Bankruptcy is a process in which consumers and businesses can eliminate or repay some or all of their debts under the protection of the federal bankruptcy court. For the most part, bankruptcies can be divided into two types — liquidation and reorganization.
Chapter 7 bankruptcy comes under the liquidation category. It’s called liquidation because the bankruptcy trustee may take and sell (“liquidate”) some of your property to pay back some of your debt. However, you may keep property that is protected (also called “exempt”) under state law. There are several types of reorganization bankruptcies, but Chapter 13 is most commonly used by consumers. In Chapter 13 bankruptcy, you keep all of your property, but must make monthly payments over three to five years to repay all or some of your debt.
Both Chapter 7 and Chapter 13 bankruptcy have many rules — and exceptions to those rules — regarding which debts are covered, who can file, and what property you can and cannot keep.
Chapter 7 Bankruptcy
Chapter 7 bankruptcy can be filed by individuals (called a “consumer” Chapter 7 bankruptcy) or businesses (called a “business” Chapter 7 bankruptcy). A Chapter 7 bankruptcy typically lasts three to six months.
Property liquidation. In Chapter 7 bankruptcy, some of your property may be sold to pay down your debt. In return, most or all of your unsecured debts (that is, debts for which collateral has not been pledged, such as medical debts and most credit card debts) will be erased. You get to keep any property that is classified as exempt under the state or federal laws available to you (such as your clothes, car, and household furnishings). Many debtors who file for Chapter 7 bankruptcy are pleased to learn that all of their property is exempt.
Secured debt. If you owe money on a secured debt (for example, a car loan for which the car is pledged as a guarantee of payment), you have a choice of allowing the creditor to repossess the property; continuing your payments on the property under the contract (if the lender agrees); or paying the creditor a lump sum amount equal to the current replacement value of the property. Some types of secured debts can be eliminated in Chapter 7 bankruptcy.
Eligibility for Chapter 7. Not everyone can file for Chapter 7 bankruptcy. For example, if your disposable income is sufficient to fund a Chapter 13 repayment plan — after subtracting certain allowed expenses and monthly payments for certain debts — you won’t be allowed to use Chapter 7 bankruptcy.
Bankruptcy doesn’t work on some kinds of debts. Though bankruptcy can eliminate many kinds of debts, such as credit card debt, medical bills, and unsecured loans, there are many types of debts, including child support and spousal support obligations and most tax debts, that cannot be wiped out in bankruptcy.
Chapter 13 Bankruptcy
Chapter 13 bankruptcy is also known as “wage earner” bankruptcy because, in order to file for Chapter 13, you must have a reliable source of income that you can use to repay some portion of your debt.
Debt limits. Your debts must be within limits set by the federal government: Currently, you may not have more than $1,149,525 in secured debt and $383,175 in unsecured debt.
Secured debts. If you have secured debts, Chapter 13 gives you an option to make up missed payments to avoid repossession or foreclosure. You can include these past due amounts in your repayment plan and make them up over time.