Bankruptcy Basics: How to File for Chapter 7 or Chapter 13

Paying Off Debt, Personal Finance
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Bankruptcy Basics: How to File for Chapter 7 or 13 Bankruptcy

Bankruptcy lets you get your overwhelming debt forgiven or restructured under the protection of a federal court.

Consumers have two main options:

  • Chapter 7 (liquidation): The quickest, simplest and most common type. Most unsecured debts, such as credit cards, medical debt and personal loans, are discharged, or forgiven. You may have to give up some assets, like an expensive car or jewelry, but the vast majority of filers do not.
  • Chapter 13 (reorganization): You repay some or all of your debt under a court-approved plan. Debts must be under a certain level, and you must have enough income to repay them over three to five years.

Bankruptcy isn’t easy or cheap, and it likely will crimp your access to new credit for seven to 10 years. But it may be the best way to salvage your finances.

Here’s a look at what bankruptcy is, whether it’s right for you, how to file, and what to watch out for along the way.

In this article:

What is bankruptcy?
Is bankruptcy right for me?
The importance of an attorney
Beware of scams
Chapter 7 versus Chapter 13
How to file for bankruptcy
Rebuilding after bankruptcy

What is bankruptcy?

Bankruptcy has some stigma and misconceptions surrounding it, and it’s not easy or cheap — but this debt relief tool might be your best bet for a better financial future.

You and your attorney will work to prove your eligibility for a debt discharge or reorganization to a bankruptcy trustee, who administers the proceedings.

Bankruptcy will leave a serious mark on your credit reports, and you’ll likely find it harder to borrow money for years to come. Even so, you’ll probably see your credit scores start to improve once you take this step to resolve your debts.

“Bankruptcy gives you a chance for a fresh start,” says Dan LaBert, executive director of the National Association of Consumer Bankruptcy Attorneys. “It’s not political; it could happen to anyone. I think when people feel that overwhelming pressure from financial stress — and they’re seeing that pressure stretch out and impact those around them — bankruptcy is a very legitimate option for them.”

Is bankruptcy right for me?

Bankruptcy may be your best solution if:

  • Your debts total more than half your annual income.
  • It would take five years or more to pay off your debt, even if you took extreme measures.
  • Your debt interferes with other aspects your life, such as your relationships or your ability to sleep.

Other debt relief options are available, such as a debt management plan through a credit counseling agency. Think through your circumstances and goals and take advantage of the free initial advice that credit counselors and many bankruptcy attorneys offer before deciding on a particular path.

“Bankruptcy is not a panacea for every situation, and I think that if you’re contemplating doing it, you should have a frank conversation with an attorney,” says California bankruptcy attorney Matthew Olson. “There’s the downside of the hit on your credit report, but frequently that will be outweighed by relief of stress and getting this problem solved and letting you move forward with your finances.”

The importance of an attorney

Bankruptcy is complicated. Although it can be tempting to hire a petition preparer to fill out paperwork and try to do the rest on your own, skipping a step or improperly filling out a form can lead to your case being thrown out or not having certain debts dismissed. That’s why finding the right bankruptcy attorney is important. In general, look for these three things when vetting potential attorneys:

  • Depth of knowledge.
  • Charges in line with the complexity of your case.
  • Confidence you can develop a good professional relationship.

“Working in bankruptcy requires a specialization,” says California bankruptcy attorney Cathy Moran. “You want someone who does enough of this kind of work to have some depth of knowledge. This is not a field for dabblers or generalists.”

Attorney fees vary greatly by location, attorney and complexity of the case. But Moran warns that bottom-of-the-barrel prices might leave you shortchanged.

“I think it’s almost inevitable that the people who are the cheapest are trouble,” Moran says. “They can’t afford to spend any time on your case, and if they think they can stay in business charging $700 for a bankruptcy, they haven’t done it very long to know that at that rate the lawyer is either making $3.25 an hour or the client is getting shorted.”

Beware of scams

Many companies promise quick fixes for your financial problems but can’t actually help resolve your debt. Watch out for any that:

  • Ask you to pay a fee before receiving any services.
  • Promise to wipe out your debt without you having to declare bankruptcy or pay a fee.
  • Tell you to make your debt payments to their company rather than your creditors, without your creditors’ explicit consent.
  • Tell you to stop communicating with your creditors or say you need professional help to contact them.
  • Promise to magically repair your credit.
  • Tell you you’re eligible for a government program to help relieve your debt; only the government agency in question can determine your eligibility.

If you think you’ve been scammed, contact the Federal Trade Commission or email the U.S. Trustee Program to get help.

Chapter 7 versus Chapter 13

Choosing between Chapter 7 and Chapter 13 will likely come down to your eligibility, your priorities and the value of assets that could be seized in a Chapter 7 bankruptcy. Each state lets you exempt a certain amount of value for certain assets; a house and car are the main ones people worry about.

Here’s how Chapter 7 and Chapter 13 work and which might be right for your situation.

 Chapter 7Chapter 13
How it worksThe vast majority of unsecured debts (such as credit cards, medical bills and personal loans) are forgiven. You must thoroughly document your finances and eligibility. You may give up some assets but likely won't have to. You get court approval of a plan to repay both unsecured and secured debts (such as mortgage and car loans) in part or whole. You'll pay over three to five years and will retain your assets.
Requirements• Must pass the means test if you have primarily consumer debts.
• Cannot have filed for Chapter 7 in the past eight years or Chapter 13 in the past six.
• Must have sufficient income.
• Unsecured debt cannot exceed $394,725. Secured debt cannot exceed $1,184,200.
• Must be current on tax filings.
• Cannot have filed for Chapter 13 in the past two years or Chapter 7 in the past four years.
Does it apply to every type of unsecured debt?No, you must still pay child support and debts you owe the government, such as taxes. The court is highly unlikely to forgive student loan debt.You'll have to repay some or all of your secured and unsecured debts over three to five years.
Can your house be seized?If the equity in your house exceeds exemption levels for your state, it may be sold. Otherwise you keep it.Not if you stay current on mortgage payments.
Can your car be seized?If the equity in your car exceeds the exemption level for your state, it may be sold. Otherwise you keep it.Not if you stay current on the payment plan.
How long does it stay on your credit reports?Up to 10 years.Up to 10 years, likely closer to seven.

An experienced bankruptcy attorney can help you determine which is best for your situation, but in general:

CHAPTER 7 IS BETTER IF:

  • Your problem debts are ones that can be discharged, or forgiven, by Chapter 7, such as medical bills or credit card debt.
  • You don’t have many assets. Many Chapter 7 filers have modest cars and not much income. If the value of your possessions falls within the exemption limits, you don’t have to worry about your assets being seized.
  • You don’t think you’d be able to pay off your debts over three to five years.

CHAPTER 13 IS BETTER IF:

  • You want to keep certain assets and/or you’re behind on your mortgage or car payments and want to make them up over time.
  • Most of your debts are student loans, child support or other debts that either can’t or are highly unlikely to be discharged under Chapter 7.
  • You have nonexempt assets that you want to keep, such as a nicer car or valuable jewelry.
  • You have a co-signer on an indebted account. With Chapter 7, creditors are free to go after your co-signer even though you’re protected. If you file Chapter 13, you can arrange to pay off the co-signed debt in your repayment plan, protecting your co-signer.

Chapter 11 is a less common form of consumer bankruptcy; it’s typically for those with debts greater than about $2 million.

How to file for bankruptcy

Your attorney will handle most of the paperwork. Your part is providing complete information on your income, expenses and debts. Here’s a general outline of what to expect:

Chapter 7chapter 13
Gather information: Speak to a lawyer about the best way to file. Bring documentation of your expenses and income, such as pay stubs, mortgage statement and car payment, to have as informed a conversation as possible.

Although attorney fees may be high, the cost of improperly filing can be even higher: Your case may be thrown out. Explore strategies for affording a lawyer or finding pro bono (no-charge) representation.
Begin counseling: Receive pre-bankruptcy credit counseling within 180 days before filing for bankruptcy. You can do this online or by phone with a credit counseling agency approved by the Department of Justice. This shouldn’t cost more than $50.
Collaborate on paperwork: Work with your lawyer to meet deadlines and fill out paperwork accurately and completely. This will include a list of your assets and liabilities, your budget and recent financial history.

For a Chapter 13 bankruptcy, you'll also file a proposed payment plan at this time.
File: To finish filing your petition, you’ll also have to pay a filing fee ($335 for Chapter 7, $310 for Chapter 13) unless you get a fee waiver.

Filing the petition will trigger what’s called an automatic stay, which means that most of your creditors won’t be able to pursue lawsuits, garnish your wages or contact you about your debts.

Note: Debtors in a Chapter 13 case must make their first payment within 30 days of filing.
Attend creditor meeting: At this meeting, a trustee will establish the accuracy of the papers you filed and may ask for further information about assets that might be nonexempt.

In most cases, the trustee will file the report and close the case shortly thereafter. If there are outstanding questions, the meeting may be postponed for you to fill in holes in your paperwork.
Attend creditor meeting. The trustee will verify the value of your assets and that you can make the payments you propose.

If satisfied, the trustee will recommend confirmation of your plan. If there are objections, the parties will try to resolve them.
Complete counseling: You must complete a pre-discharge credit counseling course before your case closes. This usually costs $50-$100; you can find accredited providers on the Department of Justice website.

Rebuilding after bankruptcy

By the time you’ve decided to file for bankruptcy, your financial situation — from your balance sheets to your credit score — is likely in ruins. But things will begin to improve once your debts are discharged or reorganized.

You can begin to focus on rebuilding your finances. Building a budget and applying for a secured credit card are good first steps.

Although a bankruptcy will linger on your credit reports for years, you can minimize its effect by working to rebuild your credit and take control of your finances.

Sean Pyles is a staff writer at NerdWallet, a personal finance website. Email: spyles@nerdwallet.com.

This article was updated July 27, 2016. It was originally published Aug. 2, 2013.

 

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