Bankruptcy: Types, Qualifications and How to File

Sometimes, your debt becomes so overwhelming that you simply cannot repay it. Bankruptcy offers a financial “do-over,” but it isn’t without serious consequences.

What is Bankruptcy?

Bankruptcy wipes out all or part of your debt. The cases are handled through the federal court system, using guidelines established by the U.S. Bankruptcy Code.

Depending on the type of bankruptcy filing, it will help you discard debt or establish a debt repayment plan. The process typically begins by filing a bankruptcy petition with the bankruptcy court. Petitions can be filed by individuals, spouses or businesses. 

There are several different types of bankruptcy. This article will focus on the two primary types of personal bankruptcy: Chapter 7 and Chapter 13. 

• Chapter 7 bankruptcy is faster and will erase many types of debt. But there are strict income requirements for filing, so you may not qualify.
• Chapter 13 bankruptcy establishes a repayment plan. You will end up paying off most of your debt on a plan that’s monitored by the bankruptcy court. 

How Does Bankruptcy Work?

How bankruptcy works will depend on the amount of debt you have and the type of bankruptcy you file, but the first steps will be the same. You’ll need to start by filing your petition in federal court. 

What Happens When You File For Bankruptcy?

As soon as you file, an “automatic stay” will take effect. This means that your credits will be required to stop trying to collect andy debts you owe. 

The court will need you to provide certain information. This includes:

• Tax returns
• Proof of income
• Mortgage statements or rent receipts
• Documentation of other debts
• Vehicle registration, proof of value, and insurance
• Statements from your bank, retirement, and other financial accounts
• Identification
• Documentation of other recurring costs, like alimony or child support

Some bankruptcy courts may require additional documents.

A Bankruptcy Trustee Will Be Appointed to Handle Your Case

A bankruptcy trustee will be appointed. The trustee will oversee your case and will either liquidate your assets in a Chapter 7 case or will establish a repayment plan if you’re filing Chapter 13. Your trustee will contact you to set up a meeting to discuss your case, so you will need to have enough schedule flexibility to take time off from work to attend this meeting.

Filing for bankruptcy isn’t free, but there are ways to reduce your overall cost. For instance, you’re allowed to represent your self in bankruptcy court. 

How to File for Bankruptcy 

The Federal Rules of Bankruptcy Procedure govern procedures for bankruptcy proceedings through the U.S. Courts System. You can find them here.

The process is relatively simple:

• Consult a bankruptcy attorney
• Figure out which type of bankruptcy you need to file
• Gather your financial documents
• Complete the mandatory credit counseling course
• Complete the bankruptcy forms
• File your bankruptcy paperwork in court
• The court will appoint your bankruptcy trustee
• Send required paperwork to your trustee
• Attend your scheduled meeting with your bankruptcy trustee (also known as a “341 Meeting” of creditors
• You and your trustee will determine how to deal with any non-exempt property
• Continue to make payments on your secured debts
• Complete your second mandatory credit counseling course
• Wait for your debts to be discharged or make your monthly payments until your payment plan is complete

READ MORE: Do I need an attorney for bankruptcy?

Types of Bankruptcy

According to U.S. Bankruptcy Code, there are six different types of bankruptcy. Each is named after the chapter in the code that describes it.

• Chapter 7 (personal)
• Chapter 13 (personal)
• Chapter 11 (most commonly used for businesses)
• Chapter 12 (for family farmers and commercial fishing operations)
• Chapter 9 (for cities and municipalities)
• Chapter 15 (for foreign nationals)

The bankruptcy basics remain the same for all types: all bankruptcy proceedings are handled in federal courts under rules outlined in the U.S. Bankruptcy Code. However, that’s where the similarities end. Each type has different costs and criteria.

READ MORE: Types of bankruptcy

At a Glance: Chapter 7 vs. Chapter 13

Chapter 7	Chapter 13
Erases most unsecured debts	You will repay some or all of your debts
Takes four to six months to complete	Takes three to five years to complete
Filing stops all debt collection efforts	Filing stops all debt collection efforts
A bankruptcy trustee will help you	A bankruptcy trustee will help you
Stays on your credit reports ten years	Stays on your credit reports seven years
Strict income requirements	No income requirements, but has debt requirements
You must sell non-exempt assets	Some assets are protected
Your credit card accounts will be closed	You can typically keep credit cards open
A bankruptcy attorney will cost about $1,500	A bankruptcy attorney will cost about $3,000

Chapter 7 Bankruptcy

Chapter 7 is commonly referred to as “liquidation bankruptcy.” A Chapter 7 bankruptcy can erase many types of debt. The most common are credit card debt and medical bills, including car loans, payday loans, and utility bills. These are known as dischargeable debts.

Pro tip: This filing type removes all unsecured debt except student loans, government taxes, child support, and alimony. The process of Chapter 7 takes about 4 to 6 months.

A Chapter 7 bankruptcy is also able to discharge back income taxes. When you file for Chapter 7, the IRS is contacted, your credit card debts are immediately cleared, and wage garnishments cease. It is known as an automatic stay.

How Chapter 7 Works

When you file Chapter 7, you must sell off your non-exempt assets to pay off your debts. Anything the court determines to be unnecessary to maintain a minimal standard of living is considered exempt. Non-exempt property includes:

• Vacation homes or real estate properties that aren’t your primary residence
• Car repossession
• Musical instruments, as long as you don’t need them for work
• Family heirlooms
• Investments, but not retirement accounts
• Jewelry with resale value

If considering Chapter 7, here are some things to keep in mind:

• The filer must be an individual or business.
• You can keep several types of property up to a dollar amount with “exemption limits.” Every bankruptcy filer can protect specific exempt property, so getting a fresh start doesn’t require starting from scratch.

Which Debts Does a Chapter 7 Filing Erase?

Chapter 7 wipes out most forms of unsecured debt, including:

• Credit card debt
• Medical bills
• Utility bills
• Personal loans
• Payday loans
• Car loans
• Debts in collections

Chapter 7 Qualifications

You don’t necessarily need to be behind on your bills to file for bankruptcy, but you must take a means test. In addition:

• The debtor must be an individual, partnership or corporation
• Individuals cannot file if a bankruptcy petition was dismissed within the preceding 180 days due to failure to appear in court or failure to comply with court orders
• You aren’t eligibile if you voluntarily dropped a previous case when creditors tried to recover property on which they held liens
• You must complete mandatory credit counseling

It’s important to note that some types of debts will not be discharged, and bankruptcy discharge will not invalidate property liens.

Chapter 7 Means Test

The means test limits the use of Chapter 7 bankruptcy to those who can’t pay their debts. It is used to determine whether your income is low enough for you to file for Chapter 7. Its function is to prevent those who earn high wages from filing for Chapter 7 bankruptcy.

To start, you’ll need to learn your state’s median income. You will then need to calculate whether your current monthly income is higher or lower than your state’s median income based on the size of your family.

Pro tip: To calculate your current monthly income, add the gross income earned over the past six months before your bankruptcy filing, then multiply it by two. 

If that total is less than your state’s median income, you’ll pass the means test. However, if your income is higher, you still have a second chance at qualification.

You will need to deduct allowed monthly expenses from your current monthly income. This total becomes your monthly “disposable income.” Households with a low amount of disposable income will have a better chance of qualifying for Chapter 7.

You can use this form provided by USCourts.gov to calculate your eligibility.

Pro tip: Some military veterans and active duty service members may not be required to take a means test. 

High-income filers who fail the means test can still use Chapter 13 bankruptcy to repay a portion of their debts, but they will not be able to use Chapter 7 bankruptcy to eliminate their debts altogether.

The Chapter 7 means test isn’t only for the disadvantaged. You can still earn a significant monthly income and qualify for Chapter 7 bankruptcy if you have many expenses, such as a hefty mortgage, car payments, taxes, and other costs.

In the end, if the person has enough to pay down the debt, the judge is likely not going to allow a Chapter 7 filing.

A Chapter 7 bankruptcy can be completed in six months, but it will stay on your credit report for ten years. 

Consequences of Filing Chapter 7

When you file Chapter 7, you must sell off your non-exempt assets to pay off your debts. Anything the court determines to be unnecessary to maintain a minimal standard of living is considered exempt. The non-exempt assets include:

• Vacation homes or properties that aren’t your primary residence
• Car repossession
• Musical instruments, as long as you don’t need them for work
• Family heirlooms
• Investments, but not retirement accounts
• Jewelry with resale value

If considering Chapter 7, here are some things to keep in mind:

• The filer must be an individual or business.
• You can keep several types of property up to a dollar amount with “exemption limits.” Every bankruptcy filer can protect specific exempt property, so getting a fresh start doesn’t require starting from scratch.
• Chapter 7 will delay foreclosure: Most people filing Chapter 7 don’t lose their homes and, in many cases, get to keep their vehicles. However, that doesn’t mean your home is permanently safe. Once the automatic stay expires, foreclosure efforts can resume if you aren’t up to date on mortgage payments
• When your credit card accounts are discharged, the credit card issuers will close your accounts. The court may allow you to keep one open account for emergencies
• It will be difficult to qualify for new types of credit for the first year or two after filing

Can Chapter 7 Stop a Foreclosure?

No, but it can delay it.

Contrary to popular belief, most people filing Chapter 7 don’t lose their homes and, in many cases, get to keep their vehicles. Chapter 7 bankruptcy doesn’t ruin your ability to get credit, but your score will take a big hit after filing and the bankruptcy will stay on your credit report for ten years.

Chapter 7 Success Rate

According to the American Bankruptcy Institute, 99% of Chapter 7 cases result in debt discharge.

Chapter 7 Success Stories

One Chapter 7 filer says “life couldn’t be better” after completing the process to discharge $58,000 in debt.

The filer is now debt-free and his now-wife had already purchased a home before the couple married, so there are no concerns about getting a mortgage. 

The filer has since found a new job, earns more money and has money to invest in a 401(k).

“I filed and life has already gotten better even before it’s been discharged,” said another Chapter 7 filer, who said his credit score has already increased and he can now work toward building an emergency fund. Between $60,000 to $70,000 in unsecured debt was discharged.

“It’s not for everyone, he said, “but I have already seen drastic improvements in my life and it’s only been a few months.”

Chapter 13 Bankruptcy

A Chapter 13 bankruptcy is known as a wage-earners plan. Chapter 13 is for someone with a steady income, and the filer will repay all or part of what they owe their lenders through an installment plan over three to five years. Chapter 13 is used by individuals, including those who are self-employed or own small businesses.

There is no income requirement, but the debt must be below a certain amount and stay on your credit report for seven years.

Chapter 13 Benefits

Chapter 13 offers protection against liquidation, most notably protecting the potential filer’s home from foreclosure. It gives you the chance to catch up on late mortgage payments.

• The filer can structure a repayment plan under better conditions and at lower interest rates, except for a mortgage.
• Any cosigners the potential filer has could have special protection as well.
• The potential Chapter 13 filer makes their payments to an impartial bankruptcy trustee, usually a bankruptcy attorney’s office. Filing bankruptcy immediately stops collection calls and letters.
• You have up to 5 years to repay your creditors, and the reorganization allows you to keep non-exempt assets such as collectibles and recreational vehicles.
• A Chapter 13 filing puts an immediate end to litigation, wage garnishment, and other forms of harassment.

Even if self-employed or operating an unincorporated business, any individual can file for Chapter 13 as long as the individual’s unsecured debts are less than $394,725 and secured debts are less than $1,184,200.

If you had a bankruptcy petition dismissed in court due to failure to appear or comply with court orders within the last 180 days and didn’t receive credit counseling, you are ineligible to file.

Chapter 13 will take longer to rebuild your credit, but the one benefit is it stays on your credit report for seven years versus 10 because you are rewarded for paying back some or all of your debt through a Chapter 13 filing.

Chapter 13 Qualifications

Chapter 13 is designed for individuals, married couples filing jointly and sole proprietorship business owners (though in this instance, any personally guaranteed business debts may be included in the repayment plan). Other qualifications include:

• You must have enough income to make your monthly payments while paying your other bills
• You must meet the debt threshold: In cases filed from now until March 31, 2025, unsecured debts must be less than $465,275 and secured debts must be less than $1,395,875
• You must be current on your tax payments for the past four years 
• You must complete mandatory credit counseling
• You will be ineligible to file if you had a bankruptcy petition dismissed within the last 180 days due to failure to appear or comply with court orders

Chapter 13 is a lengthy process. It take take three to five years to complete, and it is possible to be disqualified during the process. If your case is disqualified, debts could remain in your name. You will need to be able to successfully complete the process in order for your debts to be discharged. This includes:

• Filings
• Mandatory financial training
• Your payments

Chapter 13 will stay on your credit reports for seven years.

Consequences of Filing Chapter 13

• You’ll have to forfeit some assets: Though Chapter 13 protects essential assets, including your primary residence and car, anything considered a “luxury item” may be liquidated to repay your debts
• You won’t be in control of your own money: Any significant purchases will have to be approved by your bankruptcy trustee
• It won’t discharge every debt: Taxes, child support and student loans are typically not dischargeable 
• Co-signed loans won’t be discharged: If you borrowed money with a co-signer, those loans will not be discharged. If you can’t make the payments, your co-signer will be on the hook

Chapter 13 Success Rate

Results vary from state to state, but the American Bankruptcy Institute estimates that 40% to 70% of Chapter 13 cases are successfully completed.

Chapter 13 Success Stories

“Steve” filed Chapter 13 in 2018 with about $60,000 in credit card debt. He earned about $75,000 a year and the payment plan was $1,020 per month for five years. 

Eventually, he landed a new job and stashed away $10,000 in an emergency fund, then used a work bonus to pay off his Chapter 13 plan early. 

His credit score was in the upper 700s before filing, then fell to the mid-500s after filing. He used a secured credit card to rebuild it and is now back up to 738. He was able to purchase a car with $6,000 down and finance the rest at 8% interest.

“My credit score was in the high 700s before bankruptcy (very inflated because I always paid on time and never missed a payment but my debt to income was way off),” he said. It dropped to the mid 500s after filing and he was able to rebuild it over the last few years with a secured credit card. Just before discharge, his credit score was 702.

“I actually feel really proud of myself for coming out of this situation successfully,” he says.

READ MORE: U.S. bankruptcy statistics

How Much Does It Cost to File For Bankruptcy

You don’t have to hire an attorney to file for bankruptcy, but the process will be simpler if you do. Before you decide to save the money, check with local legal aid societies or legal clinics for free legal assistance. Ask your state’s bar association about pro bono lawyers. The U.S. Government’s legal aid website is a good starting point.

If you choose to hire a lawyer, legal fees should average around $1,500 for a Chapter 7 filing and from $3,000 to $3,500 for a Chapter 13 filing. Your costs may be substantially higher or lower depending on your location and the complexity of the case.

You’ll also have to pay a filing fee of $338 for a Chapter 7 bankruptcy or  $313 for a Chapter 13 bankruptcy. If you cannot afford to pay this fee, you can request a payment plan or waiver.

You will also have to pay for two mandatory credit counseling sessions, which should cost about $50 each.

Other costs include photocopying and mailing fees and any costs associated with attending your trustee meeting or other mandated appearances.

READ MORE: Can I file bankruptcy for free?

Who Offers Bankruptcy

Bankruptcy is only available through the U.S. Court system. Bankruptcy cases are heard in federal court.

Bankruptcy attorneys are the easiest source of information and help you navigate the process. It is possible to do it yourself, but you need to be aware that paperwork mistakes could result in case dismissal, and you could end up losing assets that a lawyer may have been able to protect.

Pro tip: Many attorneys accept credit card payments, but you will not be able to pay with your own credit card. They will accept credit cards from friends and relatives who are willing to pay the fees on your behalf. 

Chapter 13 filers are allowed to pay attorney fees through the repayment plan, so you don’t have to come up with a lot of money upfront.

Filing for Chapter 13 bankruptcy allows debtors to pay all or a portion of their attorneys’ fees through their repayment plan, which can be great if you can’t pay all the attorney fees upfront. But this chapter doesn’t work for everyone.

Pro tip: Upsolve is a website that will help you file bankruptcy for free. It provides the bankruptcy forms, videos and other resources.

There are also a number of books you can purchase that will help you navigate the process, and there are some websites devoted to helping you file at a low-cost.

We recommend:

• A Short and Happy Guide to Bankruptcy
• Personal Bankruptcy Laws for Dummies
• Too Broke for Bankruptcy: A Step-by-Step Guide to Filing Chapter 7 Bankruptcy Without an Attorney

Advantages and Disadvantages of Filing for Bankruptcy

Pros	Cons
Automatic stay stops all debt collection actions	Not all debts are dischargable
Gives your financial situation a complete reset	Significantly owers your credit score
Exemptions allow you to protect many of your belongings	Will not remove some student loan debts
Getting rid of debt will ultimately help your credit score	You will have to close your credit card accounts
Your trustee will help you through the process	Your bankruptcy will be public record
Certain back taxes can be addressed	You will have to explain how you got into this financial situation
May prevent foreclosure or repossession	You may have to wait before you can buy a car or a house
You can take on new debt after your debts have been discharged	You may lose some of your possessions

Dangers of Bankruptcy

• Loss of property
• Damage to co-signers
• Credit score damage
• Won’t fix your underlying financial issues
• You may not be able to keep your tax refund
• Feelings of inadequacy
• Mental health toll

Insolvency vs. Bankruptcy

Insolvency and bankruptcy are not the same. You can be insolvent without being bankrupt, but you can’t be bankrupt without being insolvent.

Insolvency means you’re unable to pay your debts when they are due. There are a few other ways to escape insolvency without filing for bankruptcy. Some of the most common include:

• Debt settlement
• Debt consolidation loans
• Debt Management Plans

The Bottom Line

If other debt relief methods have failed, bankruptcy can get you the complete financial reset you need. But you’ll need to do some research to figure out which type (Chapter 7 or Chapter 13) will work best for you.

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