The process of filing for bankruptcy can be a powerful tool if you’re hoping to get out of debt. Bankruptcy can erase credit card debt, medical bills, other types of unsecured debt, and it can stop wage garnishments and other collection actions. The two most common types of consumer bankruptcy individuals and married couples file are Chapter 7 and Chapter 13. In this article, we’ll explore both types of bankruptcy and how they can give families a financial fresh start.
Written by Attorney Jenni Klock Morel.
Updated July 28, 2023
Filing Bankruptcy Immediately Stops All Debt Collection Activities
As soon as you file a bankruptcy case, creditors and debt collectors must stop all debt collection activities against you. This is because of theautomatic stay, which protects filers from collections activities while their bankruptcy case is pending. This safeguard offers immediate stress relief to people who feel like they’re drowning in debt.
When you file for bankruptcy and the automatic stay will stop:
Phone calls, collection letters, andharassment from debt collectors
Bank account levies
Debt collection lawsuits for unpaid debts
However, the power of the automatic stay isn’t forever. A creditor can ask the court tolift the stay, which is essentially asking the bankruptcy court for permission to continue collection action. Thankfully, even if the stay is lifted for a specific action, the automatic stay will remain in effect for other types of collection activities until the end of your bankruptcy case.
At the end of a successful bankruptcy case, you’ll receive abankruptcy discharge, which is a court order that says you no longer owe certain debts. Creditors of these debts can never legally attempt to collect from you again — which is why you don’t need the automatic stay to extend longer than your bankruptcy case.
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Bankruptcy Can Help You Manage Your Debts
Bankruptcy gives people room to manage their debts and to take control of their financial situation. Of course, filing bankruptcy isn’t the best solution for everyone. If you have debt problems, it’s a good idea to getcredit counseling and explore your otherdebt relief options before you commit to a plan.
The bankruptcy process looks different depending on which chapter you file under.Chapter 7 and Chapter 13 are the most common types of personal bankruptcy, but each treats debt a little differently.
Bankruptcy laws create different categories of debts and offer relief based on those categories. Often, because only individuals who don’t earn much income are eligible to file for Chapter 7 bankruptcy, these cases can be “no asset” cases, meaning there’s nothing for the bankruptcytrustee to take and sell for the benefit of creditors. Usually, most of an individual’s creditors are paid (in part or, sometimes, in full) in Chapter 13 bankruptcy cases because this process includes a 3–5-year repayment plan.
Different types of debt are treated differently in bankruptcy. Priority debts are debts that are paid first in a bankruptcy. Priority debts include domestic support obligations, like spousal support (alimony) and child support. These types of debts are nondischargeable and cannot be erased by bankruptcy. Priority debts are paid in full in Chapter 13 cases.
Secured debts are debts that are backed by collateral, like a house or a car. Bankruptcy can erase your personal liability to pay back the debt, but it won’t erase the lien attached to the property. If you want to keep a house or car with a home mortgage or car loan, then you have to pay the debt off. Nonpriority debts areunsecured debts that are last in line for payment in a bankruptcy case. Nonpriority unsecured debts include credit card debt, medical debt, personal loans, utility bills, court judgments, back rent, among other types of debt.
Generally, nonpriority unsecured debts owed at the end of bankruptcy are discharged. However, there are exceptions to this general discharge rule to be aware of. Student loans are considered nonpriority unsecured debt, but they are generally not discharged through bankruptcy. This means that student loans must be paid back even after a successful bankruptcy filing. Getting student loans discharged requires the filing of anadversary proceeding and a showing ofundue hardship, which is an incredibly high burden to meet.
Depending on the types of debts you have, bankruptcy can set you up with a clean financial slate and, as part of yourcredit counseling requirements, give you some tools to create a better financial future after your case is complete.
What Does Filing Chapter 7 Bankruptcy Do?
Chapter 7 bankruptcy is the most common type of personal bankruptcy. It is the “liquidation” form of bankruptcy that provides for the sale of a debtor’s property to pay creditors. However, in more than 90% of cases, the filer is able to keep all of their belongings. Property and personal belongings valued up to a certain amount are generally protected through bankruptcy byexemptions.
Exemption schemes that vary by state, although some states allow their residents to use thefederal bankruptcy exemptions. Exempt property includes a certain amount of equity in real estate (the house you live in), cars, and other personal property, as well as retirement accounts and certain types of income and benefits, like Social Security.
Not only can you keep most or all of your belongings despite filing for bankruptcy, but Chapter 7 can alsodischarge your nonpriority unsecured debts. After receiving a successful Chapter 7 discharge, you will no longer owe credit card debt, medical bills, or other eligible debts. Creditors of discharged debts can never legally attempt to collect those debts from you again. This can give you breathing room to get your financial affairs back in order so that you can pay your other, nondischargeable debts and move on with your life.
Once your Chapter 7 bankruptcy petition has been filed, it will likely takeapproximately 3-4 months to receive your bankruptcy discharge. The discharge is the federal court order that relieves your obligation to pay back your eligible debts and prohibits those creditors from ever trying to collect on those debts again.
Themeans test determines whether you’re eligible for relief under Chapter 7 of theBankruptcy Code based primarily on your monthly income. If your income is below the state median for your household size, then you’ll automatically pass this test. If your income is above the state median for your household size, you may benefit from speaking with an attorney about whether you could still qualify for this form of bankruptcy protection by claiming more exemptions, etc. If you ultimately don’t qualify for Chapter 7 bankruptcy, you may qualify for relief under Chapter 13 of the Bankruptcy Code.
What Does Filing Chapter 13 Bankruptcy Do?
If you file Chapter 13 bankruptcy, you’ll be required to complete a three or five-year repayment plan . During this period of time, the bankruptcy trustee assigned to your case will collect your monthly payments and distribute the funds to your creditors with allowed claims. Depending on the specifics of your Chapter 13 bankruptcy plan, you may pay back most or all of your debt, or you may pay only a small percentage of your nonpriority unsecured debts.
To be eligible for Chapter 13 bankruptcy, you must have regular monthly income so that you’re able to make your plan payments and your debt must be below the allowed limits. Chapter 13 debt limits are subject to change. Currently, a Chapter 13 filer’s debt (unsecured and secured debt combined) may not exceed $2.75 million, according to the United States Courts website.
Note that if your Chapter 13 case isdismissed before you make all of your plan payments, it can leave you in a worse financial situation than before you filed bankruptcy.
What Doesn’t Filing Bankruptcy Do?
Bankruptcy is a powerful legal tool, but it is not a miraculous, cure-all. Filing for bankruptcy probably won’t be able to solve every financial problem you’re facing and it may not get rid of all your debts.
Bankruptcy May Not Get Rid of Every Debt
Many, but not all, debts can be discharged through bankruptcy.Nondischargeable debts include domestic support obligations (alimony and child support), recent tax debts, certain government fines and penalties, criminal restitution and court fines, personal injury debts arising out of driving under the influence, and debts incurred by fraud.
This is also a good place to say that you may or may not be able to get rid of your student loans in bankruptcy. You can absolutely try! In fact, the Department of Justice released new guidelines in late 2022 to make discharging student loans in bankruptcy easier and the process clearer.
To discharge your student loans, you’ll have to file additional bankruptcy forms to prove that repaying your student debt is causing undue hardship. (You’ll hear this referred to as the Brunner test.) You also have to file an additional proceeding with the Bankruptcy Court called an adversary proceeding. If this sounds intimidating, know that Upsolve may be able to help! Take our free eligibility screener now to see if you qualify for help discharging your student loans in bankruptcy.
Bankruptcy May Not Save You From Home Foreclosure or Vehicle Repossession
Bankruptcy has other limits, too. Bankruptcy might not be able to save your house from foreclosure or your car from repossession. This will depend, in part, on which type of bankruptcy you decide to file. If you file Chapter 13 bankruptcy, you’ll have the opportunity to catch up on past-due mortgage payments or missed car payments. If you can do that (while continuing to make your current payments), you can probably keep your property.
It’s important to go into Chapter 13 with clear eyes, though. Many Chapter 13 plans fail because filers can’t keep up with their monthly payments to the trustee.
Bankruptcy Won’t Prevent Future Financial Mistakes
Many filers find the information in the required credit counseling and financial management courses helpful. But it’ll be up to you to make the most of your financial fresh start. Remember that after receiving a discharge in a Chapter 7 case, you’ll have towait eight years before you can file Chapter 7 again and get another discharge. So be sure to apply the lessons you’ve learned to keep your finances in order post-bankruptcy.
Bankruptcy Won’t Fix Your Credit Overnight
Finally, bankruptcy can’t fix your credit overnight. Credit repair takes time, but people who file bankruptcy do see an increase in theircredit score over the several months after filing and are likely to have a higher credit score one year after they file bankruptcy than when they filed. This is because delinquent accounts of dischargeable debts will have a balance of zero, making your debt to income ratio more favorable. In some ways, it looks better on your credit report to get a handle on your debt by filing for bankruptcy than doing nothing to address the problem.
Bankruptcy isn’t a cure-all for every debt problem, but filing for bankruptcy can be a good option for debt management and financial relief. If you’re interested in exploring if bankruptcy is the right option for you, Upsolve offers afree tool that helps people file bankruptcy on their own. If you don’t qualify to use the free tool or your case is complex, you canget a free bankruptcy evaluation from a private bankruptcy attorney.