What Is Chapter 7 Bankruptcy and How Does It Work?

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Chapter 7 bankruptcy is a legal process designed to help people who genuinely cannot pay their debts. 

It’s often called “liquidation bankruptcy” because it can involve selling some property to pay creditors, but most people who file actually keep most or all of their belongings.

How Chapter 7 Bankruptcy Works

Chapter 7 is the most common type of bankruptcy for people, accounting for approximately 70% of personal bankruptcy filings. It provides the quickest path to debt relief, but it comes with both advantages and limitations that you should understand before filing.

• You file a petition in bankruptcy court, listing your debts, income, assets and expenses.
• A court-appointed trustee reviews your case and may sell non-exempt property to repay creditors.
• Most unsecured debts, like credit cards and medical bills, are discharged — meaning you’re no longer legally required to pay them.
• The entire process typically takes three to six months.

Steps to File for Chapter 7 Bankruptcy

To file Chapter 7 bankruptcy, you’ll need to take these steps:

• Find a lawyer that specializes in bankruptcy laws: Although you don’t have to have an attorney, you can’t get legal advice from judges or court employees when you file.
• Complete credit counseling from an approved agency: You must take this course within 180 days before filing and get a certificate proving you’ve done it.
• Fill out and file bankruptcy forms with the court: These detailed forms require listing all your income, expenses, assets, debts and financial transactions from the past few years.
• Pay the filing fee ($338) or request a fee waiver: If you can’t afford the fee, you can apply to pay in installments or get it waived if your income is below 150% of the poverty line.
• Submit your tax returns and other required documents: You’ll need to provide recent tax returns, pay stubs, bank statements and other financial records to the trustee.
• Attend a meeting with creditors (341 meeting): This mandatory hearing lets the trustee and creditors ask you questions about your finances and bankruptcy forms under oath.
• Complete a financial management course: This second required course teaches budgeting and money management skills and must be finished before your debts can be discharged.
• Wait for discharge notice from the court: About 60 to 90 days after your creditors’ meeting, you’ll receive an official notice that your eligible debts have been erased. 

Who Qualifies for Chapter 7 Bankruptcy?

Not everyone can file for Chapter 7 bankruptcy. There are specific eligibility requirements you must meet.

The most significant hurdle is the “means test,” which determines if your income is low enough to qualify. First, your current monthly income (based on the previous six months) is compared to the median income for a household of your size in your state.

If your income is below the median, you automatically qualify. If it’s above, you must complete additional calculations to show that you don’t have enough disposable income to repay a meaningful portion of your debts.

If you do pass the means test, you still need to meet the following criteria to qualify:

• Haven’t had a Chapter 7 bankruptcy in the last eight years, or a Chapter 13 bankruptcy in the last 13 years.
• Completed credit counseling from an approved agency within 180 days before filing. 
• Not acting in “bad faith,” which may involve hiding assets, providing false information or running up credit cards before filing. 

What Debts Can and Can’t Be Discharged

Certain debts can be discharged during a Chapter 7 bankruptcy, while others can’t. 

You can erase unsecured debt like:

• Credit card debt
• Medical bills
• Unsecured personal loans
• Payday loans
• Utility bills

You typically can’t erase:

• Child support
• Alimony
• Court fines and criminal restitution
• Most taxes, including taxes that you owe from previous years
• Debts from fraud

Some private and federal student loans can be discharged due to bankruptcy if you’re able to prove undue hardship. It depends on your exact circumstances and the loan itself. 

What Happens to Your Property?

What happens to your property can vary on a case-by-case basis.

Some property is exempt and protected during a Chapter 7 bankruptcy. This may include clothing, furniture and an inexpensive, non-luxury car. Some qualifying retirement accounts may also be exempt.

Many states also allow you to protect a portion of the equity in your home, though you must be up-to-date on payments. As a result, many people don’t lose their homes during Chapter 7 bankruptcy, though it’s possible. Most people who file keep most of their property.

Non-exempt assets, however, may be sold to pay creditors. This might include boats, motorcycles, vintage vehicles, rental properties, timeshares, artwork and valuable collectibles. 

Chapter 7 vs. Chapter 13 Bankruptcy

Chapter 7 is only one type of bankruptcy. Another popular option is Chapter 13 bankruptcy.

While Chapter 7 liquidates assets to eliminate debts quickly, Chapter 13 bankruptcy is a reorganization plan. 

Sometimes called a “wage earner’s plan,” Chapter 13 allows people with regular income to create a three to five year repayment plan to pay back all or part of their debts. It’s ideal for those who want to keep their property that they have a high level of equity in, catch up on mortgage or car payments, or who don’t qualify for Chapter 7 due to their income level.

Here are a few key differences: 

How Chapter 7 Affects Your Credit

Chapter 7 bankruptcy will stay on your credit report for 10 years. It’s common to see a drop on your credit score of around 200 points, which can make it much more difficult to get loans. If you are able to take out new credit cards or loans, they may be less competitive with lower borrowing limits and higher interest rates.

The good news is that the bankruptcy will come off your credit report in 10 years, and you can rebuild your credit over time with good habits. Make sure that you’re completing all payments on-time and you’re keeping your debt-to-income ratio as low as possible. 

When Chapter 7 Makes Sense

Chapter 7 bankruptcy may make sense for you in the following circumstances:

• Your income is limited or unstable.
• You have mainly unsecured debts like credit cards or medical bills. 
• You don’t own much valuable property. 
• You couldn’t complete a three to five year repayment plan.
• You’ve explored other options without success.
• You want a quick fresh start.

If you’re unsure of your best path forward, you can speak to a financial professional specializing in bankruptcy, or a bankruptcy attorney. They can help you decide what your options are and how to get started.

Is Chapter 7 Bankruptcy Right for You?

Chapter 7 bankruptcy can be a lifeline if you’re drowning in debt — but it’s not for everyone.

If you qualify and need a fresh start, it could give you a clean slate in a few months. Just remember, it comes with long-term credit impact and it’s not a cure-all for all debts.

Before you decide, talk to a bankruptcy attorney, weigh the pros and cons and explore alternatives like debt settlement or credit counseling.

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