If you're experiencing severe debt problems, filing for bankruptcy can be a powerful remedy, and knowing what bankruptcy can and cannot do will help you decide if it will work for you. One of the most impressive aspects is that bankruptcy stops most lawsuits, wage garnishments, and other collection activities and eliminates many debt types, including credit card balances, medical bills, personal loans, and more.
But it doesn't stop all creditors or eliminate all obligations. You'll still pay student loans (unless you can prove hardship), arrearages for child support and alimony, and recent tax debts. In this article, you'll learn what to expect from bankruptcy and how bankruptcy works, including what Chapter 7 and Chapter 13 bankruptcy can do, what happens only in Chapter 13 bankruptcy, and what you can't do in bankruptcy whatsoever.
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 unique benefits and solutions to debt problems. The two bankruptcy types work very differently, and the right chapter for you will depend on your income, property, and goals.
Chapter 7 bankruptcy. This chapter takes an average of three to four months to complete. Chapter 7 is primarily for low-income filers, and because it's quick, it doesn't offer a payment plan to help you keep property if you're behind on payments. Learn more about erasing your debt in Chapter 7 bankruptcy and who can't file bankruptcy in Chapter 7.
Chapter 13 bankruptcy. If you have enough income to pay at least something to creditors, you can take advantage of the benefits offered by Chapter 13, primarily the repayment plan. You'll repay some debts through the Chapter 13 plan, but can also use it to catch up on late mortgage, car loan, and other secured payments and keep the property. Find out how to pay off or discharge your debts in Chapter 13 bankruptcy.
Here's what you can expect in Chapters 7 and 13.
Once you file, the court issues 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.
The automatic stay will stop these actions as long as they remain pending. Once complete, bankruptcy won't help.
Bankruptcy is very good at erasing most nonpriority unsecured debts other than school loans. The debt is unsecured if you didn't promise to return the purchased property if you failed to pay the bill. For instance, you can erase or "discharge" unsecured credit card debt, medical bills, overdue utility payments, personal loans, and gym contracts. If you purchased property, you don't need to return it.
By contrast, you must return the purchased item if you have a secured credit card. Jewelry, electronics, computers, furniture, and large appliances are often secured debts. Read the receipt or credit contract to determine if you agreed the purchased item would be collateral to guarantee the debt.
Other debts people often agree to secure with collateral include mortgages and car loans. Filers can wipe out mortgages, auto loans, and other secured debts in bankruptcy. Still, you must return the collateral unless you make arrangements to pay what you owe.
When you voluntarily agree to secure debt with property, you give the lender a "lien" on the purchased property. A voluntary lien lets the lender recover the property if you don't pay, even if you file for bankruptcy. You'll learn more about this in "What Bankruptcy Can't Do" below.
Chapter 13 offers more benefits than Chapter 7. Here are some things only 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 allowing you to make up the missed payments over time. To make this plan work, you must demonstrate that you have enough income to pay overdue amounts and remain current on future payments. Learn more about your home and mortgage in Chapter 13 bankruptcy.
Allow you to keep property not protected by a bankruptcy exemption. No one gives up everything they own in bankruptcy. You can save (exempt) items you'll need to work and live using bankruptcy exemptions. A Chapter 7 debtor gives up nonexempt property—the trustee liquidates unprotected property for creditors—but not a Chapter 13 filer. While it might seem like you'd get to keep more assets, it's not true. Chapter 13 filers pay the value of nonexempt property to creditors through the repayment plan.
"Cramdown" secured debt when property is worth less than the amount owed. Chapter 13 has a procedure that allows you to reduce an obligation to the replacement value of the property securing it. 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 months before bankruptcy. Also, filers can't use the cramdown provision to reduce a residential home mortgage. Learn more about lowering loans using a "cramdown" in Chapter 13.
Use "lien stripping" to eliminate a junior residential home loan. This benefit isn't available unless your home is worth significantly less than the total amount you owe. Learn more about lien stripping in Chapter 13 bankruptcy.
Bankruptcy doesn't cure all debt problems. Here's what it can't do for you.
Bankruptcy doesn't 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. However, it won't take the lien off the property—the creditor can still recover the collateral. For example, if you file for Chapter 7, you can wipe out a home mortgage. But the lender's lien will remain on the home. If the mortgage remains unpaid, the lender can exercise its lien rights to foreclose on the house once the automatic stay lifts. Learn about judgment liens and other liens in bankruptcy.
Bankruptcy doesn't eliminate child support and alimony obligations. Child support and alimony obligations survive bankruptcy, so you'll continue to owe these debts in full 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. Learn about nondischargeable obligations.
Bankruptcy doesn't eliminate student loans except in limited circumstances. Student loans can be discharged in bankruptcy only if you 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. Find out more about the undue hardship standard and student loan debt in bankruptcy.
Bankruptcy doesn't eliminate most tax debts. Eliminating tax debt in bankruptcy isn't easy, but it's sometimes possible for older unpaid tax debts. Learn what's needed to eliminate tax debts in bankruptcy.
Bankruptcy doesn't 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 be eliminated. Bankruptcy won't discharge a fraud-related debt if a creditor files a lawsuit called an adversary proceeding and convinces the judge that the obligation should survive your bankruptcy. Such debts might result from lying on a credit application or passing off borrowed property as your own to use as collateral for a loan. Find out more about bankruptcy fraud.
Did you know Nolo has made the law accessible for over fifty years? It's true, and we want to ensure you find what you need. Below, you'll find more articles explaining how bankruptcy works. And don't forget that our bankruptcy homepage is the best place to start if you have other questions!
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We wholeheartedly encourage research and learning, but online articles can't address all bankruptcy issues or the facts of your case. The best way to protect your assets in bankruptcy is by hiring a local bankruptcy lawyer.