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Chapter 7 Bankruptcy Explained

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Chapter 7 Bankruptcy Explained

Written by Charles Newland on . Posted in Bankruptcy

A sad couple, bankruptcyChapter 7 bankruptcy is a useful tool for some individuals to discharge most of their debt. Chapter 7 bankruptcy, or “straight bankruptcy,” allows the filer to keep certain property exempt, while the rest is liquidated to satisfy the debt. Liquidation is the forced sale of an asset to satisfy an obligation, like loans or credit. The Bankruptcy Trustee would liquidate all of the filer’s non-exempt property to satisfy outstanding debts.

The credits then accept the payments in satisfaction of the debt; often it can be pennies on the dollar. Anything that is unpaid is discharged by the bankruptcy court.

Chapter 7 vs. Chapter 13

Chapter 7 completely discharges a person’s debt. Conversely, Chapter 13 discharges some debt and reorganizes the rest. The individual then submits a payment plan to the court which outlines how she will pay off the outstanding debts.

Qualifying for Chapter 7

Filing for bankruptcy under Chapter 7 is not available for everyone. If an individual does not qualify for Chapter 7, she must file under Chapter 13.

There are two eligibility tests, the median income test, and the means test. A person can qualify for Chapter 7 Bankruptcy under either test.

For a person to be eligible under the median income test, her total income must be below the median income in her state. For example, if someone earns $15,500 a year and the median income in her state is $15,501, her income would qualify her for Chapter 7 protection because it is below the median income level.

Failing that test, individuals may also qualify under a “means test.” In the means test, the court applies a complex formula devised by the IRS which subtracts food, rent, mortgage, and other essentials from your income and then applies additional calculations. The results of these calculations determine if a person is eligible for Chapter 7 protection.

Effect on Debt

Chapter 7 bankruptcy can discharge most, but not all, forms of debt. Certain debts are exempt, including:

  • Alimony;
  • Child support;
  • Property settlements from a divorce;
  • Tax debts;
  • Debts related to fraud;
  • Student loans; and others.

The filer remains personally liable for any debts that are not discharged.

Effect on Credit

Chapter 7 bankruptcy stays on the filer’s credit report for ten years (under Chapter 13 it is seven years). Bankruptcy on a credit report severely curtails that person’s ability to obtain loans, mortgages, credit cards, and other forms of debt.

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