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Thinking about making a fresh start? Discover everything you need to know about the different types of personal bankruptcy and small business bankruptcy.
How Chapter 7 Bankruptcy Works
While debt is as old as human civilization itself, and existed even before money came into use, bankruptcy affects more than ancient history. It can have a long term, negative impact on your credit history, even if you are able to liquefy your assets to pay back your debts. Your bankruptcy record stays with you for a decade and can hamper future purchases or loans.
The most common form of bankruptcy for individuals in the United States is called Chapter 7, Title 11 bankruptcy; the name refers to the set of laws in the United States Code that govern the process. Also known as “straight bankruptcy” or “liquidation,” Chapter 7 involves the liquidation of assets to repay creditors in the fullest extent possible. Chapter 7 bankruptcy is the simplest and quickest form of bankruptcy and both individuals and businesses can file for it.
Debtors, Creditors, and Other Terms to Know
Bankruptcy is one of the most complicated areas of the United States Code. This is because it incorporates taxes, contracts, real estate, and sometimes even corporate law. The legal specifics can vary from state to state as well.
To put it simply, bankruptcy is the final, last-resort solution to the problem of having more debt than you can pay back. In this case, you are known as the debtor; the people or companies you owe are called creditors. When you file for Chapter 7 bankruptcy, you're admitting that there is no way you can pay back any of your creditors. The bankruptcy process is designed to discharge your debt. In discharging it, it's cancelled or forgiven by your creditor, which in turn gets rid of many or all of your debts. It's important to note that not all debt can be erased by declaring bankruptcy. Certain debts are considered exempt from this process (such as spousal and child support or taxes).
For debt, there are two different kinds of debt you might owe to your creditors: secured and unsecured personal loans. Secured debts have some form of collateral, like your home or automobile, in place as a security measure. It's the lender's guarantee that you will pay the loan back. If you're unable to repay the money, the terms of the secured loan agreement give the creditor the legal right to claim that property if the loan is not repaid. Collateral is offered by you, the debtor, as security when you first apply for a loan. A creditor can also put a claim on your property after you're in their debt; this is called a lien, and it is very common in bankruptcy situations, as the creditor may impose one if they notice you're failing to meet your obligation.
Unsecured debts, on the other hand, don't carry built-in collateral; the creditor stands to lose their entire outstanding sum if you default on it. These types of debts are sometimes referred to as no collateral or signature loans as it's your word, or signature, that promises the lender you'll pay them back. The lack of collateral means that unsecured loans often carry high interest rates or are only used for small purchases or credit card use. It's important to know the difference between these types of debt, because you will still need to repay the money you've borrowed no matter how broke you are and no matter what type of bankruptcy you file.
What Happens When You File for Chapter 7
Declaring bankruptcy first involves filling out paperwork that describes your property, current income and assets, your debts, and a history of your major buying and selling habits during the past two years. After you file the paperwork, an automatic stay immediately goes into effect. This stay, or injunction, temporarily stops your creditors from trying to collect what they're owed. It goes into effect the moment the bankruptcy petition is filed. This stay is to give you momentary relief while you sort out the rest of the bankruptcy process. The bankruptcy court will assign a trustee to your case. The trustee is the person that will organize the liquidation, or sale, of your assets - your car, your house, and any other possessions that can help generate money to repay creditors. You may be eligible to keep certain exempt property, but the value of that property varies from state to state.
Once your assets are recorded and liquidated, the money goes to pay your creditors in a specific order. Usually, you must first deal with secured debts, such as your car or house; if the creditor has put a lien on some of your property, then they may take possession of it or foreclose. The liquid assets (money or cash) go towards paying off portions of your debt. Once that's done, many of your unsecured debts are eliminated, and you don't have to repay the full amount.
It's important to note that some types of unsecured debts will not be discharged in Chapter 7 bankruptcy. These debts include:
- Child support
- Alimony obligations
- Student loans (in most cases)
- Income tax debts
Some types of debt are also important enough that they must be repaid first; these priority debts vary on a case-by-case basis, but can include wages owed to an employer and some types of personal loans. A court may rule that certain debts are non-dischargeable, such as fines imposed for breaking the law. Some credit card debt is secured (though most is not) and this too would take priority.
When you file for bankruptcy, the record stays on your credit report for ten years. Some people avoid bankruptcy as they're worried about their future creditworthiness. It's vital to remember that the long-term effects of declaring bankruptcy should be weighed against how your immense debt affects your credit - it's often already ruined by the time bankruptcy becomes an option. Removing the debt from your record can improve your creditworthiness and you must use credit in order to rebuild your trustworthiness.
Chapter 7 bankruptcy is a last resort for people whose debt has spiraled out of control. It provides them a chance to start fresh, do what they can to pay back their creditors, and get out from under the thumb of collection and interest rate cycles. While there are negative consequences that may be life altering, such as the loss of your house, it can be a lifesaving move for those who desperately need it.
If you would like learn about the other types of bankruptcy, we have information on
- Chapter 9 (where a city or town can claim bankruptcy protection);
- Chapter 11 (what most businesses file for bankruptcy under);
- Chapter 13 (a form of bankruptcy where finances are restructured); or
- Chapter 15 (which applies to companies with more than one location)
If you want to learn more about Chapter 7 bankruptcy, or other types of debt solutions, fill out our simple debt solutions form or call us toll-free at 1-800-781-5187. Using our free service, AmOne's financial search specialists will be able to quickly help you locate appropriate program and company for your circumstances.