How Chapter 7 Works
Chapter 7 is sometimes referred to as a "straight" bankruptcy. The overall process is pretty cut-and-dried. You file, and a trustee is appointed to review your petition. He ascertains what property you own and what debts you owe. He liquidates assets with enough value to justify their sale. He then gives the proceeds to your creditors. Even if your creditors do not receive all of what you owe, you're no longer responsible for the balances. Your debts are discharged when your bankruptcy is over.
About 90 percent of all Chapter 7 bankruptcy estates – the pool of assets or property available to a debtor – include no property that the trustee can liquidate. These are no-asset cases; there's literally nothing there for the trustee to sell. In this case, your debts are discharged entirely – your creditors receive no money. You might wonder how this is possible, because very few people own nothing at all, but bankruptcy law has built-in mechanisms that allow debtors to remove certain assets from their estates. This results in no non-exempt property for the trustee to sell.
Debtors commonly remove property from their bankruptcy estates through the use of exemptions. The federal government and individual states offer these lists of dollar values for various assets, and provided that your property is not worth more than your available exemptions, you're permitted to keep it. You can't mix and match exemptions from different lists; you must select one set in its entirety. Some states allow you to choose between their lists and the one offered by the federal government, but others don't give you a choice – you must use theirs. If you live in New York, the state's exemption for an automobile is $4,000. You can exempt $75,000 in equity in your home, and up to $10,000 in household goods or furniture. If your car is worth $3,500, there's no point in the trustee selling it, because your exemption covers all its value. If you have $100,000 of equity in your home, however, the trustee will probably force its sale – with a $75,000 exemption, $25,000 is left unprotected. The trustee can use this money to pay down your debts if he sells the property.
Secured loans, such as your mortgage or your car loan, can work in your favor as well. For example, your home may be worth $300,000, but if there's a mortgage against it in the amount of $325,000, there's no equity – it's underwater. Your trustee won't liquidate the property because he would have to give the entire sales proceeds to your mortgage lender. Therefore, you can keep the property if you address the mortgage. Your lender will probably ask you to reaffirm your loan and take it out of the bankruptcy proceedings. Instead of discharging the debt, you would sign a new contract and keep paying on the loan as though your bankruptcy never happened. If all your property is either secured by a loan that you've reaffirmed, and all equity is covered by exemptions, yours is a no-asset case. You won't lose any of your property.