What is Bankruptcy Law?
Bankruptcy law provides individuals and businesses overwhelmed by debt with an opportunity for a financial fresh start. It's a legal process supervised by federal bankruptcy courts that can eliminate or reorganize debts while protecting you from creditor harassment, lawsuits, wage garnishments, and foreclosures.
The U.S. Bankruptcy Code offers several types of bankruptcy, each designed for different situations. For individuals, the most common are Chapter 7 (liquidation) and Chapter 13 (reorganization). These proceedings can stop collection efforts immediately through the "automatic stay" and ultimately discharge many types of debt.
While bankruptcy has serious consequences for your credit and financial future, it exists as a safety net for those facing insurmountable debt. Understanding your options, eligibility requirements, and alternatives is crucial before making this significant financial decision.
Chapter 7 vs. Chapter 13 Bankruptcy
📋 Chapter 7: Liquidation Bankruptcy
Duration: 3-6 months
Who it's for: Lower-income individuals with mostly unsecured debt
Asset treatment: Non-exempt assets may be sold
How It Works:
- Eliminates most unsecured debts completely
- Trustee may sell non-exempt property to pay creditors
- Most people keep all their property through exemptions
- Cannot discharge student loans, recent taxes, child support
- Must pass means test based on income
- Quick process (3-6 months)
- Complete debt discharge
- Keep exempt property
- Fresh start quickly
- May lose non-exempt assets
- Income limits apply
- Cannot file again for 8 years
- Remains on credit 10 years
📊 Chapter 13: Reorganization Bankruptcy
Duration: 3-5 years
Who it's for: Regular income earners who want to keep property
Asset treatment: Keep all property, repay through plan
How It Works:
- Create 3-5 year repayment plan
- Pay disposable income to trustee monthly
- Keep all property including non-exempt assets
- Can strip second mortgages in some cases
- Discharge remaining debt after plan completion
- Keep all property
- Stop foreclosure
- Reduce car loans
- Flexible payment plans
- Long process (3-5 years)
- Must have regular income
- Strict budget oversight
- Higher attorney fees
Common Bankruptcy Cases
Medical Debt
Medical bills are the #1 cause of bankruptcy, accounting for 66% of filings. Even with insurance, serious illness or injury can create insurmountable debt. Both Chapter 7 and 13 can eliminate medical debt completely.
Credit Card Debt
High-interest credit card debt can spiral out of control. Average filers have $15,000+ in credit card debt. Chapter 7 eliminates it entirely; Chapter 13 often reduces the payback amount significantly.
Foreclosure Defense
Chapter 13 can stop foreclosure immediately and give you 3-5 years to catch up on missed payments. You can also potentially strip second mortgages if your home is underwater.
Wage Garnishment
Bankruptcy stops most wage garnishments immediately through the automatic stay. The underlying debt can often be discharged, permanently ending the garnishment.
Business Debt
Personal liability for business debt from sole proprietorships or personal guarantees can be discharged. Chapter 7 for businesses liquidates assets; Chapter 11 reorganizes larger businesses.
Divorce Debt
While child support and alimony cannot be discharged, property settlement debts and joint credit obligations can sometimes be eliminated or restructured through bankruptcy.
Key Legal Concepts
The Automatic Stay
Filing bankruptcy triggers an immediate court order stopping all collection activities:
- Stops creditor calls and letters
- Halts lawsuits and judgments
- Prevents wage garnishments
- Stops foreclosures and evictions (temporarily)
- Prevents utility shutoffs
- Stops car repossessions
Dischargeable vs. Non-Dischargeable Debts
| Dischargeable Debts | Non-Dischargeable Debts |
|---|---|
| Credit card debt | Student loans (usually) |
| Medical bills | Child support & alimony |
| Personal loans | Recent tax debts |
| Utility bills | Criminal fines & restitution |
| Most lawsuit judgments | DUI injury judgments |
| Business debts | Fraudulent debts |
The Means Test
To qualify for Chapter 7, you must pass the means test showing your income is below the state median or you have no disposable income after allowed expenses. The test compares:
- Your household income to state median income
- If above median, calculates disposable income using IRS standards
- If disposable income is too high, you must file Chapter 13
Bankruptcy Exemptions
Exemptions protect certain property from being sold in Chapter 7. Common exemptions include:
- Homestead: Protects home equity (amount varies by state)
- Vehicle: Protects car equity up to certain amount
- Personal Property: Clothing, household goods, tools of trade
- Retirement Accounts: 401(k), IRA, pensions fully protected
- Wildcard: Can protect any property of your choice
Your Rights in Bankruptcy
- Right to File: Cannot be denied bankruptcy based on income alone
- Protection from Discrimination: Employers cannot fire you for filing
- Keep Exempt Property: Laws protect necessities of life
- Choose Your Chapter: If eligible for multiple chapters
- Reaffirm Debts: Can keep secured property by continuing payments
- Convert or Dismiss: Can change chapters or withdraw case
- Fresh Start: Honest debtors get discharge of debts
The Bankruptcy Process
1. Pre-Filing Requirements
Complete credit counseling course from approved agency within 180 days before filing. Gather financial documents including tax returns, pay stubs, asset lists, and debt statements.
2. File Petition
Submit bankruptcy petition, schedules, and statements to court. Pay filing fee or request waiver. Automatic stay begins immediately.
3. Trustee Appointment
Court appoints trustee to oversee case. Trustee reviews paperwork and identifies issues or assets.
4. 341 Meeting of Creditors
Attend mandatory meeting 20-40 days after filing. Answer trustee's questions under oath. Creditors rarely attend.
5. Financial Management Course
Complete debtor education course before discharge. File certificate with court.
6. Discharge
Chapter 7: Receive discharge 60-90 days after 341 meeting. Chapter 13: Receive discharge after completing 3-5 year payment plan.
Eligibility Requirements
Chapter 7 Eligibility Checklist
Chapter 13 Requirements
- Regular income sufficient for plan payments
- Unsecured debts under $465,275
- Secured debts under $1,395,875
- Current on tax filings
- No prior discharge limits apply
Costs and Fees
Chapter 7 Bankruptcy Costs
Chapter 13 Bankruptcy Costs
Note: Attorney fees in Chapter 13 can often be paid through the repayment plan.
Alternatives to Bankruptcy
Before filing bankruptcy, consider these alternatives:
Debt Consolidation
Combine multiple debts into one loan with lower interest. Works best with good credit and manageable debt levels.
Debt Settlement
Negotiate with creditors to pay less than owed. Can damage credit but less than bankruptcy. Watch for tax consequences.
Credit Counseling
Work with nonprofit agency to create debt management plan. Reduces interest rates and consolidates payments.
Debt Management Plan
Structured repayment through credit counseling agency. Typically 3-5 years with reduced interest rates.
Negotiate Directly
Contact creditors yourself to arrange payment plans, reduce interest, or settle for less than owed.
Sell Assets
Liquidate non-essential property to pay debts. Consider downsizing home or selling vehicles.
Impact on Credit and Future
Credit Score Impact
- Initial drop of 130-240 points typical
- Chapter 7 remains on credit report for 10 years
- Chapter 13 remains for 7 years from filing date
- Can begin rebuilding credit immediately after discharge
- Many see 700+ scores within 2-3 years with good habits
Life After Bankruptcy
What You CAN Do:
- Get credit cards (secured cards initially)
- Buy a car (higher interest rates initially)
- Rent apartments (may need larger deposit)
- Get FHA mortgage after 2 years (Chapter 7) or 1 year (Chapter 13)
- Keep your job (illegal to fire for bankruptcy)
What's Affected:
- Higher interest rates for several years
- Difficulty getting unsecured credit initially
- Some professional licenses may be affected
- Security clearances may require explanation
- Insurance rates may increase
When to Hire a Bankruptcy Attorney
You Should Definitely Hire an Attorney If:
- Filing Chapter 13 (very complex)
- You own a business or have business debts
- Your income is above median (means test issues)
- You have valuable non-exempt assets
- Facing foreclosure or repossession
- Have priority debts (taxes, support)
- Previous bankruptcy filing
- Creditors are challenging your discharge
What to Look for in a Bankruptcy Attorney
- Specializes in bankruptcy (not general practice)
- Handles many cases in your local court
- Clear about fees and payment options
- Explains your options thoroughly
- Good Better Business Bureau rating
- Responsive to questions
- Certified specialist where available
Frequently Asked Questions
Will I lose everything if I file bankruptcy?
No. Most people keep all their property through exemptions. In Chapter 7, exemptions protect necessities like your home, car, clothing, and retirement accounts. In Chapter 13, you keep everything but pay creditors through a plan.
Can bankruptcy stop foreclosure?
Yes. Filing creates an automatic stay stopping foreclosure immediately. Chapter 13 lets you catch up missed payments over 3-5 years while keeping your home. Chapter 7 provides temporary relief but won't save your home long-term unless you can get current.
How much debt do I need to file bankruptcy?
There's no minimum debt requirement. The decision depends on your ability to pay, not the amount owed. People file with as little as $5,000 if they cannot pay. Consider bankruptcy when debts exceed your ability to repay in 3-5 years.
Can I keep my car in bankruptcy?
Usually yes. In Chapter 7, you can keep your car if it's worth less than the exemption amount or you're current on payments and reaffirm the debt. In Chapter 13, you keep your car and pay through your plan, possibly at reduced interest.
Will my spouse have to file too?
No, spouses can file individually. However, if you have joint debts, creditors can still pursue the non-filing spouse. In community property states, both spouses' income and assets may be considered even in individual filing.
Can I file bankruptcy on specific debts?
No. Bankruptcy requires listing all debts and assets. You cannot pick and choose which debts to include. However, you can reaffirm certain debts to keep property like cars or homes.