Some of the terms used to describe chapter 7 bankruptcy proceedings have ominous overtones: liquidation, no-asset case, means test and notice of abandonment. They all have their places in the process, but what they let you know is that chapter 7 can offer you a clean slate and a fresh start in much less time than a chapter 13 plan.
How Chapter 7 Works
When you file a chapter 7 petition, the trustee assigned to your case takes control of your assets. He sells them – liquidating them into cash – to pay off your debts. If he doesn't raise enough money to pay everyone everything you owe, the balance is discharged, which means that you're no longer responsible for paying back this money. Compared to a chapter 13 bankruptcy plan, which lasts three to five years, the average chapter 7 case is over within months. You have to qualify for this kind of relief, however, by taking the means test. If your income is less than the median income for a family of your size in your state, you automatically pass – you can file for chapter 7. If your income is more, you must determine how much money you have left to pay your debts after meeting your regular monthly expenses. If you have at least $166, you must file for chapter 13 protection instead.
The Automatic Stay
As soon as you file for bankruptcy protection, an automatic stay goes into effect. This stay makes it against the law for your creditors to continue to try to collect payments from you. They can't call you, take you to court, or enforce court judgments they already have against you, such as garnishments of your wages or liens against your property. The stay lasts until your bankruptcy is complete, at which time your debts are discharged anyway. Creditors may petition the court to lift the stay. This generally happens if a secured creditor, such as your mortgage lender, wants to proceed with foreclosure or repossession because you're significantly behind on your payments.
The You'll-Lose-All-Your-Property Myth
Although it's true that your property is subject to liquidation in chapter 7, most debtors don't lose anything. That's because they have no-asset cases in which they can protect their property with exemptions, so there's nothing available for the trustee to liquidate. Exemptions are value amounts of property that the trustee can't take and sell. For example, if your state offers a $3,000 exemption for automobiles, and if your vehicle is worth $3,000, the trustee can't liquidate it. If your vehicle is worth $10,000 and it is secured by a $7,000 loan, the trustee still won't liquidate it, because your $3,000 in equity is covered by the exemption. According to the National Association of Bankruptcy Trustees, the majority of debtors have no non-exempt property for the trustee to sell, so they file a report of no distribution with the court instead of liquidating anything; there's no money to distribute to creditors. The trustee might also abandon some of your property if its non-exempt value is negligible, declining to liquidate it because your creditors wouldn't get much anyway.
Discharge of Debts
Most of your unsecured debt is discharged at the end of your chapter 7 bankruptcy. These debts include credit cards and medical bills. But some exceptions exist. For example, student loans are unsecured, but they're not typically dischargeable. Chapter 7 treats secured debts, such as mortgages and auto loans, differently. Even if your obligation to pay them is discharged, bankruptcy doesn't eliminate the liens against the property. Therefore, lenders have the right to take their collateral back. If you're not behind in your payments at the time you file for bankruptcy, however, this may not happen. If you continue making payments, the lender may let you keep the property. However, these creditors will probably want you to sign a reaffirmation agreement, which is a brand new contract that supplants the old one. It restores your obligation to repay the loan, regardless of your bankruptcy.