How to Declare Bankruptcy

Declaring Chapter 7 or Chapter 13 Bankruptcy

The two most common types of bankruptcies for individuals are Chapter 7 and Chapter 13, named for their corresponding chapters in the U.S. Code. The choice between Chapter 7 and Chapter 13 bankruptcy is largely determined by your finances:

  • Chapter 7: Liquidation – For low-income debtors. The court sells any nonexempt assets and uses the money to pay creditors. The rest of the debt is immediately discharged.
  • Chapter 13: Adjustment of Debts –For debtors with steady income. The filer agrees to a plan to repay a significant portion of the debt over three to five years. The rest is discharged.

The first step in declaring both Chapter 7 and Chapter 13 bankruptcy is the means test, a set of forms called schedules that determines whether you have the financial "means" to pay off your debts. To complete those forms, you will need the following information [source: U.S. Courts]:

  • List of all creditors and the amounts owed to each
  • Source, amount and frequency of your income
  • List of all of your property
  • Detailed list of your monthly living expenses

If the court determines that you don't make enough money to pay off even a portion of your debts, it will proceed with Chapter 7 bankruptcy. The court will assign an impartial trustee to sell all of your nonexempt assets and property, known as the bankruptcy estate. Since most property is exempt from sale under state and federal bankruptcy law, most Chapter 7 filers keep their homes, cars and personal belongings.

As part of the Chapter 7 process, most filers only appear in court once to meet with their trustee and creditors. One advantage of Chapter 7 is that all debt remaining after the liquidation of assets is discharged immediately.

In a Chapter 13 case, the debtor keeps all assets, but has to submit a repayment plant to the court. If the plan is approved, all debts are consolidated into one monthly payment, which can be automatically deducted from the debtor's paycheck. If the debtor earns less than the state median income, the repayment plan lasts three years. If the debtor earns more, it's five years [source: U.S. Courts]. Any remaining debt is discharged after successful completion of the repayment plan.

One consideration is that a Chapter 7 bankruptcy will stay on your credit report for 10 years, while a Chapter 13 bankruptcy is removed after only seven years [source: FICO].

Next we'll look at some of the laws that govern the bankruptcy process and why you should definitely hire a lawyer.