Keeping up with bills is not an easy or a fun task. For most people, managing finances comes without any training. Add that to living from paycheck to paycheck and it’s easy for bills to get past you. If you get too far behind, sometimes the only way out is to consider bankruptcy. One of the most common of the six types of bankruptcy is Chapter 7. But just what is Chapter 7 bankruptcy? Most don’t know what it is, let alone how it can help them deal with out-of-control finances.
Let’s dig in to Chapter 7 to uncover the details. Chapter 7 bankruptcy is also called liquidation or straight bankruptcy. In short, Chapter 7 goes like this:
- You file the necessary forms and a petition with a federal bankruptcy court.
- The federal court selects a trustee to supervise your case.
- The trustee takes your assets, sells them, and pays off creditors who’ve filed claims against you.
- Within a few months, you’re discharged or released from liability for your former debts.
The trustee won’t take everything you own. You’ll keep enough to continue your life without your previous debts. If you don’t have any assets, you may have a “no-assets case.” In a no-asset case, there are no assets to sell and creditors don’t get paid.
Not everyone can file for Chapter 7. Filers have to have income that doesn’t exceed a certain threshold in order to be eligible to file.
Before You File for Chapter 7
Before filing for a Chapter 7 bankruptcy and having a bankruptcy case on your hands, you’ll need to undergo credit counseling and pass a means test.
Mandatory Credit Counseling
Federal bankruptcy laws mandates that anyone who files for Chapter 7 bankruptcy complete credit counseling within 180 days before filing. The credit counselor has to be an approved credit counseling agency. Counseling can be in person or over the phone. Some courts offer online counseling sessions.
The purpose of counseling is to ensure that you are fully aware of your options. A knowledgeable credit counseling can shed light on your options and help you understand if you really need to file for bankruptcy or have other means to get out from under mounting debt.
Before you file, a means test is required to determine if you have more monthly income that your state’s median monthly income. It’s a way to prevent what the courts dub “abusive” filings. According to the U.S. Courts “Bankruptcy Basics” authored by the Administrative Office of the United States Courts, “Abuse is presumed if the debtor’s aggregate current monthly income over 5 years, net of certain statutorily allowed expenses, is more than (i) $11,725, or (ii) 25% of the debtor’s nonpriority unsecured debt, as long as that amount is at least $7,025.2”
In other words, a means test is used to determine if you can afford to pay for at least a significant part of your debts and, therefore, don’t really need to file bankruptcy. The test was added to the bankruptcy code in 2005. Under rare circumstances, applicants who fail the means test have still been able to file.
The Chapter 7 Bankruptcy Process
Before you approach a court to file for Chapter 7 bankruptcy, it’s important to gather your financial documents, such as credit card and bank statements, loan documents, and evidence of your salary. You’ll need this information to complete the documents needed to file for bankruptcy, such as schedules of assets and liabilities, a schedule of income and expenses, a statement of financial affairs, and a schedule of executory contracts and unexpired leases. You can download these bankruptcy documents and instructions for free on the United States Courts website.
These documents disclose as much of your finances as possible to the bankruptcy court. The court also requires a list of property, debts, expenses, income, creditors, property transfers and more.
Once you have your documents completed, you submit your filing with your local court. To find a bankruptcy court close to you, visit the United States Courts court locator page. Choose “bankruptcy” under court type and add your location.
Filing requires that you pay a filing fee that includes $245 for filing the case, $46for administrative costs and $15 as a trustee charge. Some filers may qualify to have these fees waived.
Once you’re assigned a trustee, you’ll also need to provide him/her with a copy of your most-recent tax return and any returns filed once your case begins.
Other documents that may be needed include:
- A certificate proving you’ve undergone credit counseling and a copy of any debt repayment plan created by your credit counselor
- Copies of paychecks received 60 days before filing
- A statement of your monthly net income and any anticipated increase in income or expenses after filing
- A record of any interest you have in federal or state qualified education or tuition accounts
Once you’ve filed, collection agencies can no longer pursue payments from you for the most part and possibly only for a short time. The court will alert creditors listed in your petition to stop pursuing payment from you. This includes those creditors pursuing lawsuits against you, garnishing your wages and calling you on the phone to ask for payment.
After filing for bankruptcy and if your petition is granted, the court then sends out a notice of a debtor’s meeting of creditors. Think about this as an invitation card to everyone you owe money to. This list of creditors is pulled from the information you provide in your bankruptcy petition. During this meeting, the trustee assigned by the court to your case asks creditors questions about the bankruptcy, including whether all the information contained within your bankruptcy document is correct.
If a trustee feels the need to further investigate the bankruptcy, he or she can opt for a continuation of the meeting on another date. During this meeting, any creditor can ask questions about the bankruptcy and your personal finances. Usually, the creditors that attend are limited to the IRS and car loan lenders that ask about non-dischargeable taxes—those that have to be paid—and car payments.
Any of your property that is deemed non-exempt property by the court can be seized and sold by the trustee. Exemptions are granted by federal and state statutes to let you protect some property. Examples of exempt property include:
- Lower-value autos
- Household items and funiture
- Lower-value jewelry
- Pensions and retirement accounts.
This is the final phase of a Chapter 7 bankruptcy. If the trustee and the creditors raise no objections to the discharging your debts, the court issues a discharge order. This typically happens in two to three months of the date of the first meeting of creditors. The last day a creditor can file a complaint is within 60 days following the first creditor meeting. If the 60 days pass and no complaint is filed, the discharge is filed a few days later.
More than 99% of Chapter 7 bankruptcies end in discharge. Note though that not all of your debts will be discharged including federal student loans, child support, alimony, and some tax obligations.
Those debts that are discharged makes it illegal for creditors whose debts have been discharged to contact you or continue or initiate legal action against you for those debts. Essentially, upon discharge, all discharged debts are wiped out. Although, creditors do still have the legal right to go after a co-debtor, provided he/she hasn’t also filed for bankruptcy or been granted a discharge.
Find out more about bankruptcy in “How to Build Credit After Bankruptcy?” And find out how filing for bankruptcy will affect your credit score and credit report in “3 Things Bankruptcy Does to Your Credit Score.”
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