What Is Chapter 7 Bankruptcy?

Chapter 7 bankruptcy is a “second chance” to regain control of your finances by having most of your unsecured debt, including credit card debt, medical bills, and personal loans, legally discharged by a bankruptcy court.

In virtually all cases, however, it does not discharge student loans, tax debt, alimony, or child support.

Chapter 7 is known as “liquidation bankruptcy.” It is the quickest, simplest, and most common type of bankruptcy. While nationwide bankruptcy filings in 2023 were up 16.8%, the ratio of Chapter 7 filings among all bankruptcies held steady at 60%, according to the United States Courts.

Ed Flynn from the American Bankruptcy Institute said that in a sample of over 30,000 Chapter 7 cases closed in 2023, the debt forgiveness rate for attorney-represented filers was 96.8%. In other words, if you qualify to file Chapter 7 – and hire an attorney – you probably will succeed.

It is worth noting that self-represented filers were successful only 62.5% of the time.

Some of the difference can be explained by this first hurdle: Not all Chapter 7 applicants qualify for bankruptcy; the court applies a “means test” to each Chapter 7 filing. The bankruptcy means test examines financial records, including income, expenses, and secured and unsecured debt to determine if your disposable income is below the median income (50% lower, 50% higher) for your state. The means test income level varies by state.

Applicants sometimes are required to sell any nonexempt assets, but data suggests that happens only on rare occasions. Flynn said he reviewed filings from the administrative office of the U.S. Courts and asset cases closed from the U.S. Trustees and 93% were “no asset cases,” meaning there is not enough equity or value in the property for a trustee to sell it and pay off creditors.

In other words, your not likely to lose things you own just because you have to file Chapter 7 bankruptcy.

This has to be on anyone’s list of upside considerations: Generally, the Chapter 7 process takes time, but can be completed in 4-6 months.

How Does Chapter 7 Bankruptcy Work?

Successful applicants for Chapter 7 bankruptcy are able to wipe out a host of unsecured debts, while others, by law, stick like flypaper. Still others fall into gray areas that are decided on a case-by-case basis.

Dischargeable debts under Chapter 7 include:

• Credit card balances (including overdue and late fees)
• Collection agency accounts
• Medical bills
• Personal and payday loans (unsecured)
• Mortgage or automobile loans for which you are unable to pay (but creditors can reclaim the house or vehicle)
• HOA fees (if you surrender the home or condo)
• Utility bills
• Civil court judgments (not based on fraud)
• Social Security overpayments
• Veterans’ assistance loans and overpayments

Non-dischargeable debts under Chapter 7 include:

• Child support
• Alimony
• Student loans
• HOA fees (if you keep the home or condo)
• Personal injury debts owed resulting from an event while you were intoxicated
• Unsecured debts intentionally unaccounted for in your filing
• Tax liens**
• Secured debts

*Must prove undue hardship for student loans to be discharged.
**Income tax debt that is at least 240 days old and meets other restrictions.

Getting the Chapter 7 ball rolling involves the filing of a variety of documents and shelling out for an assortment of fees – except in cases of extreme hardship in which filers can qualify for low cost bankruptcy.

Here’s the short course for hardy do-it-yourselfers:

1. Begin by filling out a lengthy series of forms that detail records of assets, liabilities, income, expenses, and overall financial standing, as well as any existing contracts or leases in the debtor’s name.
2. Pre-bankruptcy credit counseling ($20-$100) is the next required step for debtors filing under Chapter 7. These courses typically are offered by nonprofit credit counseling agencies, who look at your financial situation to determine if there are other avenues (debt management, debt consolidation, debt settlement, nonprofit debt settlement) that could resolve the issue without having to file bankruptcy.
3. If it’s determined bankruptcy is your best solution, you must take the forms you filled out in Step 1 and file a petition for bankruptcy at the local bankruptcy court.
4. From there, it’s time to reach into your wallet (what’s left of it) and start paying for the process. Yes, bankruptcy involves costs of its own. There’s a fee for petition filing ($335), court fees (vary by state) and, unless you’re still self-represented, attorney fees (averaging $1,250, and paid up front, according to the National Bankruptcy Forum).
5. Bankruptcy generates a small mountain of paperwork, which becomes public record. Bankruptcy court participants often are listed in newspapers and online, so there’s a potential loss of financial control and privacy.

Chapter 7 Property Exemptions

We mentioned above that Chapter 7 often is referred to as “liquidation bankruptcy,” which suggests everything the debtor owns is available for one big yard sale to help satisfy creditors.

Only rarely, however, does the extreme liquidation scenario meet reality.

The process can be punishing, but the impetus behind bankruptcy law is getting consumers out of crushing debt and providing a fresh start. Taking everything from Chapter 7 applicants would do nothing to get them back on their feet, ready to become financially successful contributors to their communities.

With this in mind, bankruptcy law exempts property that qualifies as “necessities of modern life” — that is, possessions necessary for living and working.

“Everyone requires stuff to keep a job and a house,” says Auburn, Calif.-based attorney and consumer finance consultant Lyle Solomon, “and bankruptcy's fresh start would be meaningless if it deprived you of everything you own.

“That does not mean that you must keep all you own. Instead, bankruptcy exemption laws safeguard property that people require, such as a working car, furniture, and clothing. It's ‘nonexempt’ if a bankruptcy exemption doesn't cover your property.”

Property exemptions include:

• Motor vehicles (to a certain value).
• Reasonably necessary clothing.
• Reasonably necessary household goods and furnishings.
• Household appliances.
• Jewelry (to a certain value).
• Pensions.
• A portion of equity in the debtor's home.
• Tools of the debtor's trade or profession (to a certain value).
• A portion of earned, but unpaid, wages.
• Public benefits, including public assistance (welfare), Social Security, and unemployment compensation, accumulated in a bank account.
• Damages awarded for personal injury.

Who Is Eligible for Chapter 7 Bankruptcy?

Even if you are in dire financial straits, Chapter 7 may not be for you. Applicants must clear assorted hurdles before a bankruptcy court approves the filing. Among them:

• As mentioned above, applicants must complete a debt counseling course with an approved credit counseling agency no more than 180 days before filing.
• You cannot have filed a Chapter 7 bankruptcy within the previous eight years.
• You cannot have filed a Chapter 13 bankruptcy within the previous six years.
• Filers for Chapter 7 or Chapter 13 bankruptcy whose cases were dismissed must wait at least 181 days before another attempt.
• Also as mentioned above, filers must undergo a test of financial scrutiny. Either your average monthly income for the previous six months must be less than the median income for a household of the same size in your state; or you must pass a means test to determine whether you have sufficient disposable income to make partial payments to unsecured creditors.
• Filers who fail the means test may still be able to file a Chapter 13 (personal reorganization) bankruptcy.
• Even if you are able to file, but the court determines you’re attempting to defraud your creditors, the court may dismiss your case.

When to File Chapter 7 Bankruptcy?

Filing for bankruptcy may well be the right choice. But the successful discharging of your debts will weigh heavily on your financial future for several years. Don’t be hasty. Make certain you have scrutinized the five warning signs before you make your final choice.

“It is a common misconception that individuals and couples should file Chapter 7 bankruptcy at the first sign of trouble,” says Sumeet Sinha, founder, and CEO of FinPins.com, a personal finance blog and educational resource. “You may consider Chapter 7 if creditors are harassing you, garnishing your wages and bank accounts and you have no way to pay off the debts. You may consider Chapter 7 as a last resort after your best efforts to pay your debts fail.”

Five strong signs that indicate filing for Chapter 7 may be the correct remedy include:

1. Your unsecured debts total more than half your annual income.
2. It would take five years (or more) to pay off your debt, even if you took extreme measures.
3. Your debt creates stress in essential aspects of your life, such as relationships, ability to focus on work, and your ability to sleep.
4. Despite your best efforts to follow a budget, you have little to no disposable income.
5. Your monthly income is below the median level in your state.

» Learn More: Filing Bankruptcy for Credit Card Debt

What Are the Steps to Filing Chapter 7 Bankruptcy?

We have discussed the do-it-your yourself steps. Nonetheless, the success of your Chapter 7 bankruptcy most likely will lie in finding an experienced bankruptcy attorney. Once you decide on an attorney, you can refer creditors to your lawyer’s office. Filing the petition will trigger an “automatic stay,’’ which means creditors can’t pursue lawsuits, garnish your wages or contact you about your debts.

Don’t take our word for it. “I would counsel someone who is considering Chapter 7 bankruptcy to consult with an attorney to discuss the ramifications of filing for bankruptcy,” Sinha says. “Bankruptcy can have a long-term impact on a person's credit score and ability to obtain credit in the future.”

 Here is a potential timetable:

1. The process begins with the debtor filling out a series of forms detailing records of assets, liabilities, income, expenses, and overall financial standing, plus any existing contracts or leases in the debtor’s name.
2. Pre-bankruptcy credit counseling Typically conducted by nonprofit credit counseling agencies, certified counselors examine the debtor’s financial situation to determine if there are other, less radical, solutions, such as debt management, debt consolidation, or debt settlement.
3. If bankruptcy emerges as the best fix, you, or your attorney, must take the forms you filled out in Step 1 and file a petition for bankruptcy at the local bankruptcy court.
4. Fees to formalize the filing are described above.
5. Once your case is filed, the court appoints a trustee to verify the documents you submitted. The trustee will want to see copies of bank statements, paycheck stubs, tax returns, etc., to check the accuracy of your documents.
6. Next up: a meeting with the trustee and creditors, if any creditors decide to pursue the debts you are trying to discharge. The trustee (and possibly the creditors) may have questions about some of your documents; you are required to respond. The trustee has 30 days to object to property the debtor wants to retain. Other creditors have 90 days from the meeting to file suit alleging their debt should not be eliminated in the bankruptcy. It’s possible the trustee will say the Chapter 7 case should have been filed as a Chapter 13.
7. The next step is to make sure if you made promises about secured debt – usually a home or automobile, but sometimes a personal loan – you fulfilled those promises.
8. Then comes a second counseling session called “debtor education,” lessons on handling debt and other personal finances presented, again, by nonprofit credit counseling agencies. The goal of debtor education is to help you make a success of your fresh start. Unless you’re a high-stakes real estate developer, one bankruptcy is enough for a lifetime.
9. If all goes well – and, as noted earlier, in the vast majority of attorney-represented cases it does – the judge will discharge your qualified debts, eliminating your legal obligation to repay your creditors.

Once completed, your financial situation will seem like a mess because it is, at least temporarily. Without debts, though, you can start on the road back. Setting up a budget and applying for a secured credit card are some preliminary steps.

Chapter 7 Bankruptcy Discharge

The successful conclusion of a Chapter 7 bankruptcy involves a discharge, what the Administrative Office of the U.S. Courts describes as a “release [for] individual debtors from personal liability for most debts and prevents the creditors owed those debts from taking any collection actions against the debtor.”

Remember, however, the limits of the sorts of debts that can be discharged in a Chapter 7 bankruptcy. Filers who have retained an attorney to see them through the process will have an opportunity to review what, if any, obligations remain after a successful discharge.

As noted earlier, all but a tiny percentage of attorney-supported Chapter 7 filings are discharged. However, the court takes an aggressively dim view of Chapter 7 applicants who are found to be pulling a fast one.

Chapter 7 filings can be rejected for a variety of reasons, among them: debts for money/property acquired by false pretenses; debts for fraud; debts for malicious injury when contested by the injured creditor; or debtor, without satisfactory explanation, makes a material misstatement or fails to provide documents/information related to an audit of the debtor’s case.

What You Must Avoid Before Filing Chapter 7 Bankruptcy

There’s some protocol to follow in the months before filing for bankruptcy. Failing to follow these instructions could undermine your efforts. Here’s what not to do before bankruptcy, whether it’s Chapter 7 or another type.

Don’t Pay Creditors — Sounds weird, right? Hear us out. To the extent you can, continue to make routine payments. But any large or unusual payments could be viewed as “preferential transfers.’’ That means one creditor has benefited unfairly over others.

No New Debt — A new creditor could claim you took out a loan or ran up the balance on a credit card without intending to pay it back. Legally, that’s fraud and it will not be forgiven.

No Unusual Transactions — Don’t stray from the routine. Don’t transfer titles of cars or homes. Don’t buy luxury goods. Don’t transfer your business or remove your name from it. Each of these activities can be classified as fraud.

Be Truthful and Complete — You are required, while filing for bankruptcy, to provide full and complete information. You must disclose any debt, assets, accounts, or other financial information.

“It is important not to destroy any financial documents or records related to the filer's debt,” Sinha says. “The court will look at a filer's recent financial transactions to determine if they were made with the intent to fraudulently avoid paying their debts.”

Adds Solomon, “People use many wrong tricks to hide their assets before filing for bankruptcy, but they don't know all these tricks can be caught easily by the trustee.”

Failure to fully and honestly comply could lead to fraud and potential criminal charges.

Hands Off Retirement Funds — Generally, retirement plans and accounts are shielded from bankruptcy proceedings. Keep them safe while considering bankruptcy; don’t even think about using those funds to pay down debt.

Use Common Sense — You should not file for bankruptcy if you’re about to receive a large sum of money, such as an inheritance. You could use that money to pay down your debts. Otherwise, if you’re involved in a bankruptcy process, that money could be seized by a court representative to pay your debts.

Never think you can get away with something sneaky or dishonest. Your bankruptcy lawyer is always a good resource for answering questions on what is right or wrong in this situation.

What Are the Pros and Cons of Chapter 7 Bankruptcy?

At the risk of sounding all naggy, filing for Chapter 7 bankruptcy is a huge decision. Do not enter into it casually. Know the consequences. The pros and cons of Chapter 7 bankruptcy must be weighed carefully before you arrive at a decision.

Pros of Chapter 7

• Filing Chapter 7 immediately ends lenders’ aggressive collection actions.
• Chapter 7 is easily understood and explained to curiosity-seekers and future lenders. Sure, they might have questions about bankruptcy and how it will affect your credit. But if you talk yourself out of Chapter 7 when it could be the right decision, consider a future of trying to explain missed debt payments, defaults, repossessions and lawsuits. All of those will pound your credit, too.
• You will be forced to be more disciplined financially. If you ever intend to borrow again, you will need to be frugal and demonstrate responsibility in repaying debt. Even though you might be able to open new lines of credit as soon as one to three years after filing for bankruptcy, your interest rates will be much higher. Demonstrating ability to pay those debts on time is the only way to get the interest rates down.
• In many states, exemptions will allow you to keep many of the things you own, including more property than you probably need. After you file, you will be able to keep any salary you earn and any property you purchase. Take a look at the Chapter 7 home equity exemption to see if your house is at risk.
• Whether you are successful with your Chapter 7 bankruptcy, you are able to file bankruptcy again after the time limit has passed.
• You get the benefit of a fresh start, which is not to be underestimated. “As your debts get discharged, you become financially free,” Counselor Solomon says. “This further leads to being emotionally free. You no longer need to worry about how to pay off your debts or make ends meet. When the stress and anguish go away from your life, you can make better decisions and can further handle your financial life better.”

Cons of Chapter 7

• Bankruptcy can hurt your credit score. Chapter 7 bankruptcy can remain on your credit report for up to 10 years — though if bankruptcy is a viable option, chances are your credit is already tarnished.
• You will lose all of your credit cards.
• You may lose luxury possessions, like a boat or second home, depending on how much equity you have.
• You may, under certain circumstances, lose your car.
• You will need to wait 2-4 years (depending on the type of loan) before you are able to get a mortgage.

What Are the Alternatives to Chapter 7 Bankruptcy?

• Know your rights — If you’re chiefly concerned about aggressive, even harassing, actions by creditors, explore your rights under the federal Fair Debt Collection Practices Act and consumer protection statutes in your state. Abuses can be alleviated by filing an action against the perpetrators.
• Working with creditors — If you’re up to the challenge, contact your creditors and attempt to work out a repayment plan that better fits your circumstances. Explore with them reducing the amount owed; if you file Chapter 7, they’re likely to get nothing.
• Debt management — If you shrink from the idea of taking on your creditors or debt collectors — and there’s nothing wrong with that — but you still like the idea of reducing payments while getting out of debt, contact a nonprofit credit counseling agency. You’re going to be talking to one eventually if you do file for Chapter 7; might as well do it while you’re keeping your options open.
• Debt settlement — Only for the thick-skinned, debt settlement typically involves a third party that will attempt to negotiate cut-rate payoffs to creditors using money you have deposited into an escrow account over a period of 18-36 months. While the account is being built, you’ll be directed to make no further payments to creditors, incurring late fees, mounting interest charges, and unceasing collections attempts. Ultimately, however, what creditors agree to accept to wipe out your debt may be a fraction of what you owed.
• Debt payoff planning — Whenever viable, do-it-yourself debt payoff schemes are well worth exploring. Requiring stubborn budgeting and fiscal discipline, debt-payoff plans can make you the master of your financial future. Methods of accomplishing debt payoffs include:
  • Debt snowball, in which you make minimum payments on all your unsecured debt except the smallest. That one you target to pay down to zero, then continue to pick off the next smallest in turn until all your debts are satisfied.
  • Debt avalanche, in which you target your debts based on interest rates, highest to lowest; pay minimums on all, but target the highest interest rate for elimination. Then work your way through the rest of your debts in similar fashion.
• Debt consolidation loan — If you’re able, get a personal loan from a debt consolidation company like a bank, credit union, or online lender that’s large enough to pay off all your unsecured debt. You’ll likely score a lower overall interest rate, and you’ll have a date-certain when the loan will reach zero.
• Mortgage refinancing — You may be able to use some of the equity in your home for a cash-out refinancing that will enable you to pay off your unsecured debt and end up with a single monthly payment that is smaller than the combination of credit card minimums plus your current mortgage.
• Help from family or friends — For some, avoiding bankruptcy means putting everything on the table, even hitting up family and/or friends for help. If you have loved ones who are just as keen to keep you out of bankruptcy court, one or more of them may need only to be asked for aid — a loan, or even an outright donation.
• Increasing income — Kind of a no-brainer, right? If you had more income, you might not be in a financial crisis. What to do? Ask the boss for a raise, not because you need it, but because you have studied the market and discovered you are underpaid for the product you deliver. … Or you could fit in a part-time job. … Or you have skills that could be useful in the gig economy, or by freelancing. Explore: Opportunity for raising your income abounds.
• Decreasing expenses — If your financial predicament is a result of undisciplined spending, and not some unforeseen calamity, you’re not going to want to hear this. Nonetheless: Getting your budget in balance by eliminating weight on the spending side absolutely must happen, and certainly will happen if you file for Chapter 7 bankruptcy. Get ahead of the process, and perhaps avoid it altogether, by carving out all but absolute necessities.

What to Do After Chapter 7 Bankruptcy

What awaits the bankrupt individual on the sunny side of a discharge? Possibly — hopefully — a whole new way of thinking about money.

“Bankruptcy is a fresh start for a debtor,” says Catherine Peek McEwen, a Federal Bankruptcy Judge for the Tampa-based Middle District of Florida. “That’s the pep talk I give my law students, and to everyone who comes into my courtroom.”

That restart button must not be confused with a Men in Black Neuralyzer. Amnesia about the pain of a process is great for childbirth — so we’ve been told — but wretched for living a post-bankruptcy life.

A successful post-bankruptcy life will involve careful (and realistic) budgeting, prudent spending, diligent earning and investing, keeping your accounts current, and otherwise overseeing an orderly financial house.

If all this sounds daunting, or you’re certain you’ll need to be coached up routinely, get with a nonprofit credit counseling agency. There you will find free, no-obligation assistance from professional certified counselors. Helping consumers develop an affordable monthly budget is their specialty.

You’ll benefit from their training and experience as you plot your financial future with a livable budget enhanced by savvy tips on how to make the bottom line come out in your favor every month.

Once paying bills on time becomes habit, and you maintain modest — or zero — balances on your secured credit card — you will begin to rebuild your credit after bankruptcy, regaining favor with lenders and credit card companies. A few years of good practice and your creditors will forget this ever happened.

You, however, being both happier and wiser, and in close association with your credit counselor, will keep the lessons of Chapter 7 close to your heart.

Chapter 7 Bankruptcy FAQs