What Is Bankruptcy?

What you need to know about Chapter 7 and Chapter 13 bankruptcy.

Bankruptcy is a process that allows consumers and businesses to get out from under debt with the protection of the federal bankruptcy court. For the most part, bankruptcies fall into one of two types—liquidation and reorganization.

  • Chapter 7 bankruptcy. In Chapter 7 bankruptcy, the trustee might take and liquidate (sell) some of your property to pay back debt. However, you can keep (exempt) particular property protected under state law.
  • Chapter 13 bankruptcy. By contrast, Chapter 13 bankruptcy reorganizes debt for high-income earning individuals. Although you can keep all of your property, you’ll have to pay the value of any assets that aren’t protected by your state’s exemption laws. You’ll also fund a three- to five-year Chapter 13 bankruptcy payment plan with your discretionary income—the amount remaining after subtracting reasonable monthly expenses.

In this article, you’ll learn more about the types of debts that get discharged (forgiven) in bankruptcy, who will qualify for a discharge, and the property you’ll be able to exempt.

Chapter 7 Bankruptcy

Both individuals (consumers) and businesses can file for Chapter 7 bankruptcy. A Chapter 7 bankruptcy typically lasts four to six months.

Eligibility. Not everyone can file and receive a discharge under this chapter. For example, if most of your debts are consumer debts (as opposed to business bankruptcy debt), and your disposable income is sufficient to fund a Chapter 13 repayment plan after subtracting certain allowed expenses, you won't be allowed to use Chapter 7 bankruptcy. You’re also limited to a discharge every eight years. For more on this and other requirements, see Chapter 7 Bankruptcy -- Who Can File?

Property. You’ll be able to exempt the essential property needed to work and maintain a home such as clothes, some equity in a car, and household furnishings. Many debtors who file for Chapter 7 bankruptcy find that all of their property is exempt under applicable state exemption laws (and sometimes federal exemption laws). To learn more, see Bankruptcy Exemptions in Chapter 7.

Secured debt. If you owe money on a secured debt, such as a mortgage or car loan, you’ll have a choice of allowing the creditor to repossess the property (and discharge the debt) or, if you’re current on your payments, keeping the property and continuing to make your payments under the contract.

Nondischargeable consumer debt. Bankruptcy works well to eliminate many debts owed by individuals, such as credit card balances, medical bills, and personal loans. However, some debt, including domestic support obligations and current income tax bills, can’t be wiped out in bankruptcy. For more information, see What Bankruptcy Can and Cannot Do.

Nondischargeable business debt. Bankruptcy doesn’t wipe out debt owed by a business. It’s rare for a company (other than a sole proprietorship) to file for Chapter 7 bankruptcy because in most cases, more efficient ways to wind down the business exist. This chapter works well when the owners want the bankruptcy trustee to sell and distribute assets to creditors in a transparent manner. However, there are several ways owners can find themselves personally liable for the business debt. Contact an attorney if you’re considering filing a business bankruptcy.

Get step-by-step instructions on filing Chapter 7 bankruptcy in How to File for Chapter 7 Bankruptcy by Attorney Cara O'Neill and Albin Renauer.

Chapter 13 Bankruptcy

In Chapter 13 bankruptcy, or "wage earner" bankruptcy, you must have a reliable source of income to repay some portion of your debt.

Repayment. You’ll propose a repayment plan that details how you are going to pay back your debts over three to five years. The minimum amount you'll have to repay depends on how much you earn, how much you owe, and the value of your nonexempt property. See The Chapter 13 Repayment Plan for in-depth information.

Debt limits. You cannot have more than $1,1484,200 in secured debt and $394,725 in unsecured debt (as of April 2016).

Mortgage and car payment arrearages. Many people use the Chapter 13 bankruptcy repayment plan to catch up on past due house and car payments and avoid repossession or foreclosure. For more information, go to Your Home and Mortgage in Chapter 13 Bankruptcy and Reducing Loans and Non-Residential Mortgages in Chapter 13 Bankruptcy.

For more information on Chapter 13 bankruptcy, see Chapter 13 Bankruptcy: Repay Your Debts, by Stephen Elias.

Other Types of Reorganization Bankruptcy

In addition to Chapter 13 bankruptcy, there are two other types of reorganization bankruptcy: Chapter 11 and Chapter 12.

Chapter 11 bankruptcy. Chapter 11 bankruptcy is typically used by financially struggling businesses to reorganize their affairs. It is also available to individuals whose debt exceeds the Chapter 13 thresholds. If you are considering Chapter 11 bankruptcy, you'll need to talk to a lawyer.

Chapter 12 bankruptcy. Chapter 12 is similar to Chapter 13 bankruptcy. But to be eligible for Chapter 12 bankruptcy, at least 80% of your debts must arise from the operation of a family farm or fishery. If you’re interested in this bankruptcy type, you should consult with a lawyer.

More Information

For clear-cut answers, information, and strategies, see The New Bankruptcy: Will It Work for You? by Stephen Elias (Nolo).

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