When you are buried under piles of debt, it might feel like there's no way to climb out and regain your financial footing. The good news is there are some options that can help you get to a better place. As a last resort, many people with excessive amounts of debt often choose to file for Chapter 7 bankruptcy, but this choice does come with severe consequences that have a serious impact on your credit and other aspects of your financial future.
In order to file Chapter 7 bankruptcy, your accumulative debt has to equal more than half of your total annual income. Other indicators may be having debt that would take more than 5 years to clear or having your financial situation impact relationships or other parts of your life.
Before you jump in and start the process of filing for bankruptcy, there are several important things that you need to know, including the requirements and process of filing, as well as what to expect in the aftermath. Filing for Chapter 7 bankruptcy is a serious decision that will impact your financial life for years to come. Let's take a closer look at what you need to know about filing Chapter 7.
Chapter 7 Bankruptcy
Also known as the straight or liquidation bankruptcy, Chapter 7 bankruptcy can wipe out several different varieties of unsecured debt, including credit card debt.
Why Do People File for Bankruptcy?
Because everyone's financial situation is unique to their own life, there are tons of reasons that someone could be interested in pursuing Chapter 7 bankruptcy. However, many of the filers actually begin the process for very similar reasons, with the 3 most common being divorce, job loss, and medical debt. No matter what your reasoning for needing to file may be, an experienced bankruptcy lawyer will be able to assist you and guide you through the process.
Requirements to File
In order to file for Chapter 7, there are several requirements that need to be met in order to proceed with the filing. One of the biggest is the financial requirement. Your debt needs to be at least half of your total annual income. Otherwise, the average of your income over the last 6 months needs to be below the median income level for households of the same size in the state you reside in. If not, you can pass the means test, which determines whether or not you can afford to make partial payments on your debts based on how much disposable income you have.
Additional requirements to file include:
- You haven't filed for Chapter 7 bankruptcy within the previous 8 years
- You haven't filed for Chapter 13 bankruptcy during the previous 6 years
- If your attempt at filing bankruptcy was tossed out, it is required to wait at least 181 days before refiling
- Within 180 of filing for bankruptcy, you may need to finish a group or individual credit counseling course that is being offered by an approved credit counseling agency. This is not always required.
- If it is found that you are trying to defraud creditors, a judge is allowed to throw out your case.
The Consequences: How Filing for Bankruptcy Impacts Your Credit
After your bankruptcy has been completed, your credit report will reflect that the debts that were covered by your bankruptcy have been discharged. For 10 years from the date of your court case filing, your credit score will show your Chapter 7 bankruptcy. The longer it's been since the filing, the less your credit score will be impacted. Another thing that you may see is a drop in your credit score once the bankruptcy appears. Those that already had a lower score won't see as big of a hit, but if you had a higher credit score, then you'll probably see a fairly steep drop.
Future creditors see a bankruptcy on your file, and they're instantly aware that you had prior debt obligations that you were unable to fulfill. One of the risks that come with filing for bankruptcy is that a lender sees the bankruptcy on your credit report, and they decide they aren't willing to work with you at all until the bankruptcy has been discharged. Other lenders will see the bankruptcy and approve your application, but with some specific stipulations, including high-interest rates and other unappealing terms.
Rebuilding Your Credit After Bankruptcy
The good news about filing for bankruptcy is that your credit won't reflect this major financial decision forever. You can even begin the credit rebuilding process during the 10 years that the bankruptcy is shown on your report. Rebuilding your credit may seem like a daunting task, but there are some things you can do to begin improving your score right away.
- Monitor Your Credit: Since your chapter 7 bankruptcy can send your credit score into a tailspin for a minimum of 100 points, sometimes 200 or more, make sure that each item is discharged properly.
- Use Your Credit Responsibly: Don't overextend, and only use credit limits within your means. Be consistent with your payments and make sure they're made on time, every time.
- Build An Emergency Fund: Building an emergency fund can help prevent you from having to rely on a potentially high-interest credit card purchase in an emergency. A modest emergency fund can get you out of a tough situation and can potentially save you thousands in interest on a balance that you carry for months on a card.
- Lower Your Credit Utilization: Since your utilization makes up a huge portion of your credit score, keeping your total utilization lower than 30% can mean a much better reflection in your score.
- Be Patient: Rebuilding your credit isn't going to be instant, and in all likelihood, it will take a year or more to begin to see any meaningful changes in your score. Make sure you maintain the effort in the meantime, and your score will keep climbing.
How to File Bankruptcy Chapter 7
When it comes to filing for bankruptcy, this is not a process you should attempt to tackle on your own. The very first step to take before you file is looking into professional help with your case. Depending on the outcome of your credit counseling and a meeting with a financial advisor, you may decide that it's time to proceed with finding a lawyer to help you file your case.
Seeking Professional Help
Before you start the process of filing for bankruptcy, you should seek out help from a credit counseling agency. Many individuals end up being able to work with an agency to come up with a debt repayment plan that works with their current financial circumstances, avoiding bankruptcy altogether.
If your meetings with a credit counselor or financial advisor are not successful in avoiding bankruptcy, the next step you should take is finding an experienced bankruptcy lawyer that can help you through the process. Once you have decided on a lawyer to work with, you can refer creditors to your attorney rather than speaking with them directly.
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Filing Chapter 7 Bankruptcy
When working with a qualified attorney, you should expect the bankruptcy process to take about 4-6 months to complete. The process is time-consuming but can benefit you in the long run.
- The first thing the debtor will need to do is fill out several forms that detail their entire financial situation. This includes income, assets, liabilities, expenses, and any leases or contracts that are in their name.
- The next step is to complete the pre-bankruptcy credit counseling. This allows a qualified agency to look over your current finances to see if there are any alternative ways to handle your debt rather than filing bankruptcy.
- If your credit counselor decides that there aren't any options that will work, your attorney will fill out all proper forms; then they will go to the local bankruptcy court to file the bankruptcy petition.
- Next, all applicable fees will need to be paid before filing. Once filed, everything will be looked over by a trustee to ensure everything submitted is accurate. They will need to see all of your tax returns, bank statements, and check stubs.
- Next, if any of the creditors decide to go after the debts you want to be discharged, you'll need to have a meeting with the trustee and the creditor, where you'll be required to answer some questions regarding the information you provided.
- Now you'll need to show whether or not you fulfilled your promises about any secured debt you may have acquired.
- After that, you'll need to attend a debtor education counseling session. This is where you learn how to handle your debt to avoid ending up back in the same spot again.
- If everything goes according to plan and it is determined that you are approved for your bankruptcy, you will no longer be legally obligated to pay any of the qualified debts the judge dismisses.
Making The Decision To File Chapter 7 Bankruptcy
Deciding to file for chapter 7 bankruptcy is not a choice to be made lightly, and while there are some serious credit impacts, it can have, in some situations, the benefits outweigh those drawbacks. Filing can be complex, but once you do it, you will begin to experience immediate relief from the constant, crushing pressure of overwhelming debt. You will finally have the chance to catch your breath and begin to rebuild your finances.
Shawn Manaher is a former financial advisor, has founded 5 online businesses, and is a coach, speaker, podcast host, and author. He's been featured on The Consults Corner on TAE Radio, The Writing Biz, What's Your Story, and more.