If you’re facing serious debt problems, filing for bankruptcy can be a powerful remedy. It stops most collection actions, including telephone calls, wage garnishments, and lawsuits (with some exceptions). It also eliminates many types of debt, including credit card balances, medical bills, personal loans, and more.
But it doesn't stop all creditors, and it doesn’t wipe out all obligations. For instance, you’ll still have to pay your student loans (unless you can prove a hardship) and arrearages for child support, alimony, and most tax debts. Read on to learn more about the things that bankruptcy can and cannot do.
Bankruptcy allows people struggling with debt to wipe out certain obligations and get a fresh start. The two primary bankruptcy types filed—Chapter 7 and Chapter 13 bankruptcy—each offer different benefits, and, in some cases, treat debt and property differently, too. You’ll choose the chapter that’s right for you depending on your income, property, and goals.
Here are some of the things you can expect bankruptcy to do.
Once you file, the court puts in place an order called the automatic stay. The stay stops most creditor calls, wage garnishments, and lawsuits, but not all. For instance, creditors can still collect support payments and criminal cases will continue to proceed forward.
The automatic stay will stop all of these actions as long as they’re still pending.
Bankruptcy is very good at wiping out unsecured credit card debt (the debt is unsecured if you didn’t promise to give back the purchased property if you didn’t pay the bill), medical bills, overdue utility payments, personal loans, gym contracts. (If you have a secured credit card, such as from a jewelry, furniture, or electronics store, you’ll have to give the purchased item back.) In fact, filing for bankruptcy can wipe out most nonpriority unsecured debts other than school loans.
How quickly your debt will get wiped out will depend on the chapter you file:
If you can’t afford a payment that you secured with collateral—such as a mortgage or car payment—you can wipe out the debt in bankruptcy. But you won’t be able to keep the house, car, computer, or other item securing payment of the loan (more below under “What Bankruptcy Can’t Do”).
Chapter 7 and 13 each offer unique solutions to debt problems. Chapter 7 is primarily for low-income filers, and therefore, it won’t help you keep property if you’re behind on payments. But, if you have income to pay at least something to creditors, then you’ll be able to take advantage of the additional benefits offered by Chapter 13.
Here are some of the things that Chapter 13 can do.
Stop a mortgage foreclosure. Filing for Chapter 13 bankruptcy will stop a foreclosure and force the lender to accept a plan that will allow you to make up the missed payments over time (you’ll also have to stay current on your regular monthly payments). To make this plan work, you must be able to demonstrate that you have enough income to support such a repayment plan. (For more information, see Your Home and Mortgage in Chapter 13 Bankruptcy.)
Allow you to keep property that isn’t protected with a bankruptcy exemption. No one gives up everything that they own in bankruptcy. You’re allowed to protect (exempt) items you’ll need to work and live using bankruptcy exemptions. A Chapter 7 debtor gives up nonexempt property, but not a Chapter 13 filer. This doesn’t mean that you get to keep more assets, however. You’ll need to pay the value of any nonexempt property to your creditors in your repayment plan.
"Cram down" secured debts when the debt balance is more than the value of the property that secures them. Chapter 13 has a procedure that allows you to reduce a debt to the replacement value of the property securing it (but you’ll have to pay off the debt in full through your plan). For example, if you owe $10,000 on a car loan and the car is worth only $6,000, you can propose a plan that pays the creditor $6,000 and discharge the rest of the loan. However, exceptions exist. For instance, you can't cram down a car debt if you purchased the car during the 30-month period before you filed for bankruptcy. Also you won’t be able to use the cramdown provision on the mortgage of your residential home. (To learn more about cramdowns, check out Reducing Mortgages and Loans in Chapter 13 (Cramdowns).)
For more information on Chapter 13 bankruptcy, including other benefits, see Chapter 13 Bankruptcy: Keep Your Property & Repay Debts Over Time, by Attorney Cara O’Neill.
Bankruptcy doesn’t cure all debt problems. Here's what it can’t do for you.
Prevent a secured creditor from foreclosing or repossessing property you can’t afford. A bankruptcy discharge eliminates debts, but it doesn’t eliminate liens. A lien allows the lender to take property, sell it at auction, and apply the proceeds to a loan balance. The lien stays on the property until the debt gets paid. If you have a secured debt (a debt where the creditor has a lien on your property), bankruptcy can eliminate your obligation to pay the debt, but it won’t take the lien off the property—the creditor will still be able to recover the collateral. For example, if you file for Chapter 7 bankruptcy, you can wipe out a home mortgage; however, the lender’s lien will remain on the home. As long as the mortgage remains unpaid, the lender can foreclose on the home (once the automatic stay lifts, of course).
Eliminate child support and alimony obligations. Child support and alimony obligations survive bankruptcy, so you’ll continue to owe these debts in full, just as if you had never filed for bankruptcy. And if you use Chapter 13, you’ll have to pay these debts in full through your plan.
Eliminate student loans, except in very limited circumstances. Student loans can be discharged in bankruptcy only if you can show that repaying the loan would cause you "undue hardship," which is a very tough standard to meet. You must prove that you can’t afford to pay your loans currently and that there’s very little likelihood you can do so in the future. (For details on the undue hardship standard, see Student Loan Debt in Bankruptcy.)
Eliminate most tax debts. Eliminating tax debt in bankruptcy isn’t easy, but it’s sometimes possible for older unpaid tax debts. (Find out the requirements in Eliminating Tax Debts in Bankruptcy.)
Eliminate other nondischargeable debts. The following debts aren’t dischargeable under either chapter:
If you file for Chapter 7, these debts will remain when your case is over. In Chapter 13, you’ll pay these debts in full through your repayment plan.
Debt related to fraud might, or might not get eliminated. A fraud-related debt won’t be discharged if a creditor files a lawsuit (called an adversary proceeding) and convinces the judge that the debt should survive your bankruptcy. Such debts might be the result of lying on a credit application or passing off borrowed property as your own to use as collateral for a loan. (Learn more in What Is Bankruptcy Fraud?)
This article is intended to provide an overview of the bankruptcy process only. Filing for bankruptcy is complicated and the information provided here is not exhaustive. You can learn more about what bankruptcy can do for you by speaking with a local bankruptcy lawyer, or, for a more in-depth explanation of both Chapter 7 and Chapter 13 bankruptcy, see The New Bankruptcy by Attorney Cara O’Neill.