Drowning in Consumer Debt? Chapter 7 Might Be the Answer

We live in a time of economic distress and uncertainty, often reflected by high levels of debt being carried by families and individuals. When you start to miss payments and become delinquent on bills, you should consider whether Chapter 7 bankruptcy could be right for you.

Basically, Chapter 7 of the U.S. Bankruptcy Code allows a consumer a "fresh start." After Chapter 7, the debtor can go forward with life, but free of the crushing debt load of the past.

A Chapter 7 bankruptcy usually remains on the debtor's credit report for 10 years, although this does not mean you have bad credit for 10 years. Most people have a score in the 600s within one year after filing bankruptcy. Credit scores will continue to go up as debtors make payments on time.

According to the Administrative Office of the U.S. Courts, 2010 saw 1,593,081 federal bankruptcy filings. By far the most numerous were those filed under Chapter 7 for personal, nonbusiness debt at 1,100,116 filings.

Chapter 7 is commonly also called a liquidation bankruptcy or a straight bankruptcy. A simple summary of the Chapter 7 process:

  • The debtor files a petition in federal bankruptcy court that triggers an automatic stay under which his or her creditors must stop trying to collect all of the person's debts.
  • The debtor's nonexempt assets are sold by a bankruptcy trustee with the proceeds going to pay off debts. Exempt assets may be kept by the debtor.
  • Secured debt (loans secured by property like home mortgages and car loans) can continue to be paid by the debtor during Chapter 7, allowing him or her to retain the asset. If the debtor falls behind on secured payments, the lender can ask the court to take the asset back.
  • The trustee will first pay priority claims like taxes, followed by unsecured debt like credit cards. Basically unsecured creditors split proportionately the remaining money.
  • Remaining debt is legally forgiven.

As a practical matter, most consumers don't end up selling off much or any property because most of the assets of the average consumer are exempt. Which assets are exempt from the trustee sale is determined by federal or state law, depending on the state. For example, in Colorado, state law applies and spells out exactly what and how much of the debtor's property is out of reach of the trustee and may be kept by the debtor in Chapter 7.

This article is a brief overview of Chapter 7; the actual provisions are more complex. If you face mounting bills and there is not enough money to keep current on everything, talk to a skilled bankruptcy attorney about your options and whether Chapter 7 or another type of bankruptcy might help to solve your financial problems.