What Are the Downsides to Filing Chapter 7 Bankruptcy?

By Heather Frances J.D.

Chapter 7 bankruptcy helps some debtors clear out old debts to start fresh, but it isn't a perfect solution to every person's debt problems. First, you have to meet certain income guidelines to file this type of bankruptcy case, and even if you do qualify, it may not be in your best interests to use Chapter 7.

Your Assets May Be Sold

Chapter 7 is often referred to as liquidation bankruptcy because the debtor's nonexempt assets are sold by a court-appointed bankruptcy trustee who uses the sale proceeds to pay down the debtor's debts. Though many assets qualify for exemptions based on state or federal laws, each debtor's circumstances are unique. For example, you might be able to keep one vehicle, but be forced to sell another one if your state's exemption list only exempts one. Other types of bankruptcy, such as Chapter 13, do not require the sale of assets.

Not All Debts Can Be Discharged

The biggest benefit of Chapter 7 is the discharge, or erasure, of certain debts. Generally, the bankruptcy process allows the debtor to retain some necessary assets while erasing some of his outstanding debt. However, Chapter 7 discharge does not apply to all debt, and you could leave the bankruptcy case owing nearly as much as you owed to begin with, depending on the type of debts you have. Debts you cannot discharge include family support obligations, government-backed student loans, and certain taxes. If your debt load primarily consists of such debts, Chapter 7 may not be the best choice for you.

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Time Limits Apply

Although you can file for bankruptcy more than once, Chapter 7 bankruptcy rules allow a discharge only once every eight years. Thus, you cannot regularly file for bankruptcy to continue discharging debts as you accumulate them. Mandatory credit counseling helps debtors learn skills to avoid getting back into debt, but if you fall on hard times or do not apply the credit skills you learn, you may struggle financially before you are allowed to file a Chapter 7 bankruptcy case again.

Negative Impact on Credit Rating

Your bankruptcy case will be reported to the three major credit bureaus, and lenders can see it on your credit report. This hurts your credit rating, and it may be difficult for you to obtain credit for years after you complete your bankruptcy case. Thus, even if you are in better financial shape after your bankruptcy, you may not be able to get a new credit card or obtain a home loan until several years have passed. You can help rebuild your credit score after bankruptcy by making timely payments on your remaining debts.

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Advantages & Disadvantages to Declaring Bankruptcy

References

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