelcome surprise, you need to first understand that secured debt has two components:
- Your personal liability for the debt (i.e. how much you owe), which is dischargeable in Chapter 7
- Your creditor’s lien, or legal claim, on the collateral (e.g., your house securing your mortgage) for the debt, which is not dischargeable unless you can “avoid” it (see below).
Although your secured debts can be discharged under Chapter 7 bankruptcy, the liens attached to them can survive. That means a creditor can enforce a lien to recover the collateral, or property, securing a debt if Chapter 7 does not render the lien “unenforceable.”
Fortunately, you can remove, or “avoid,” certain liens imposed on your property. Liens that can be avoided (except tax liens) include those that “impair,” or eat away at, the value of property youclaim as exempt,such as the following:
- Garnishment Lien: This type of lien is a court order demanding that your money or property (e.g., wages) be seized and paid toward your debt. The automatic stay can only halt the enforcement of this lien while your bankruptcy case is open. Afterward, your creditor can collect against the collateral upon your discharge or with court permission.
- Nonpossessory, Nonpurchase Money Security Interest/Lien: This type of lien is attached to property you already owned and pledged as collateral such as household items, work tools and jewelry. You did not use the money you borrowed to purchase the collateral. Such liens are common with typical finance company loans.
- Nonconsensual Judgment Lien on Your Vehicle or Home: This lien is one that a creditor can, by law, attach to your property without your agreement after the creditor wins a lawsuit against you. It can only be avoided if all of the following criteria are met: 1) The lien arose from a court-issued money judgment; 2) some of the collateral’s equity is exempt; and 3) the lien would impair your exempt equity if the asset were sold.
If you have one of the above liens attached to your property, you can avoid it by filing a motion within 30 days of filing your Chapter 7 petition or before the meeting of creditors, whichever is sooner.
Alternatives to Lien Avoidance
Long-term debts such as mortgages and car loans will survive bankruptcy unaffected. If you cannot avoid the lien on the property that secures a debt, you will have other options to choose from either to relieve yourself of the liability for the lien or to retain the property. They include including the following:
- Redeem the Collateral: You can pay your creditor for the entire replacement value of tangible personal property (i.e. other than real estate, such as a car, a boat, jewelry) that secures a debt. In other words, you can keep the property if you can buy it out right. A couple of rules: 1) The property must be claimed as exempt or abandoned by your trustee; and 2) you should pursue this option only if you owe more on the asset than it is worth.
- Surrender the Collateral: You can give the property back to your creditor, which will then classify the debt as unsecured and therefore discharged at the end of your case. When you do, your liability for the lien is also eliminated. You may only give up collateral if you are current on your payments toward the debt it secures.
- Reaffirm the Debt: You can agree with the creditor to keep paying the debt and waive the discharge by voluntarily signing a Reaffirmation Agreement before you receive the discharge. Your creditor will agree not to repossess your property so long as you do not default on your payments according to the newly determined schedule and pay all or an agreed-upon portion of the reaffirmed debt.
The burning question for most Chapter 7 debtors is “How much property can I keep?” In Chapter 7 bankruptcy, that depends on which of your property is classified as “exempt” or “nonexempt.” The former means you may keep the property (or its value), whereas the latter means you must surrender it to your trustee.
Exemption laws are defined at the federal and state levels. As of the time of this writing, 20 states allow debtors to choose between state and federal laws. The rest must abide by their state’s exemption system.
Some of the most common exemptions include your primary home and automobile (depending on whether you are current on your mortgage or car loan payments, how much equity you have in them and how much of that equity you can exempt) and clothing, among many others. The list of nonexempt property is much smaller, typically including your second vehicle and vacation home (if applicable) as well as your bank account balances and a few others.
Most Chapter 7 bankruptcy cases are “no-asset” cases, which means debtors do not have any nonexempt property that can be sold to pay off their creditors. In other words, they may keep all of their assets. You can learn more through WalletHub's guide on Bankruptcy Exemptions: What You Can Keep.
In most cases, Chapter 7 debtors automatically receive a discharge at the end of their case. If successful, you will receive a discharge within three (3) to six (6) months. At this time, the judge will issue a discharge order and notify your creditors accordingly. The notice will state that you have been released from personal liability for your discharged debts and will prevent the creditor from taking any further actions to collect.
If you do not receive a discharge, the court will explain why. Your trustee or a creditor may also object to your discharge, in which case a judge will order a hearing. Your attorney may need to appear in court to defend you against the objection.
|You Are Eligible for a Discharge If:||You Are NOT Eligible for a Discharge If:|
|You are an individual, a sole proprietor or a general partner in a business filing for yourself, NOT on behalf of your business, which is a separate legal entity.||You received a discharge in a Chapter 7 case you filed within the past eight (8) years.|
|You successfully completed a financial management course from a government-approved agency or debt education provider after filing your petition. (This is different from the credit counseling course you took before filing.)||You file a waiver of discharge in your current Chapter 7 case after you have been granted relief, and the court grants the waiver.|
|You received a discharge in a Chapter 13 case you filed within the past six (6) years except if you paid at least 70% of your unsecured debts through a Chapter 13 repayment plan that you proposed in good faith.|
|You refused to answer questions or comply with court orders either in your own or someone else’s (e.g., a relative or business associate) Chapter 7 case.|
|You hid, destroyed or falsified your financial documents or business records.|
|You committed fraud against your creditors or trustee by hiding, transferring or destroying your property.*|
|You misrepresented or withheld information on your bankruptcy petition.*|
|You failed to adequately explain any loss or deficiency of assets.*|
*Note: This is also grounds for revoking your discharge after you have been granted one; your case trustee, the U.S. Trustee Program or your creditor can request revocation.
Credit Counseling Fee
Credit counselors may charge a nominal fee, usually between $20 and $50. They must disclose their fees to you prior to the start of the course.
For those who cannot afford the fee, many counselors will provide their services for free or at a reduced price. If that is true in your case, you must request a waiver from the credit counselor before you begin the session.
Bankruptcy Filing Fee
As of June 1, 2014, the filing fee for Chapter 7 is $335. Filing fees can change and are updated periodically. You must pay the fee to the court clerk at the time of filing. There are other options for the filing fee, including a fee waiver and paying by installment. If you and your spouse are filing jointly, you will pay only one set of fees for your joint case. Failure to pay the fee is grounds for dismissal.
Bankruptcy Attorney Fees
Costs typically range between $1,000 and $2,500, depending on the complexity of your case. This fee must be paid in advance. As an alternative, you can enlist a cosigner, but you’d still need to pay most of the fees in advance. Some attorneys will reduce or waive their fees entirely, though this is quite a rare practice.
Under bankruptcy law, your attorney must disclose his or her fees to you and they must be approved by the court.
Converting to a Different Chapter
As a debtor, you have a one-time right to voluntarily convert your Chapter 7 case to Chapter 11, 12 or 13, provided that you are eligible for the new chapter.
Cost to Convert from Chapter 7
Depending on the chapter to which you convert your case, you may need to pay a “conversion fee,” which is the difference between the filing fees for Chapter 7 and the new chapter. Check with your local bankruptcy court for the most current fees associated with your particular chapter conversion. There is no conversion fee when you convert from Chapter 7 to Chapter 13. Whichever chapter you convert to, keep in mind that your lawyer may charge additional legal fees as well.
One reason you may wish to convert to Chapter 13 is to retain property that you otherwise might need to surrender under Chapter 7. Converting to Chapter 13 won’t always be your choice, however, as the court may order a conversion if you qualify for Chapter 13. If you convert from Chapter 7 to 13 (voluntarily or otherwise), you will possibly have to file new forms. Remember that some courts may require local bankruptcy paperwork in addition to official forms and schedules.
The court may block your conversion to a Chapter 13 case if:
- Your debt load is too high or you don’t have a stable source of income.
- You acted in bad faith (e.g., you concealed assets on your bankruptcy petition).
- Your current Chapter 7 case was already converted from another chapter.
Declaring bankruptcy is the most destructive thing you can do to your credit. The depth of the damage, however, will depend on your credit score to begin with as well as the information that previously existed in your credit report. If your credit was bad initially, bankruptcy may cause only a slight dip in your score. Otherwise, it may cause your score to plummet.
- The bankruptcy record, which becomes public information, will stay on your credit report for ten (10) years.
- Apart from the bankruptcy record, the accounts included in your bankruptcy will be noted as such on your report. They’ll be deleted after seven (7) years from the date the debt became delinquent, not the date you filed your bankruptcy petition. Some of your debts may therefore disappear before your bankruptcy record is erased.
Rebuilding Your Credit
Bankruptcy will have a lasting effect on your credit, but the damage won’t be permanent. You can rebuild your credit by carefully following the right steps once bankruptcy is over.
As a general rule, the following is the best way to begin rehabilitating your damaged credit:
- Pay your bills on time. Making sure you don’t miss any payments will demonstrate to creditors that you can be a responsible consumer even after bankruptcy.
- Apply for a secured credit card. Such cards require you to deposit a certain amount of money that will both serve as your credit line and provide a line of defense for the credit card issuer in case you fail to pay your debt. Secured credit card activity is tracked by the major credit reporting agencies, so these cards are excellent credit-building tools.
- Hire a Competent Attorney: An experienced bankruptcy attorney not only can help you navigate the Chapter 7 bankruptcy process, he or she also can represent you against challenges to your case should they arise. If you’ve never hired an attorney before, you should first compare attorneys in your area and speak with at least three to learn about their backgrounds, rates and experience. Beware of scams as well. Bogus “bankruptcy preparers” will offer their services for much cheaper rates, an instant red flag. This is not a step in which you should cut corners.
- Be Honest: Make sure to report all of your income, assets, debts and expenses to your bankruptcy attorney and trustee. More importantly, do NOT lie under oath — an offense punishable by law — as you respond to questions about your disclosures in the bankruptcy petition. Concealing your property or misrepresenting information on your bankruptcy paperwork can result in immediate dismissal, criminal prosecution or ineligibility to file for bankruptcy in the future.
- Be Organized and Punctual: Chapter 7 bankruptcies are document-intensive, and the paper work is time-sensitive. Before you meet with your attorney and trustee, make sure you’ve gathered all of the documents and records that are necessary to file your case. This harmonizes your relationship with them and eases the process. In addition, you must honor the due dates and deadlines for your paperwork, especially your petition and payments. If you don’t submit the required forms and schedules within 15 days of filing your petition, the court may dismiss your case.
- File at the Right Court: Filing at the wrong courthouse is a common mistake among Chapter 7 filers, especially those who represent themselves. The proper place to file your bankruptcy petition is in the federal (not state) bankruptcy court located where you resided, maintained your principle place of business or kept your primary assets for the majority of the 180-day period prior to filing. If you moved across state lines in the past 180 days and lived the majority of the time in your new state, your bankruptcy court may still require you to use your former state’s procedures Consult your bankruptcy attorney in this case.
File at the Right Time: There are several factors that determine when you should or should not file for Chapter 7, including the following:
- Many debtors mistakenly resort to bankruptcy without knowing the full extent of their problems. Sometimes, all it would have taken to become debt-free was to improve their budgeting and money-management skills. Speak with a credit counselor beforehand to help you find other, less extreme avenues for debt relief.
- If you anticipate receiving an income tax refund or acquiring a nonexempt asset, it’s best to file after the refund or asset is in your possession and has been used. Otherwise, you will lose the nonexempt portion of the refund or asset when you surrender it to your trustee.
- If you anticipate acquiring nonexempt assets or money through an inheritance, life insurance or divorce within 180 days after filing your case, you should hold off on actually filing for Chapter 7. Otherwise, you will need to surrender the property and money to your trustee.
- If you’ve previously received a discharge under Chapter 7 and are thinking of filing again, consider opting for Chapter 13 bankruptcy instead. However, you must wait at least four (4) years to file for Chapter 13 after receiving a Chapter 7 discharge. Filing for Chapter 13 after receiving a Chapter 7 discharge is known as a “Chapter 20” bankruptcy.
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