by: Kathleen Michon, J.D.
Chapter 7 bankruptcy, also called liquidation bankruptcy or straight bankruptcy, is the most popular form of bankruptcy relief for individuals. The basic idea behind Chapter 7 bankruptcy is this: The bankruptcy trustee liquidates your property to pay off your creditors. In return, most or all of your debts are discharged (wiped out). In reality, most Chapter 7 bankruptcy debtors give up little, if any, property.
Here's an overview of how Chapter 7 bankruptcy works.
In Chapter 7 bankruptcy, you file a packet of papers (called the petition) with the court. Your papers list all of your debts and property as well as recent financial transactions.
Not everyone is eligible for Chapter 7 bankruptcy. You must take and pass something called the "means test" in order to qualify for Chapter 7 bankruptcy. If your income is lower than the median income in your state, you automatically pass the means test. If your income is over the state median, you must include information about your expenses. Essentially, if you can fund a Chapter 13 repayment plan (where you repay some of your debts over a three to five year period), you won't qualify for Chapter 7.
When you file for Chapter 7 bankruptcy, the court assigns a bankruptcy trustee to your case. The trustee's job is to see that your creditors get paid as much as possible. If you have nonexempt property, the trustee will sell the property and use the proceeds to pay your unsecured creditors.
Once you file your Chapter 7 bankruptcy petition, the court automatically sends out a notice to your creditors about the automatic stay. The automatic stay prohibits most creditors from continuing with collection activities during your bankruptcy. This means creditors cannot call you, collect money from you, foreclose on your home, repossess your car, or place a lien on your property.
There are some exceptions to the automatic stay, however. And creditors can go into court and ask the judge to lift (remove) the automatic stay.
To learn about about how the automatic stay protects you from creditors, see our article on Bankruptcy's Automatic Stay.
State and federal laws deem some property outside of the reach of the bankruptcy trustee, called "exempt" property. Each state has a list of exemptions, and the federal bankruptcy code does too. Exemptions apply to certain types of property up to a certain dollar amount. If the equity in your property is covered by an exemption, you get to keep it.
Most Chapter 7 filers end up keeping most or all of their property. For more, see our section on Bankruptcy Exemptions.
If you have pledged property as collateral for a debt, this is called a secured debt. If you default on secured debt payments, the creditor can take the property. Examples of secured debts include mortgages and car loans.
In Chapter 7 bankruptcy, if the property that secures a debt is otherwise exempt, you can keep the property if you are current on your loan payments. If, however, you are behind on your loan payments, you will most likely lose the property. For this reason, Chapter 7 is often not a good option for homeowners who want to save their home but are behind in mortgage payments.
At the end of your bankruptcy case, most of your debts will be discharged, which means you no longer owe them. There are exceptions to the discharge however. Examples of debts that cannot be discharged include most student loans and child support arrears.
See Bankruptcy and Debt Relief for detailed articles on debts discharged in bankruptcy.