When you're experiencing severe financial issues, filing for bankruptcy can be a powerful option to help you get over significant money obstacles. Unfortunately, bankruptcy can't solve every financial problem. Before you file, it's important to define your goals and to understand how bankruptcy can help you achieve them.
In this article, we will cover
- how bankruptcy can help you solve some difficult financial issues
- the limitations of bankruptcy and what it is not designed to accomplish
- the differences between Chapter 7 and Chapter 13, the two types of bankruptcy that consumers file most often
- bankruptcy's two most powerful tools, the automatic stay and the discharge, and
- additional resources you might find helpful as you're exploring how bankruptcy can help you get a fresh start.
How Bankruptcy Can Help
Although people file bankruptcy cases for many different reasons, most people hope that bankruptcy will help them manage or eliminate pressing debt. Depending on the chapter you file, you'll be able to:
- stop foreclosure, repossession, lawsuits, and other collection activities
- eliminate your personal liability for most types of debt, and
- reorganize your debts and catch up on missed payments.
What Does Chapter 7 Do?
Here is how Chapter 7 functions to help you get a handle on your thorny money issues:
- Chapter 7 is often called straight bankruptcy or liquidation bankruptcy.
- In Chapter 7, most of your debts are discharged (wiped out). In exchange, you turn over nonexempt property to a trustee appointed by the bankruptcy court. The trustee sells the nonexempt property and distributes the proceeds to your creditors.
- The property you're allowed to keep is called exempt
- You must "qualify" to file a Chapter 7 through a means test. If the means test shows that you have disposable income each month (income left over after you pay for necessities), a Chapter 13 repayment plan might be more appropriate for you.
- Most of your unsecured debts (debts with no collateral) will be discharged, such as medical bills, personal loans, and most credit cards.
- Most of your secured debts (those with collateral) will also be discharged, but you will probably have to surrender the collateral unless you're willing to continue payments (reaffirm) or you pay the creditor the value of the collateral (redeem).
- The Chapter 7 process usually takes four to six months.
- Chapter 7 will stop foreclosures, car repossessions, lawsuits, and many eviction actions, but the reprieve will normally only last until the case is closed or your discharge is issued. Depending on the type of debt, Chapter 13 might be a better choice.
What Does Chapter 13 Do?
Although a Chapter 13 repayment plan takes longer, it offers options not available in a Chapter 7 case.
- Chapter 13 is a repayment plan that will last three to five years.
- You'll make monthly payments for three to five years to a trustee, who will distribute the funds to your creditors. Instead of turning over your nonexempt property to the trustee, you'll pay out the value of the nonexempt property over the length of your repayment plan.
- The size of your monthly plan payment is based on your income, expenses, types and balances of debts you owe, and the value of any nonexempt property.
- You'll pay certain priority debts through your plan, like past-due child support and recent past-due taxes. If you're facing foreclosure or repossession, you can use the repayment plan to pay mortgage or car loan arrearages over time. If your income allows it, you might also have to pay back a portion of the unsecured debt you owe, like credit cards and medical bills.
- Many people who can't qualify for Chapter 7 because they make too much money (they can't pass the means test) find that Chapter 13 is a viable alternative.
- If you intend to keep the collateral that secures your mortgage, car loan, or other secured loan, you'll have to keep up with the regular payments even as you're catching up on past due payments through the Chapter 13 plan.
- Chapter 13 might allow you to reduce the interest rate or the principal (steps known as a "cramdown") on a qualifying car loan.
- You can use Chapter 13 to manage or pay off debts that are nondischargeable in Chapter 7, like student loans, child support or spousal support arrearages, recent tax debts, and debts related to fraud.
What Bankruptcy Can't Do
Bankruptcy doesn't cure all debt problems. Here's what it can't do for you.
- Bankruptcy doesn't prevent a secured creditor from foreclosing or repossessing property you can't afford.
- Bankruptcy doesn't eliminate child support and alimony obligations.
- Bankruptcy doesn't eliminate student loans, except in limited circumstances.
- Bankruptcy doesn't eliminate most tax debts.
- Bankruptcy doesn't eliminate other nondischargeable debts, including
- debts you forget to list in your bankruptcy papers (unless the creditor learns of your bankruptcy case),
- debts for personal injury or death due to intoxicated driving, and
- fines and penalties imposed as a punishment, such as traffic tickets and criminal fines and restitution.
You may be able to pay some of these debts off through a Chapter 13 repayment plan.
Learn more about what Chapter 7 and Chapter 13 can offer.
Bankruptcy's Automatic Stay and Discharge
Bankruptcy's two most potent tools are the automatic stay, which halts most credit collection actions as soon as the case is filed, and the discharge, which forgives or eliminates your liability for most debts. Whether you file a Chapter 7 or a Chapter 13 bankruptcy case, the automatic stay and the discharge will be the two most important elements in your plan to achieve a fresh financial start.
The Automatic Stay Will Stop Most Collection Activities
The automatic stay is a powerful order that goes into effect as soon as you file for bankruptcy. The stay prevents most creditors (but not all) from initiating or continuing collection activities against you. Here are some collection actions you might encounter and how the automatic stay affects them.
The automatic stay will stop:
- most creditor calls and letters
- foreclosures that have not been completed
- evictions except those in which the landlord obtained a writ of possession or an eviction judgment before you filed
- most other lawsuits, and
- wage garnishments.
The automatic stay will not stop:
- criminal cases
- most family and divorce matters (except for property division)
- collection of nondischargeable taxes, like property taxes or current income taxes
- evictions when the court has entered a judgment for possession for the landlord, and
- enforcement of matters concerning health and safety, like levying punishments for toxic chemical spills.
Bankruptcy can't be used to hold off some creditors indefinitely. Some creditors with compelling reasons can ask the bankruptcy court to lift (remove) the stay so that the creditor can protect its rights. For instance, if you don't pay your car loan, the lender can ask the court to lift the stay to allow for repossession. Your rights will also be limited when you file more than one bankruptcy case within a year or when you dismiss a case after a creditor filed a motion to lift the stay, and you want to refile.
The Bankruptcy Discharge Can Eliminate Most Types of Debt
The reason most people file for bankruptcy is to wipe out (discharge) debt. When you receive a bankruptcy discharge, it extinguishes your liability to pay back many types of obligations, such as credit card debt, medical bills, and personal loans.
But not all debts can be discharged in bankruptcy.
Common examples of nondischargeable debts include:
- recent tax obligations,
- alimony and child support
- student loans (unless you can prove that paying them back is an undue hardship on you, but this is extremely difficult to do), and
- debts obtained by fraud.
If you can't discharge the debt in Chapter 7, a Chapter 13 repayment plan can help. You can pay most of these nondischargeable debts through the repayment plan, as long as you can afford to pay them off over three to five years. If the loan is scheduled to extend beyond five years, like many home mortgages or student loans, you won't have to cram them into a five-year period, but you might not get the same benefits from bankruptcy that you will with shorter loans.
Learn about debt discharge in Chapter 7 and discharging debt in Chapter 13.
From the lists above, you'll see that Chapter 7 and Chapter 13 are designed to accomplish different but related goals. Both can help you manage or eliminate burdensome debt, but they do that in different ways.
More Bankruptcy Resources
Visit these resources to learn more about how Chapter 7 and Chapter 13 bankruptcy can help you eliminate burdensome debt, catch up on important payments, and reorganize your finances.
Nolo's Free Bankruptcy Guide
Which Type of Bankruptcy Should You File? Chapter 7 vs. 13
Is it Better to File a Chapter 7 or 13 Bankruptcy?
Completing the Bankruptcy Forms