What Is Bankruptcy? - 2021 Rundown

If you don't know how bankruptcy works, this is the right place to start. You'll learn about the differences between Chapters 7 and 13, whether you can erase your debt, and if you can keep your property.

When debt gets out of control, bankruptcy can help you get back on your feet. Find out whether you can get a fresh start by answering these common bankruptcy questions:

  • Can I erase my debt and keep my property?
  • Should I file for Chapter 7 or 13?
  • Do I qualify for bankruptcy?
  • What will happen after I file?

The information below will help. You can also use the ten-question bankruptcy quiz to spot potential issues quickly. It works by flagging areas you'll want to look into further with a bankruptcy lawyer.

Can I Erase My Bills in Bankruptcy?

Filing for bankruptcy is serious business. It can impact your credit score for up to ten years, so filing won't make sense unless you can get rid of a good amount of debt. That's why we're covering this big question first.

Before you do anything else, check whether bankruptcy will wipe out (discharge) your debt. Credit card balances, medical bills, personal loans, back rent, gym memberships, payday loans, and utility bills all go away in bankruptcy. You can also erase mortgages, car loans, and other debt secured by collateral—but you'll have to return the house, car, or other property to the lender.

However, some debts don't go away. Child and spousal support obligations and recently incurred income tax bills are common examples of "nondischargeable debt." And the court won't discharge student loans unless you file a separate lawsuit and meet the requirements to win—something most people can't do.

Even if you have nondischargeable debt, bankruptcy might still be an option. In Chapter 7, you'll pay nondischargeable debt after your case ends, but it should be easier to do because you'll owe fewer debts.

Most Chapter 13 filers walk away debt-free because filers must pay nondischargeable debts in full through the Chapter 13 repayment plan. You won't have to fully pay long-term debts like mortgages or student loans. You'll still owe the balances after your case ends.

Can I Keep My Property in Bankruptcy?

Everyone needs essential belongings to work and live. Although you won't lose everything in bankruptcy, you don't get to choose what to keep, either. Your state lists the items bankruptcy filers can protect in its bankruptcy exemption laws, although some states let filers use the federal bankruptcy exemptions if they'd protect more property. (You must pick one list or the other—you can't use exemptions from both lists.)

You'll use the same exemptions in both Chapters 7 and 13. But what will happen to your nonexempt property—things an exemption doesn't cover—is very different. In Chapter 7, you'd lose the nonexempt property, and the trustee appointed to manage your case would sell it and give the proceeds to your creditors. In Chapter 13, you don't lose nonexempt property. Instead, you have to pay creditors what it's worth through the repayment plan.

Review your state's bankruptcy exemptions to get a feel for the property you'd keep (state links are at the bottom). If your state isn't there, check Nolo's state bankruptcy exemption articles.

Will Chapter 7 or 13 Bankruptcy Work for Me?

Not all debt problems are the same. Different chapters solve different issues, so we've outlined the key points below to help you get a sense of how each bankruptcy type works.

  • Chapter 7 works well if you live a frugal lifestyle but struggle to make ends meet. Chapter 7 is quick. In three to four months, you'll wipe out credit card and utility balances, medical bills, and more. You'll also be able to keep property essential to work and live. Any luxury property gets sold for the benefit of creditors. Income limitations apply.
  • Chapter 13 works for those with an excellent monthly income and high debt. You'll pay creditors an amount you can afford for five years. Unlike Chapter 7, filers can keep all of their property. Repayment plans can be expensive. Filers must have enough monthly income to meet this chapter's debt payment rules.
  • All filers will choose Chapter 13 when facing foreclosure, repossession, or losing property in Chapter 7. Only Chapter 13 provides a way for filers to catch up on past-due payments and stop foreclosure or repossession. Also, you can keep everything in Chapter 13, but it can be expensive. You have to pay your creditors the value of any property you'd lose in Chapter 7.

TIP for Business Owners: For the most part, businesses don't file for Chapter 7 or 13. Instead, consider Chapter 11 or Chapter 11 subchapter V for small businesses. Also, be sure that you understand that a personal filing could negatively affect your company and any partners you might have. Learn more about businesses in bankruptcy.

Do I Qualify for Bankruptcy?

Sometimes it's easy to figure out whether you're qualified for bankruptcy. For instance, Chapter 7 debtors qualify if their gross income is less than the state's median income for the family's size. It's just a matter of simple math and checking a chart. If you don't pass that first hurdle, you'll have a second chance to figure in your expenses, but more factors come into play. Here's where you'll find out more about passing the means test and qualifying for Chapter 7.

Qualifying for Chapter 13 isn't ever simple, and because of the numerous complicated rules, you'll want to work with a bankruptcy lawyer. Until then, you can learn about the Chapter 13 repayment plan and get an idea about whether you make enough income to cover what you'll have to pay. Or try out this Chapter 13 repayment plan calculator. It's not perfect, but it will show you what you must pay (you might have to pay more).

How the Bankruptcy Process Works

Soon after you file your "petition" or bankruptcy paperwork, calls, letters, wage garnishments, and even collection lawsuits should come to a halt. It happens because of the "automatic stay" order the court immediately puts in place.

Next, the court will ensure the information in the petition is correct. You'll turn over bank statements, paycheck stubs, tax returns, and other documents for the bankruptcy trustee's review. All filers will attend a "341 meeting of creditors." At the meeting, the trustee will check your identification and ask questions about your filing. Creditors can appear and ask questions too, but they rarely do. Learn more about the Chapter 7 bankruptcy process.

Chapter 13 filers or counsel will also need to attend a confirmation hearing. The judge will review any objections to your proposed repayment plan and decide whether it meets all requirements necessary to be approved or "confirmed."

Filers must also complete two educational courses. You'll take the credit counseling course before you file your case. You must take a debt management class before you receive the discharge wiping out qualifying debt.

Need More Help?

We want you to find the information you need. For more easy-to-understand bankruptcy articles, go to TheBankruptcySite or consider buying a self-help book like The New Bankruptcy by Attorney Cara O'Neill.

We wholeheartedly encourage research and learning, but online articles can't address all bankruptcy issues or the facts of your case. The best way to protect your assets in bankruptcy is by consulting with a local bankruptcy lawyer.

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