What Is Bankruptcy?

How Does Bankruptcy Work? The Basics Explained

Bankruptcy was designed to help people and businesses get debt relief. In other words, it’s a way for folks in a tough financial situation to get a fresh start. Chapter 7 and Chapter 13 bankruptcy are the two most common types of bankruptcy that individuals and married couples file. They are named after the chapters in the U.S. Bankruptcy Code that regulate how they work. 

Both types of bankruptcy aim to eliminate or manage debt, but they do so in different ways. Chapter 7 wipes out qualifying debts quickly, often within a few months, while Chapter 13 sets up a repayment plan that lasts 3–5 years. Which chapter is right for you depends on your financial situation, including your income, the type of debt you have, and your long-term goals.

The Goal of Bankruptcy: A Fresh Start

Ultimately, all bankruptcy filers are hoping to get a bankruptcy discharge. This is a court order that permanently eliminates your obligation to repay your eligible debts and gives you a clean slate. As long as you meet all legal requirements, the bankruptcy court should grant your discharge. 

This order is permanent, and it applies to all dischargeable debts, which typically include credit card debts, medical bills, payday loans, personal loans, and past-due utility bills. It won’t wipe out non-dischargeable debts like child support, alimony, or some past-due taxes.

Immediate Relief Through the Automatic Stay

While you await your bankruptcy discharge, you’ll get the protection of the automatic stay. It takes effect as soon as you file your bankruptcy petition with the court. While the automatic stay is in place, you are protected against all kinds of collection activities, from phone calls and letters to wage garnishment and debt lawsuits. 

The automatic stay is important because it gives you some breathing room while your bankruptcy case is being processed.

The Role of the Bankruptcy Court and Trustee

The United States Bankruptcy Court oversees your bankruptcy case and ensures that all laws and rules are followed. The court reviews your filing, addresses any disputes, and ultimately grants your bankruptcy discharge, which eliminates your eligible debts. In most personal bankruptcy cases, you won’t need to interact directly with a judge, but the court plays a key role in approving your case and making sure the process runs smoothly.

After you file your case, a bankruptcy trustee takes over key responsibilities. The trustee reviews your paperwork to confirm it’s accurate and ensures that creditors are treated fairly. In Chapter 7 cases, the trustee determines whether you own any non-exempt property that could be sold to pay creditors, though this happens in rare cases. In Chapter 13 cases, the trustee collects your monthly payments and distributes them to your creditors according to your repayment plan. The trustee acts as the middleman so you don’t have to interact directly with creditors during the bankruptcy process.

What Are the Different Types Of Bankruptcy?

There are several different types of bankruptcy, each designed for different situations. The most common types that individuals and businesses file are named after chapters of the U.S. Bankruptcy Code:

• Chapter 7: Quickly eliminates most unsecured debts like credit card bills and medical debt, often within a few months

• Chapter 13: Creates a repayment plan lasting 3–5 years, allowing you to catch up on missed payments for secured debts like mortgages or car loans

• Chapter 11: Designed for businesses or individuals with significant debts or valuable assets, allowing them to reorganize their finances and keep operating while paying creditors over time

• Chapter 12: Specifically for family farmers and fishermen, offering a repayment plan tailored to their unique financial circumstances

Chapter 7 and Chapter 13 are the most common forms of bankruptcy, so let’s take a closer look at each of those.

What Is Chapter 7 Bankruptcy?

Chapter 7 is by far the most popular type of personal bankruptcy. It wipes out most unsecured debts, including medical bills, personal loans, payday loans, and credit card debt. Past-due rent and utility bills are also unsecured debts. Some people can also get their federal student loans discharged through Chapter 7, but this requires an additional process called an adversary proceeding.

Chapter 7 bankruptcy is the quickest form of bankruptcy relief in the United States. As long as the filer completes all required steps and certain deadlines have passed, the bankruptcy court enters the discharge order. This means the bankruptcy discharge is typically granted within 3–4 months of filing the case with the bankruptcy court. As soon as this happens, the filer can take advantage of their fresh start and begin rebuilding their credit score. 

When you file Chapter 7, you’ll have to submit information about everything you owe and own and claim exemptions to protect your property. If you have property that isn’t covered by exemptions, it’s at risk of being sold by the bankruptcy trustee. That said, more than 95% of all Chapter 7 filers don’t lose anything but their debts.

Can You Keep Your Car and House in Chapter 7 Bankruptcy?

Mortgages and car loans are secured debts, meaning the property backs up the loan and the lender can reclaim the property if you fail to pay the loan. These debts work differently in Chapter 7.

Whether you can keep your car or house in Chapter 7 bankruptcy depends on a few factors, including the value of your property, how much equity you have in it, and whether you're current on your loan payments. Most people filing Chapter 7 can keep these items if they’re protected by exemptions. 

Also, if you're still paying off a car loan or mortgage and want to keep the property, you’ll need to stay current on those payments. Otherwise, the lender — also called a secured creditor — can still repossess the car or foreclose on the home, even if the bankruptcy wipes out your personal liability for the debt.

Does Chapter 7 Bankruptcy Get Rid of All Debts?

Some types of debts are considered non-dischargeable, and Chapter 7 won’t erase them. These include:

• Recent income tax debt

• Alimony

• Child support

• Debt incurred from illegal acts (embezzlement, larceny, etc.)

During the bankruptcy process, you’ll be protected against collection actions for these debts, thanks to the automatic stay. But once the discharge is granted, the creditor (typically the IRS, the state taxing authority, or a former spouse or partner) can start trying to collect their debt again. They can even start or resume a wage garnishment.

If you have a regular income and owe tax debt, child support, or alimony, Chapter 13 may be a better fit. You can schedule a free consultation with an experienced bankruptcy attorney to see if this is the best option for you.

What You Need To Know About Chapter 7 Bankruptcy Eligibility

Not everyone qualifies for Chapter 7 bankruptcy. To be eligible, you must pass the means test, which was put in place to make sure that only those who truly can’t afford to repay their debts can use Chapter 7. Here’s what you need to know:

• Income requirements: The means test compares your income to the median income for a household of your size in your state. If your income is below the median, you automatically qualify.

• Disposable income test: If your income is above the median, you can still qualify by showing that your necessary living expenses leave you with little to no disposable income to repay creditors. This calculation follows a strict formula set by bankruptcy law.

• Exceptions to the means test: If most of your debts are business-related, the means test may not apply to you. Similarly, some individuals with military service may also be exempt.

Even if you pass the means test, you’ll need to meet other basic requirements, such as completing a credit counseling course before filing and demonstrating that you haven’t filed another bankruptcy case recently.

What Is Chapter 13 Bankruptcy?

Chapter 13 bankruptcy is sometimes called reorganization bankruptcy because it allows individuals with regular income to reorganize their debts and pay them off over time. Instead of wiping out debts immediately like Chapter 7, Chapter 13 creates a repayment plan that lasts 3–5 years. During this time, you make monthly payments to a bankruptcy trustee, who distributes the money to your creditors.

This type of bankruptcy can be especially helpful for people who want to catch up on missed payments for secured debts, like a mortgage or car loan, while keeping the property. It can also reduce the balance or interest rate on certain secured debts. At the end of a successful payment plan, any remaining eligible unsecured debts, like credit card or medical bills, are discharged. While Chapter 13 takes longer than Chapter 7, it can help you protect your property and manage debts you can’t afford to pay in full right away.

Chapter 13 is more complicated than Chapter 7, so it’s advisable to hire an attorney to get legal help filing your case. People who file Chapter 13 without a lawyer are rarely successful.

How To File Bankruptcy: A 10-Step Overview

Chapter 7 and Chapter 13 start with the same nine steps. But, once a Chapter 13 case is filed, the filer has to propose and confirm a debt repayment plan, which is pretty complicated and won’t be covered here. Instead, step 10 will provide an overview of how to handle your car loan in Chapter 7 bankruptcy. 

Step 1: Collect Your Documents

You’ll need to provide the bankruptcy court and the bankruptcy trustee with a lot of information. Some of the information you’ll put in your bankruptcy forms, and some documents you’ll provide to the trustee in addition to the forms. 

Get a recent copy of your credit report and collect your paycheck stubs, tax returns, bank statements, and any other documents showing your income, your debts, your assets, and your expenses.

Step 2: Take the Required Credit Counseling Course

You can’t file your bankruptcy case until you’ve completed a credit counseling course from an approved credit counseling agency. You can take this class anytime during the six months before filing for bankruptcy.

Step 3: Complete the Bankruptcy Forms

There are 23 bankruptcy forms you must complete as part of your bankruptcy proceeding. If someone is helping you, they’ll likely have you provide the necessary information in a questionnaire. If you’re filing pro se (without a lawyer), you’ll have to fill out the forms yourself either by hand or through a computer software program like Adobe. If you’re eligible, Upsolve’s free web app will guide you through the process of completing your forms.  

Step 4: Get Your Filing Fee

United States courts charge $313 for a Chapter 13 filing and $338 for a Chapter 7 filing. If you’re filing Chapter 7 bankruptcy and your household income is less than 150% of the federal poverty guideline, you’re eligible to file for a fee waiver. Otherwise, be ready to pay the full fee in the form of a cashier’s check or money order when you go to the court to file your case. If you have to file quickly but don’t have the full amount, you can ask the court for permission to pay the fee in installments by filing this form along with your bankruptcy petition. 

Step 5: Print Your Forms

Most bankruptcy courts don’t allow individuals to file cases online. Usually, you need to file the hard copies of your forms in person at the bankruptcy court or send them via mail. It’s a good idea to make a copy of your forms to keep for your own records.

Step 6: File Your Bankruptcy Forms

Whether you go in person or send your bankruptcy forms in by mail, submit them all along with your court filing fee (or application for waiver/installments) to the court clerk’s office. This will officially start the case. Once done, you’re protected by the automatic stay. 

Step 7: Mail Documents to Your Trustee

Once a bankruptcy trustee is assigned to your case, they’ll send you a request for certain supporting documents. At minimum, you will need to send your recent paycheck stubs and tax returns to the trustee.

Step 8: Take the Required Debtor Education Course

Before you can get your bankruptcy discharge, you have to complete a debtor education course through an approved provider. You have up to three months from your bankruptcy filing date to complete this requirement, but it’s typically best to get it out of the way so you don’t forget later. Once done, submit your certificate of completion to the court to let the bankruptcy judge know that you’re ready for your discharge when the time comes.

Step 9: Attend Your 341 Meeting

About a month after filing your bankruptcy case, your 341 meeting will take place. It’s one of the requirements to get your discharge. You’ll need your picture ID and Social Security card for this meeting. Even though they’re sometimes called the meeting of creditors, most 341 meetings involve only you and your trustee and take less than 5 minutes to complete.

Step 10: Deal With Your Car Loan

For Chapter 7, if you have a car loan and want to keep the car, you can either reaffirm the debt or redeem the vehicle. Reaffirming the debt basically keeps everything the same with your car loan, though sometimes lenders will make certain concessions as part of the reaffirmation process. Redemption is much less common as it requires you to pay the market value of your car to the lender in one lump sum. 

Remember, if you’re filing Chapter 13, this step of the process will look different. 

What Are the Alternatives to Bankruptcy?

Bankruptcy isn’t the only option if you’re struggling with debt. Depending on your financial situation, you may have alternatives that can help you avoid filing for bankruptcy. Here are some common options:

• Debt settlement: You can negotiate directly with creditors to settle your debt for less than the full amount owed. This works best if you have a lump sum to offer in exchange for the reduced balance.

• Debt management plan (DMP): A credit counseling agency can help you set up a structured repayment plan to pay off your debts over time, often with reduced interest rates.

• Debt consolidation: This involves taking out a new loan to combine multiple debts into a single payment, ideally with a lower interest rate.

If you’re struggling with a particular debt like a car or home loan due to a temporary financial hardship, you can also contact the lender and ask for forbearance or a lower monthly payment. 

How To File Chapter 7 Bankruptcy for Free With Upsolve

Many people who file bankruptcy have suffered big setbacks resulting in a stressful financial situation. Some examples include divorce, job loss, or a serious illness that left them with huge medical bills. Others have simply fallen behind, then been unable to catch up as late fees and interest increased credit card debt and other debts to unmanageable levels.

Having to pay several hundreds of dollars in attorney fees in addition to the court filing fee is simply not an option for many in this situation. 

If you have a simple Chapter 7 case, you may be eligible to use Upsolve’s free web app to prepare your bankruptcy forms and file your case without a lawyer. Our app is free for those who qualify. If you’re ready to free yourself from debt and move into a better life, just answer a few questions to see if we can help you navigate the process and get your fresh start! 

Upsolve Co-Founder Jonathan Petts explains the basics in the video below. ⬇️

Sources:

1. American Bankruptcy Institute. (2002). Bankruptcy by the Numbers - Chapter 7 Asset Cases. ABI Journal. Retrieved August 4, 2020, from https://www.abi.org/abi-journal/chapter-7-asset-cases

2. United States Courts. (n.d.). Bankruptcy Court Miscellaneous Fee Schedule. Retrieved August 10, 2020, from https://www.uscourts.gov/services-forms/fees/bankruptcy-court-miscellaneous-fee-schedule