Bankruptcy Basics: When is Chapter 7 A Good Option?

Straight Bridge

Chapter 7  bankruptcy is also known as a straight bankruptcy.  It can be quick and straight forward, depending on the facts of the case.

The simplest definition for Chapter 7 is that debts someone can’t pay back are discharged, or forgiven, and they get a chance to start over debt free.

How do you know if you should file a Chapter 7 bankruptcy?

Chapter 7 Bankruptcy is a good option if:

• all of your property is protected from creditors  OR
• walking away from the debts is worth giving up property that is not protected

             AND

• after paying your necessary and reasonable living expenses, there is no income left to pay towards your debts.

What property is protected in Chapter 7?

Some property is protected from creditors if they sue you, but the creditors can keep trying to collect for years, or they can wait until you get property that isn’t protected.  The property that is protected from creditors is called exempt property.

In bankruptcy, you also get to keep exempt property but once you file bankruptcy, you don’t need to worry about the creditors every trying to collect again.  Chapter 7, you have to give up non-exempt assets on the day you file, but then it is over.  The non-exempt property can be sold.  Whatever money they get is applied towards your bills, and but you won’t owe a balance even if the debts aren’t paid off.

Exemptions vary from state to state and determining which law applies can be complicated.   What you get will depend on where you live, and also how long you have lived there.  Exemptions are modest in some states, and more generous in others.   If you have lived in your state at least  two years, you get your state’s bankruptcy exemptions.  If you haven’t, then you might be required to use either the exemptions from a state you used to live in or the Federal exemptions.

What if all your property isn’t exempt?

If you have some property that isn’t exempt, there may be ways to increase your protection, but it must be done with care.  It is important to consult an  experienced bankruptcy lawyer in your state to determine which exemptions you can claim, what assets are protected, and how to plan and maximize your exemptions for the best protection available.

Sometimes you can can get better exemptions if you have some flexibility about where and when to file your bankruptcy case.

You might get better treatment if you file before you have to use the laws of your state, or it might be better if you wait to file your bankruptcy case after you can use them.

What debts are written off in Chapter 7?

Most debts are discharged in bankruptcy but the goal of most people who file for bankruptcy is to discharge  general unsecured debts (without collateral) like credit cards, loans, and medical bills.  Some taxes, student loans, support and a few other types of debt is not discharged.

What about secured debts, like home loans or car loans?

Those debts can be discharged too if you are willing to walk from the collateral, but you don’t get to file bankruptcy on a secured debt and get the collateral for free.

Many people are able to  file Chapter 7 bankruptcy and keep their home or car.  It depends on how much equity there is in the property.   As long as the equity is protected, then the bankruptcy shouldn’t cause you to lose the asset, but you do need to make the payments.

What if you don’t have non-exempt assets, but you do have discretionary income?

If all your assets are protected, you might want to file a  Chapter 7  and start over.   Your income and expenses are disclosed in your bankruptcy petition in different formats.  Depending on how much you make and spend, you might not qualify for 7 and you might need to consider Chapter 13 instead.

You have to report what you really make and spend.  Sometimes people do have money to pay towards their debts, but not enough.  Your income and expenses are also evaluated using a formula called the Means Test to determine if there is a presumption that you ought to have money to pay towards your debts.  The Means Test is often inaccurate.   Sometimes it says you have extra income that isn’t there, and sometimes it says you are broke when you aren’t.

• Chapter 13 might be a better option for you if you don’t qualify for Chapter 7 because of  the Means Test,  you have money to pay towards your debts, or you have assets that you can’t exempt but want to keep.