Author’s note from Attorney Howard Iken: Chapter 7 bankruptcy provides relief for individuals drowning in debt. It eliminates most unsecured debts, allowing people to prioritize essential expenses. Eligibility is determined through means testing. Couples can file jointly, but it affects both credit scores. Though bankruptcy initially harms credit, responsible financial management helps rebuild it. The process involves an automatic stay on collections, a meeting of creditors, and a trustee’s role. Choosing bankruptcy is a tough decision but can lead to a fresh start.
Chapter 7 Bankruptcy is a Good Option
When financial hardships have made it impossible to pay normal monthly bills, many people choose to bury their heads in the sand over the situation because they are frightened and frustrated and have no idea how to stop the inevitable. Debt collectors may be calling constantly, or process servers might be lurking outside to serve a debt collection lawsuit. Verbal abuse may be a part of debt collection; although it is illegal to verbally hassle debtors, it does occur. Unfortunately, the longer a person in this situation avoids confronting their financial problems, the worse the situation is likely to get.
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In some cases, a Chapter 7 bankruptcy may be the only way to get much-needed relief. Chapter 7 bankruptcy is also known as Liquidation Bankruptcy, and essentially allows a person who finds themselves drowning in debt to permanently avoid the majority of their unsecured financial debts. Those who qualify for a Chapter 7 bankruptcy can reduce their financial obligations, allowing them to pay their mortgage or rent, pay medical expenses, buy groceries, and pay for any other crucial monthly expenses.
Chapter 7 Alternatives
Those who are considering Chapter 7 bankruptcy should explore their other available options before making the final decision. For those whose corporation, partnership, or sole proprietorship is in financial difficulty, a better outcome might be achieved through a Chapter 11 bankruptcy. This type of bankruptcy allows the debtor to seek debt adjustment through extensions on the time for payment, or a reorganization or adjustment of debts. A sole proprietorship business could also be eligible to file for Chapter 13 bankruptcy as could an individual debtor with a steady income.
Chapter 7 Bankruptcy versus Chapter 13 Bankruptcy
Chapter 13 bankruptcy gives those who are having financial difficulties a way to save their homes from foreclosure through a structured payment plan. One of the reasons people may prefer Chapter 7 bankruptcy is that repayment of debts is not required. Chapter 13 bankruptcy does require debts to be repaid, however, a three-to-five-year repayment plan is created for the debtor. Unfortunately, many of those who file for Chapter 13 bankruptcy fail to complete their payment plan. Chapter 7 bankruptcy can be completed more quickly than Chapter 13 bankruptcy—usually within three to six months—and allows debtors to keep all or at least most of their property. Some debtors will not qualify for Chapter 7 bankruptcy, however, and may have to look into Chapter 13 bankruptcy. If the income of the debtor is sufficient to qualify for a Chapter 13 repayment plan, then Chapter 7 bankruptcy filing will not be allowed.
Eligibility for Chapter 7 Bankruptcy
In order to qualify for Chapter 7 bankruptcy, the debtor must be an individual, rather than a partnership, a corporation, or other business entity. Regardless of the level of debt, relief is available under Chapter 7, so long as the debtor meets all other eligibility requirements. The Chapter 7 “means test” allows debtors to determine whether their income is low enough to qualify for Chapter 7 bankruptcy. The formula is meant to prevent debtors with higher incomes from obtaining Chapter 7 bankruptcy relief. If the debtor has a significant level of debt, they may still be allowed to have a fairly high level of regular income.
Allowed monthly expenses will be deducted from the debtor’s current monthly income. The current monthly income is calculated using the average income over the six months prior to filing bankruptcy. The difference between allowable monthly expenses and current monthly income is known as “disposable income.” A debtor with a high level of disposable income will not be able to take advantage of Chapter 7 bankruptcy. The debtor must also determine whether their income is more or less than the median income in their state of residence.
Those who earn more than the median income must calculate whether there would be enough disposable income left to repay some of their debt. If the answer to that question is “yes,” the process gets more complex. If the debtor’s monthly income is less than the median household income for those in Florida, they pass the means test with no further tests required and can file for Chapter 7 bankruptcy. The easiest way for a debtor to determine whether they pass the means test and qualify for Chapter 7 bankruptcy is to use an online means test calculator.
Other issues which could prohibit a debtor from applying for Chapter 7 bankruptcy include the following:
- No debtor may file under Chapter 7 bankruptcy unless he or she has received credit counseling (from an approved agency) within 180 days of the filing. If the debtor develops a debt management plan with the help of a credit counselor, that plan must be filed with the court.
- During the 180 days preceding the current Chapter 7 bankruptcy petition, if it is found the debtor willfully failed to appear before the court or comply with court orders, therefore had a prior bankruptcy petition dismissed, he or she will not qualify to file Chapter 7 bankruptcy.
- If the debtor voluntarily dismissed a prior Chapter 7 bankruptcy case after his or her creditors attempted to recover lien-based properties, the debtor does not qualify for a Chapter 7 bankruptcy.
If a debtor does not pass the Chapter 7 means test or otherwise qualifies under Chapter 7 rules, he or she is limited to using Chapter 13 bankruptcy.
How Does Chapter 7 Bankruptcy Work?
Once a debtor has determined he or she is eligible to file Chapter 7 bankruptcy, a petition will be filed in a bankruptcy court serving the area where the debtor lives. The debtor must also file schedules of assets and liabilities with the court as well as a schedule of current income and expenses, a statement of financial affairs, and a schedule of contracts and leases. The case trustee must also be provided a tax return for the most recent tax year and possibly additional tax returns as well. A statement of monthly net income as well as a record of federal or state-qualified education tuition interest must also be filed.
If the debtor anticipates an increase in income or expenses after filing for Chapter 7 bankruptcy, a statement of that anticipation must be filed with all other documents. The Florida filing fees for bankruptcy must be submitted along with the documents, generally a $245 case filing fee, a $75 miscellaneous administrative fee, and a $15 trustee surcharge fee. Debtors who fail to pay these fees could have their Chapter 7 bankruptcy case dismissed. Debtors whose income is less than 150 percent of the poverty level, and who cannot pay the Chapter 7 bankruptcy fees—even in installments—may have those fees waived by the courts.
Do Married Couples File for Chapter 7 Bankruptcy Together?
A husband and wife can file an individual Chapter 7 bankruptcy petition or joint petition. If the husband and wife choose to file jointly, they still must meet all document filing requirements as if they were individual filers. Should a couple choose to file jointly, all combined property and debts become a part of the bankruptcy. While it makes sense in some situations to file jointly, in others a debtor might be better off filing alone. A joint Chapter 7 bankruptcy filing will wipe out all dischargeable debts owed by both spouses.
If only one spouse files for Chapter 7 bankruptcy, the spouse who does not file is still responsible for their own debts as well as joint debts. If a couple is carrying a significant amount of joint debt, it doesn’t really make sense for one spouse to file individually. On the other hand, if there are few joint debts and one spouse has a considerable level of individual debts, it might not make sense for the spouses to file jointly. Determining whether to file jointly or individually may also depend on whether one spouse has enough exemptions to protect the couple’s property. If one spouse has a significant level of non-exempt, separate property, it might be better for the other spouse to file individually in order to protect those assets.
How Will a Chapter 7 Bankruptcy Affect My Credit?
A joint bankruptcy will be reflected on both spouses’ credit reports. Obviously, filing Chapter 7 bankruptcy will have a negative effect on credit scores, despite the fact that in most cases the credit score increases shortly after the bankruptcy (then is likely to take a nosedive). A Chapter 7 bankruptcy can remain on a debtor’s credit report as long as 10 years, however, the individual debts should all drop off the credit report by seven years.
While most people who are considering filing Chapter 7 bankruptcy are concerned about their credit score dropping, they must weigh this against the likelihood that their credit score will drop if they are unable to pay their debts. Generally speaking, bankruptcy decreases a credit score from 160 to 220 points. Depending on where the score started, this could take it down to the “poor” category. While time is the only real remedy for repairing a credit score, if the debtor manages new debts responsibly, the score will gradually increase.
How the Bankruptcy Case Will Progress
Once a Chapter 7 bankruptcy petition is filed, most collection actions against the debtor will be automatically stopped. All creditors are notified that the debtor is filing Chapter 7 bankruptcy. So long as the “stay” is ineffective, creditors are not allowed to initiate a lawsuit against a creditor, to continue a lawsuit, instigate wage garnishments, or even make a phone call to the debtor demanding payment. Anywhere from three weeks to forty days following the filing of the petition, a meeting of creditors will be held.
During this creditor meeting, the trustee and the creditors are allowed to ask questions. The debtor must attend this meeting and answer those questions and will be placed under oath to do so. If the petition was filed jointly, both husband and wife must attend and answer questions. Within ten days of the time of the creditor’s meeting, the trustee will report to the court regarding whether the case at hand meets the means test or could possibly be an abuse under the means test.
The Role of the Chapter 7 Bankruptcy Trustee
Once the Chapter 7 bankruptcy petition is filed an impartial case trustee is appointed to administer the case as well as to liquidate the non-exempt assets of the debtor. The trustee accomplishes this liquidation by selling any property belonging to the debtor which is free and clear of liens. If all the assets of the debtor are exempt (or subject to valid liens), a “no asset” report will be filed by the trustee and no distributions will be made to unsecured creditors. The trustee has the power to set aside preferential transfers made to creditors within 90 days prior to the petition as well as to undo pre-petition property transfers and pursue non-bankruptcy claims such as fraudulent conveyances.
Making the Decision to File Chapter 7 Bankruptcy
There is no doubt that making the decision to declare Chapter 7 bankruptcy is extremely difficult. The decision will affect your future, your credit, your self-image, and your reputation for a significant length of time. On the other hand, your quality of life can improve in the short term as the harassing calls and letters stop. Try to look at it from the viewpoint that the sooner you file for Chapter 7 bankruptcy, the sooner you can begin rebuilding your credit.