Is Chapter 7 Bankruptcy the Right Choice for You?

Determine if Chapter 7 bankruptcy is a good option for you.

Before you file for Chapter 7 bankruptcy, you’ll want to decide if it makes financial sense. You can determine if Chapter 7 bankruptcy is right for you by asking yourself the following questions:

  • Are you judgment proof—that is, are creditors legally barred from taking your property or income even if you don't file for Chapter 7 bankruptcy?
  • Will Chapter 7 bankruptcy discharge enough of your debt to make it worth your while?
  • Will you have to give up property you want to keep?

Depending on your answers to these questions, you might find out that Chapter 7 bankruptcy won't help much or, in the alternative, that it is a good choice for you.

(For a discussion of other options, including the possibility of doing nothing, see Alternatives to Bankruptcy.)

Do You Have Wages or Valuable Property?

A creditor will take the time to determine whether you have assets before taking steps to collect from you. If you don’t have an income stream or property other than basic household items and a modest car—and you the situation isn’t likely to change—you’re judgment proof. A creditor will be unable to collect from you, so it’s unlikely that filing for bankruptcy will be necessary.

The same is true if all of your income comes from Social Security (which can't be taken by creditors), and all of your property is exempt (your state’s exemption laws protect certain property from creditors—more on this below).

If you do have valuable assets, you can expect your creditors to take action. You can count on collections for taxes, child support, and student loans occurring quite quickly because the law allows creditors special collection rights. Other unsecured creditors—such as those with credit card balances, medical debt, utility balances, and the like—must first sue you in court and obtain a court judgment before they can start collection procedures, such as a wage garnishment or seizure of personal property.

If a creditor serves you with a lawsuit, you’ll want to speak with a bankruptcy attorney as soon as possible. Filing a bankruptcy case before the creditor receives a judgment will help avoid liens being placed on your property (liens don’t always go away in bankruptcy, thereby giving the creditor a permanent right to your assets). Even if the creditor already has a judgment against you, however, filing for bankruptcy can often provide needed relief.

(Learn more about how creditors can collect from you.)

Will Chapter 7 Bankruptcy Discharge Enough Debt?

Certain categories of debt aren’t dischargeable in Chapter 7 bankruptcy. It doesn't make much sense to file for Chapter 7 bankruptcy if your primary goal is to eliminate these nondischargeable debts. The main nondischargeable debts are:

  • back child support and alimony obligations
  • student loans, unless repayment would cause you undue hardship
  • income taxes less than three years past due
  • recent debts for luxuries, and
  • court judgments for injuries or death to someone arising from your intoxicated driving.

The bankruptcy judge might find that some types of debts are nondischargeable if the creditor objects to a discharge in the bankruptcy court. These debts include:

  • debts incurred by fraud, such as lying on a credit application or writing a bad check
  • debts from willful or malicious injury to another or another's property
  • debts from larceny (theft), breach of trust, or embezzlement, or
  • debts arising out of a marital settlement agreement or divorce decree that aren't otherwise automatically nondischargeable as support or alimony.

If the bulk of your indebtedness is from debts that creditors might object to being discharged, you won’t want to move forward with your case without speaking with a knowledgeable bankruptcy attorney. Being accused of any type of fraud in bankruptcy can come with serious consequences.

To learn more about these debts, see Nondischargeable Debts in Chapter 7 Bankruptcy.

How Much Property Will You Have to Give Up?

Whether or not you decide to file for Chapter 7 bankruptcy might depend on what property of yours will be taken to pay your creditors ("nonexempt" property) and what property you get to keep ("exempt" property).

Certain kinds of property are exempt in almost every state, while others are almost never exempt. The following are items you can typically keep (exempt property):

  • motor vehicles, up to a certain value
  • reasonably necessary clothing (no mink coats)
  • reasonably needed household furnishings and goods (the second TV might have to go)
  • household appliances
  • jewelry, up to a certain value
  • personal effects
  • life insurance (cash or loan value, or the proceeds of life insurance), up to a certain value
  • pensions
  • part of the equity in your home
  • tools of your trade or profession, up to a certain value
  • a portion of unpaid but earned wages, and
  • public benefits (welfare, Social Security, unemployment compensation) accumulated in a bank account.

Items you must typically give up (nonexempt property) include:

  • expensive musical instruments (unless you're a professional musician)
  • stamp, coin, and other collections
  • family heirlooms
  • cash, bank accounts, stocks, bonds, and other investments
  • a second car or truck, and
  • a second or vacation home.

Learn more about bankruptcy exemptions, such as which state and federal exemptions you can use, as well as the exemption amounts in each state.

What Is a Chapter 7 Asset Case?

If money is available to pay debt, the bankruptcy court will instruct creditors to submit documentation (an official proof of claim form) that verifies the amount owed by the filer.

Is the case an asset case? When you file a Chapter 7 case, you must disclose all of the property you own on forms called schedules. You must also identify the things that you can keep (exempt) under your state’s exemption laws. If you can exempt all of your property, nothing will be available for creditors, and the court will label your case a “no asset case.” By contrast, your case will be an asset case if you own more property than you can protect in bankruptcy.

What happens to property in an asset case? You’ll keep your exempt property. The bankruptcy trustee—the official tasked with managing your case—will sell the remaining property, called “nonexempt property,” for the benefit of your creditors. After the deadline to submit a proof of claim form passes, the trustee will distribute the funds according to a priority ranking system. Debts that rank higher in priority get paid in full before lower priority debts. For instance, domestic support obligations and taxes rank higher than credit card balances and student loans.

Filing an asset case can make sense. It’s unusual for an individual to have an asset case because most cash-strapped people sell valuable items to pay for living expenses. By the time they’re ready for bankruptcy, there’s nothing left. A filer might choose to file an asset case if the dischargeable debt (the amount that will go away) is significantly greater than the value of the nonexempt property. The scales might tip even further if the debtor faces a wage garnishment or lawsuit, or if the debtor owes a priority debt that won’t get discharged in bankruptcy. In the latter case, the sales proceeds will get applied to the debt, thereby taking some of the sting out of losing the nonexempt property.

Example. Jon owes $60,000 in credit card debt and $40,000 in unpaid taxes. He also owns a sailboat worth $15,000. Even though he will lose the boat, he decides to file for Chapter 7 bankruptcy. He knows that because his taxes are his highest priority debt, all of the money from the boat sale will go toward paying down his nondischargeable tax debt, while all of the credit card debt will get wiped out. Therefore, even though Jon stands to lose property, he’ll be in a better financial position afterward because instead of being in the red by $85,000 ($100,000 debt - $15,000 boat value = $85,000), he’ll reduce his total debt down to a $25,000 in nondischargeable tax debt.

Cosigners in Chapter 7 Bankruptcy

If someone is also responsible for one of your debts—for instance, a relative cosigned on a car loan or your business partner is equally liable for a debt—that person will still be on the hook if you file for Chapter 7 bankruptcy. The bankruptcy case wipes out the obligation of the filing debtor only. So if the debt is of a type that you can discharge in Chapter 7 bankruptcy, you will no longer be legally responsible for paying it, but the other person obligated to pay the debt will. (Learn more about cosigned debt in Chapter 7 bankruptcy.)

For clear-cut answers, information and strategies you need to figure out whether bankruptcy is the right solution for you, get The New Bankruptcy: Will It Work for You?, by Attorney Cara O’Neill.

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