Overview of Chapter 7 Bankruptcy: What Can Chapter 7 Bankruptcy Do For Me?

Chapter 7 bankruptcy:

• eliminates most unsecured debts (e.g. credit card, pay day loans, medical bills, etc),

• stops lawsuits,

• stops wage garnishments,

• stops collection activity (the 20 phone calls per day), and

• gives you a true, financial fresh start.

Freedom from debt is not to be feared. Embrace the opportunity the law allows to stop suffering under the burden of debt.  Bankruptcy is not for deadbeats; most bankruptcy debtors suffered a financial loss of some kind including, divorce, illness, failed business, job loss, decreased income, severe injury, or other unforeseen financial hardship.

Chapter 7 bankruptcy should not be feared. It exists to help people who are struggling financially. Chapter 7 bankruptcy is your release from financial stress. Too many people and almost every bankruptcy attorney fail to recognize the psychological benefits of bankruptcy. When we are under stress, whether we are aware of the stress, we are unable to focus. Right now, things are probably not working out for you; right now it seems as if everything is against you. That feeling is the result of financial stress. The stress and distraction of your financial challenges is preventing you from achieving your potential. Once you relieve that burden, you will be amazed at the freedom and opportunity that arise. All of sudden things seem to start working out for you, your head clears, ideas and opportunities arise, and life improves.

Thus, chapter 7 bankruptcy is a fresh start in both a financial and often times psychological sense.

What Debts are, and are not, eliminated in chapter 7 bankruptcy?

Most unsecured debts are eliminated in chapter 7 bankruptcy. Credit cards, medical bills, lines of credit, pay day loans, over draft protection, and personal loans are dischargeable debt. There are 18 classes of debt that cannot be eliminated in bankruptcy, but for the average individual, the two most commonly encountered are student loans and recent income tax debt. Student loans are not eliminated in bankruptcy unless the debtor (you) can prove that paying your student loans would create an undue financial hardship. Recent income tax debts that arose in the prior 3 years before filing bankruptcy cannot be eliminated in bankruptcy, but income tax debts older than 3 years may be eliminated in bankruptcy under certain circumstances. Note, some debts that cannot be discharged in chapter 7 bankruptcy can be discharged in a chapter 13 bankruptcy.

In addition, your personal responsibility on secured loans is eliminated in chapter 7 bankruptcy. What does that mean? When you take out a loan to buy a car or a house, you take out a secured loan. A secured loan creates two responsibilities for the debt. The first type is the security interest; the security interest allows the lender to repossess/foreclose if you stop making payments. The second type is your personal guarantee to pay the loan; in the event the pledged property is worth less than is owed on the loan, the lender can pursue you for the difference (otherwise known as the deficiency balance). A chapter 7 bankruptcy eliminates your personal guarantee.  However, the security interest in unaffected by the bankruptcy.

Will I lose my car?

It is quite rare for someone to lose a car (or any asset for that matter) in bankruptcy. For the people I work with, the only individuals that lose their necessary vehicle are those that want to lose it (e.g. payment too high, car not in good condition, etc). So long as you are current on payments, the lender will not repossess your car as a result of bankruptcy. So long as any equity in your car is within your states bankruptcy exemption, you will not lose your car to the bankruptcy. For example, in Colorado, the vehicle exemption is $5,000; if your car is worth $12,000 and you owe $8,000, the bankruptcy court cannot force you to sell your car to get at the $4,000 of equity because that equity amount falls within the $5,000 Colorado vehicle exemption. Even if the equity in your vehicle exceeds your states bankruptcy exemption amount, there are 3 alternative strategies for keeping your car.

Will I lose my house?

As with cars, the same general rule applies to your home. If you are current on payments, the bank will not foreclose. If the equity in your home does not exceed your state’s exemptions, you will keep your home. However, if you cannot afford to keep your home, chapter 7 bankruptcy will eliminate your responsibility for any deficiency balance that may become due after the bank sells your home.

How do I qualify for chapter 7 bankruptcy?

To determine if you qualify for chapter 7 bankruptcy and whether chapter 7 bankruptcy is in your best interests, you should consult and hire a competent attorney to represent you. However, a person’s eligibility to file chapter 7 bankruptcy is dictated by the Means Test as outlined in bankruptcy code section 707.

The Means Test is made up of 3 Tests

Test 1: The Over/Under (note, this is how I refer to it, over/under is not official terminology).
The Over/Under simply asks whether in the previous 6 months before filing your chapter 7 bankruptcy is your combined household income (excluding any income from the Social Security Administration) above your state’s annual median income for your household size.  If you are under, you presumably qualify for chapter 7 bankruptcy and you do NOT go on to Test 2, if you are over, you go on to Test 2

Test 2: Disposable Monthly Income Test.
If you are over median on Test 1, then the Means Test has you calculate what, if any, disposable income you might have after deducting the IRS allowed expenses, secured debt payments, and certain other expenses from your income. If you have disposable income (money left over after all deductions), then you are presumably a chapter 13 bankruptcy as Test 2 is showing you have some money to pay back something to your creditors.

Passing Test 2 is an art form. Unfortunately, very few attorneys take the time to massage a case to see if a person can pass the Disposable Income Test.

Test 3: Not Enough Disposable Income to Matter.
If you have disposable monthly income according to Test 2, then you move to Test 3. Test 3 rarely applies; but basically, if your monthly disposable income multiplied by 60 is less than $6,575, then you are presumably a chapter 7 bankruptcy, If your disposable monthly income multiplied by 60 is between $6,575 and $10,950 and that amount will not pay at least 25% of your non-priority unsecured debt, then you presumably qualify for chapter 7 bankruptcy. In essence, within those narrow guidelines, the bankruptcy code is saying that there is not enough left over at the end of the month to matter.

Exceptions to the Means Test

There are certain exceptions to even bothering with the means test; the exceptions are limited, but very useful and even many bankruptcy attorneys do not know how to properly employ these exceptions.  If you qualify for one of these exceptions, you don’t even complete the means test and you can even have disposable income or very high income and still qualify for chapter 7 bankruptcy.

How does bankruptcy affect my credit?

Make no mistake, a bankruptcy has a negative impact on your credit, but it is NOT a 10 year death sentence to your credit. Most people will find their credit will recover within 2 years of filing bankruptcy. In fact, many people report getting credit card offers within 3-6 months of receiving their bankruptcy discharge. Bankruptcy does not affect the “availability” of credit, but in the short term, bankruptcy will affect your “cost” of credit. If you accept a credit card within that 2 year post bankruptcy period, you will pay a higher interest rate.

The dirty secret is this; any option for resolving your financial challenges, be it bankruptcy, debt settlement, or consumer credit counseling, that is not paying your creditors under the terms of the original lending agreement affects your credit negatively. Don’t be that person that sacrifices their financial future by using savings, liquidating retirement accounts, and so forth in a vain effort to “stay afloat.” Your credit will recover over time after bankruptcy.