What is Bankruptcy?

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Bankruptcy is a legal debt relief process that gives people who are struggling financially a way to hit the reset button. The U.S. Bankruptcy Code created three different ways for people to get a fresh start. These three types of bankruptcy are commonly called Chapter 7 bankruptcy, Chapter 11 bankruptcy, and Chapter 13 bankruptcy based on sections of the bankruptcy law that describe how they work. 

The most popular type of personal bankruptcy, Chapter 7, can wipe out many unsecured debtscompletely. Chapter 13 stops all collection actions, including a pending foreclosure, while the bankruptcy filer catches up past-due balances by making monthly payments over time. Chapter 11 bankruptcy is a reorganization bankruptcy similar to Chapter 13, but it is typically used only by businesses and individuals with a lot of business debt, and ongoing business, or a lot of expensive property, including real estate. It's much more expensive than the typical consumer bankruptcy case, so Chapter 7 or Chapter 13 are much more common types of bankruptcy. 

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.

Bankruptcy can interrupt the cycle of growing debt and juggling payments immediately. Most bankruptcy filings trigger an “automatic stay” to give the filer immediate protection from their creditors. The automatic stay tells creditors, debt buyers, and others that all debt collection activity must stop instantly. That’s true even if the creditor is threatening repossession, you’re facing a wage garnishment, or you have already been sued. 

Bankruptcy law was written in part to help people get control of their finances and build more stable futures. Overwhelming debt can affect every aspect of a person’s life, including health, work performance, and family relationships. So, starting fresh has powerful benefits for individuals and families. But, bankruptcy benefits society as well. People who are crippled by debt often can’t participate meaningfully in the local and national economy. Bankruptcy not only gives people a chance to improve their lives, but also to spend, invest, start businesses, and contribute to the economy in many ways. It's a legal process available to individuals, businesses, even entire towns and counties in need of a fresh start!

Bankruptcy cases are managed by two different governmental units working together. The first is a division of the federal court system. The Bankruptcy Court receives bankruptcy filings, enters orders, grants or denies the bankruptcy discharge, and decides any conflicts between the bankruptcy filer and creditors or the bankruptcy Trustee. The bankruptcy Trustee handles the on-the-ground aspects of the case, like reviewing bankruptcy filings to ensure that they are complete and accurate. 

This article will help you understand the bankruptcy basics, including the differences between the two types of personal bankruptcy (Chapter 7 and Chapter 13) and the basic bankruptcy process. This knowledge can help you make informed decisions about the right solution for you.

Chapter 7 Bankruptcy Explained

Chapter 7 bankruptcy can eliminate many unsecured debts. Unsecured debts include debts like medical bills, personal loans, payday loans, and credit card debt. Past-due rent and utility bills are also unsecured debts. All of the types of debt listed here can typically be wiped out in a successful Chapter 7 case. 

Chapter 7 bankruptcy provides the quickest form of bankruptcy relief available in the United States. Unlike Chapter 11 or Chapter 13, this type of bankruptcy may take as little as 4-5 months to complete. The discharge order entered at the end of a successful Chapter 7 case frees the bankruptcy filer from paying unsecured, dischargeable debts from before the bankruptcy case was filed. Better yet, the filer can start rebuilding their credit score as soon as the discharge is granted.

There are some limitations, though. 

First, not everyone qualifies for Chapter 7 bankruptcy. Congress wanted to make sure people who filed bankruptcy truly needed a fresh start. So, Chapter 7 filers must qualify for this form of debt relief based on their income. The first step is to determine whether your income is above or below the median household income for a family of the same size in your state. Don’t worry, though. If your income is above the median, that doesn’t necessarily mean you can’t file Chapter 7. It just means you go on to the next step to find out whether you qualify under the second, extended part of the Means Test. The Means Test compares income with allowed expenses to determine whether you have enough extra money--called “disposable income”--to pay some of your debts.

Second, filing bankruptcy under Chapter 7 doesn’t offer a solution for all types of debt. Chapter 7 generally won’t help with secured debts, such as car loans and mortgages, if the bankruptcy filer wants to keep the property and catch up on the loans. And, certain types of unsecured debt are nondischargeable. That means even though the debt is unsecured, it can’t be eliminated in a Chapter 7 bankruptcy case. Nondischargeable debts include:

  • Child support and other domestic support obligations, such as alimony

  • Student loan debt, with very rare exceptions

  • Recent tax debts

Debt may also be nondischargeable if it’s the result of fraud, willful destruction of property, or certain other malicious actions.

Finally, Chapter 7 may not be a good option for people who have a lot of high-value assets. Chapter 7 bankruptcy is also called “liquidation,” which means converting nonexempt propertyto cash to pay creditors. However, that rarely happens in typical Chapter 7 bankruptcy cases, because many assets are exempt. Exempt assets are protected from creditors, and can’t be sold or liquidated in bankruptcy. State law governs bankruptcy exemptions, so they are different in every state. Some states give filers the option to choose federal lawinstead of state law to protect their property. Some common examples of property that is protected from creditors include:

  • A certain amount of value in a home

  • A certain amount of value in a motor vehicle

  • Household goods such as furniture and appliances

  • Work tools

  • Clothing and other personal items

Many states also include a “wildcard” exemption, which means the bankruptcy filer can choose additional property to protect, including money in a bank account, up to a certain dollar amount. 

Because of these protections, 96% of people who file for Chapter 7 bankruptcy keep all of their property. 

Here’s how the Chapter 7 bankruptcy process works:

Prepare Chapter 7 Bankruptcy Forms

A Chapter 7 bankruptcy filing includes several forms, and careful preparation is critical. In addition to the bankruptcy petition, the bankruptcy filer must provide schedules and accountings of debts, income, assets, and other financial information. The Bankruptcy Court may dismiss or throw out a case if the Trustee finds significant errors or incomplete information. Carefully complete and review your forms, taking time to look up any information you are unsure of. But, don’t file them yet. First, you must complete credit counseling.

Take Course 1

The first course a bankruptcy petitioner must complete is a credit counseling session. It usually takes about 90 minutes, and can be completed online or over the phone. The goal of credit counseling is to ensure that you have explored all of your options and made an informed decision about bankruptcy. Congress considered this step so important that you are required to include a certificate of completion with your bankruptcy filing. Personal bankruptcy cases filed without this certificate, issued by one of the approved providers for the district, may be dismissed.

File Forms

Once you have received your credit counseling certificate and completed and double-checked your forms, you’ll file the forms with your local Bankruptcy Court. You can find the right Bankruptcy Court by putting your city, state, and zip code into the official court locator on the U.S. Courts website. It’s usually best to take your forms to the courthouse rather than mailing them. That gets your case started more quickly, gets the automatic stay entered sooner, and allows you to get a file-stamped copy of your bankruptcy forms immediately.

Pay Filing Fees

The filing fee for a Chapter 7 bankruptcy case is $335. Don’t worry, though. If you can’t afford to pay the filing fee, you can apply for a fee waiverif your income is below 150% of the federal poverty guidelines. Or, if you can afford the fee but don’t have all of the money when you want to file, you can ask to pay it in installments. The installment plan allows the fee to be broken into up to four payments, paid over up to 120 days. If the Court finds that you can afford to pay your filing fee by making monthly payments, it may order you to do so instead of granting your application for a fee waiver.

Attend Bankruptcy 341 Meeting

For most people who file Chapter 7 bankruptcy, the 341 meetingis the only appearance required. Most filers never have to go to a courtroom to appear before a bankruptcy judge. The 341 hearing is overseen by the bankruptcy Trustee, and often lasts only a few minutes. The trustee will ask questions to make sure the bankruptcy filer understands the process, and to clarify or double-check the information in the bankruptcy filing. You may also hear this hearing called the “meeting of creditors.” Creditors have the right to come to the meeting and ask questions, but they usually don’t.

Take Course 2

During the bankruptcy case, you must take another course. This one is a personal financial management course, typically called “debtor education.” While the credit counseling course was intended to help in your decision-making process, debtor education aims to help you improve your finances after bankruptcy. This course can be completed on the telephone or online, and usually takes about two hours. Again, it’s important to choose one of the providers approvedfor your district for this course. You will have to file your certificate of completion with the Bankruptcy Court before you can receive your discharge.

Receive Discharge Letter

The bankruptcy discharge is the goal of a Chapter 7 case. The discharge order is what frees you from the debt you had before filing bankruptcy. And, the discharge order forbids creditors and debt collectors from trying to make you pay debt that has been discharged. Timelines vary slightly, but you can usually expect to receive your discharge letter about two months after your 341 hearing. You’ll want to keep this letter and send a copy to any creditor or debt collector who calls or sends you a bill for debt that was included in your bankruptcy. It's also a good idea to get a copy of your credit report about 60 days after your discharge was entered, so you can make sure all creditors are reporting your Chapter 7 bankruptcy correctly.

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Chapter 7 v. Chapter 13 Bankruptcy

Although both are intended to help people get out of debt and build better financial lives, Chapter 7 and Chapter 13 bankruptcy are two very different processes. Chapter 7 bankruptcy moves relatively quickly, eliminates most unsecured debt, and enables the filer to walk away from secured debts that are simply no longer manageable. But, Chapter 7 can’t help you catch up past-due mortgage debt or other secured loans. Typically, people choose Chapter 7 if:

  • They have mostly unsecured debt, or want to surrender the property that serves as collateral and discharge debt that was secured, and

  • They have few or no non-exempt assets, and so don’t stand to lose property in a Chapter 7 case

Chapter 13 bankruptcy is centered around a three-to-five-year repayment plan. Chapter 13 is often a good option for people who don’t qualify for Chapter 7 because they have too much income. But, they’re not the only ones who opt for Chapter 13.

Some people who qualify for Chapter 7 choose Chapter 13 instead because:

  • They have non-exempt assets they want to keep

  • They have secured debt, such as mortgage loans, that they want to bring up to date through the bankruptcy repayment plan

  • They want to use the Chapter 13 process to reduce balances due and interest rates on certain types of secured debt

  • They want to convert second mortgages into unsecured debt through a process called “lien stripping,” which is only available when the first mortgage exceeds the value of the property

Although Chapter 13 typically requires repayment of at least some unsecured debt, any dischargeable, unsecured debt remaining at the end of a successful repayment plan is eliminated when the discharge is entered. Since the legal process involved in filing Chapter 13 bankruptcy is much more nuanced than Chapter 7, it is recommended that you speak to a bankruptcy attorney about filing a bankruptcy case under Chapter 13. 

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Free Bankruptcy Filing with Upsolve

For most people in need of bankruptcy, qualifying for Chapter 7 is not difficult. Basic requirements include passing the Means Test and not having received a discharge in a Chapter 7 case filed within the previous eight years. If you’ve received a discharge in a Chapter 13 case in the past, the waiting period to file Chapter 7 is six years from the original filing. There is also a 180-day waiting period if a prior case was dismissed for certain specific reasons.

Those who pass the Means Test and are not subject to a waiting period need only complete credit counseling, carefully and completely fill out the appropriate forms, pay the filing fee and file the papers with the Bankruptcy Court to start a Chapter 7 case. 

Upsolve is a non-profit organization headquartered in New York City that is dedicated to helping people regain control of their finances through Chapter 7 bankruptcy. We know that many people who need bankruptcy protection can’t afford to hire a bankruptcy lawyer to represent them. But, the bankruptcy process can be intimidating for someone unfamiliar with the court system. That’s where we come in.

Our Chapter 7 filing solution 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 find out whether we can help you navigate the process and get your fresh start! 

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Upsolve is a 501(c)(3) legal aid nonprofit that started in 2016. Our mission is to help low-income Americans in financial distress get a fresh start through Chapter 7 bankruptcy at no cost. We do this by combining the power of technology with attorneys. Spun out of Harvard Law School, our team includes lawyers, engineers, and judges. We have mission-driven funders that include the U.S. government, former Google CEO Eric Schmidt, and private charities.

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