What is Chapter 7 bankruptcy?
Chapter 7 bankruptcy – often referred to as the “fresh start bankruptcy” - is the most common type of bankruptcy filing. In 2017, there were 472,135 Chapter 7 cases filed in the United States.
From start to finish, Chapter 7 normally lasts about 5 months and is a great way for consumers to achieve a financial fresh start.
In Chapter 7, individuals are allowed to completely discharge (wipe away) their debts. In exchange, some of their property may be “liquidated” (sold and converted to cash) in order to repay creditors. However, that rarely happens because these individuals are allowed to “exempt” (protect) certain assets from being sold.
Debts That Can Be Wiped Away
In a typical Chapter 7, an individual is allowed to discharge (wipe away) all of their unsecured debts. This includes credit cards, medical bills, payday loans, personal loans, repossessions, utilities, old taxes, etc.
Debts that Cannot be Wiped Away
Typically in a Chapter 7, an individual cannot discharge student loans, recent taxes, child support, alimony or maintenance obligations, or fraudulently incurred debts. Everything else can be wiped away.
How the Process Works
The process starts when the debtor (the person filing for bankruptcy protection) files a bankruptcy petition. As soon as this petition is filed with the court, an “automatic stay” is issued.
The automatic stay is extremely powerful. It goes into effect the second the bankruptcy petition is filed and prevents creditors from taking any further collection activity against the debtor. This means that garnishments must stop, lawsuits must be dismissed, and threatening phone calls and letters must end.
The petition that is filed with the court is about 40 pages long and lists certain information about the debtor. The debtor must disclose their name, address, social security number, household size, assets, creditors, income, living expenses, and certain tax information.
Right after the petition is filed, two things happen. First, the court sends out notice to all of the creditors, informing them that the debtor is under bankruptcy protection and all collection activity must stop. Second, the court appoints a trustee to review the case.
The Role of the Trustee
The trustee is usually a private attorney whose job it is to review the debtor’s assets, as well as the exemptions the debtor has claimed, and determine if there are any unexempt assets to sell to pay back to the creditors.
Exemptions are very important to the bankruptcy process. If a debtor claims a piece of property exempt, then the trustee is prevented from selling that property. Each state has their own set of exemptions and they very greatly.
Here is a quick example that shows how exemptions work (and how they very from state to state). Suppose a debtor lives in Kansas and owns a car that is paid in full and worth $10,000. Kansas has a $20,000 automobile exemption. Therefore, because the car is worth less than the full exemption amount, the car is fully exempted and the bankruptcy trustee cannot sell it.
But if the debtor lived in Missouri, it would be a completely different situation. Missouri’s automobile exemption is only $3,000. Therefore, if the car is paid in full and worth $10,000, then a bankruptcy trustee can sell the car and use the proceeds to repay the creditors. The debtor, however, would get to keep $3,000 (the amount of the exemption) of the sales proceeds.
Just to illustrate one further point, assume the car in the Missouri example had a lien against for $11,000. In that situation, the trustee would not sell the car, because if he/she did, the proceeds would just go to the lienholder and there would be no recovery for the trustee or the creditors. Therefore, if a car is financed, there is a good chance that you will be able to keep it and continue to make payments on it through the reaffirmation process.
Many debtors who file Chapter 7 are financing houses or cars and want to keep those debts. By reaffirming these debts (aka “recommitting” themselves to the debts), the debtor can prevent a debt for a house or a car from being discharged in the bankruptcy.
Credit Score After Bankruptcy
As funny as this sounds, bankruptcy often helps people increase their credit score. By the time someone considers filing bankruptcy, they usually have several negative trade lines on their credit report and their overall credit score has taken a hit. Once the bankruptcy discharge is entered, the creditors are required to notate that the debt has been discharged in bankruptcy and there is a zero balance owed – which is why the credit score goes up.