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Chapter 7 – Liquidation Bankruptcy

Overview

The most common type of bankruptcy for individuals is known as Chapter 7, or Liquidation Bankruptcy. This bankruptcy structure is designed to liquidate an individual debtor’s assets, and then to use the funds to pay the creditors to whom debts are owed. Once that step is taken, any debts that have not been paid are mostly written off, since the debtor has nothing else that can be used to settle debt. A couple of exceptions to debt that is written off include child support and student loan debt. This type of bankruptcy is sometimes referred to as “straight” or “ordinary” bankruptcy. To liquidate assets means to turn them into cash, or sell. When this is done, the creditors that are owed money receive some of it back, but in many cases, they are also forced to write off a good amount of the debt.

Consequences of Chapter 7 Bankruptcy

Chapter 7 – Liquidation Bankruptcy

Filing for Chapter 7 bankruptcy is considered a fresh start, a way to wipe one’s credit slate clean. It can serve as a big relief to the debtor, but it also damages their credit very significantly. The Fair Credit Reporting Act states that a Chapter 7 bankruptcy may appear on one’s credit report for 10 years from the date it is filed. This means that future borrowing of all kinds becomes difficult. To secure themselves against the risk of lending to someone that has a record of being less than reliable with their financial debts previously, financial institutions may deny financing, charge higher interest rates and / or require a cosigner. Having these consequences to consider, debtors often try to avoid bankruptcy unless it is truly a last resort, especially if they know they will need to seek car or home financing, or need a credit card in the near future.

What Happens to the Home You Own if you File for Chapter 7 Bankruptcy?

If a debtor owns their home, and files for Chapter 7 bankruptcy, they may lose their home. There are two main conditions for losing your home during this process:

  • Being behind in mortgage payments
  • Having a significant amount of equity in your home

If a property is mostly owned by a bank, and a homeowner filing for Chapter 7 does not have much equity, it really cannot be effectively liquidated to pay creditors. If the homeowner is behind in mortgage payments, the bank that owns the mortgage will start short sale or foreclosure proceedings. This is a separate process from the bankruptcy filing.

Homestead Exemptions

In some cases, homeowners filing for Chapter 7 can keep their home even if there is equity in it. This can sometimes be achieved with the Homestead Exemption. All states have a system of bankruptcy exemptions that a bankruptcy filer can use to protect their property. In most states,this is based on dollar value of the property, but some states limit the number of acres you can protect from creditors.The amount of the homestead exemption depends on the following factors:

  • Where and when the property was purchased
  • Whether the state in which the debtor is filing allows the use of federal exemptions
  • Whether the debtor has moved within the last few years
Chapter 7 – Liquidation Bankruptcy

Homestead exemptions can be Federal or State. State homestead exemptions vary greatly from state to state, from just a few thousand dollars in equityto as much as $500,000, or even the entire value of the property. It is important to research state-specific exemptions when considering filing for Chapter 7 bankruptcy. The Federal law also has a list of homestead exemptions. If a debtor can’t claim state residency,he or she can use Federal exemptions. This is not a common scenario, but it does happen.In some states, debtors are allowedto choose between State and the Federal exemptions, but it is them an either / or scenario, as they cannot be combined.

A limit exists in the bankruptcy code regarding the amount of equity one can exempt if there is a move to another state. This exists to prevent debtors from moving to another state just for a more advantageous exemption. Debtors that have owned a home continuously in a state for at least 40 months, can usually exempt the total amount of equity in the property that’s allowed under the exemption. Another key Federal bankruptcy code rule that can affect a homestead exemption is the 730-day rule. To use the state or federal exemptions, in the cases the state allows it, you must live in the state for at least 730 days. If that requirement is not met, one would apply the exemptions of the state wherehe or shelived for the better part of the 180 days immediately before the 730-day period.

How to Decide Whether to File for Chapter 7 Bankruptcy

Making a decision to file for Chapter 7 bankruptcy should be a thorough and involved process. Taking the below steps can help you decide whether Chapter 7 is the best route for you:

  • Step 1 Obtain a copy of your most recent credit report and review it thoroughly.
  • Step 2 From your credit report, make a list of all debts, and assess how much you can pay towards them every month. This will likely require you to look at your monthly spending and earning, and put together a budget.
  • Step 3 Contact your creditors and attempt to negotiate a payment plan that fits into what you can afford.
  • Step 4 If you see something on your credit report that you consider to be invalid, such as a bill you never received, you can try to appeal the debt in writing. This usually starts as a formal written request to the creditor asking for more information about the debt.
  • Step 5 If there is a debt you cannot settle on your own, but you want to avoid filing for bankruptcy, you can consider defaulting on it and accepting the hit your credit score takes, as it is likely to have a lesser impact than bankruptcy. In these cases, know that the creditor has the right to take you to court, and exercising that right might result in a court-ordered judgment against you to pay the debt.
  • Step 6 Assess how likely you are to need financing in the next ten years. Will you need to purchase or lease a car? Rent a residence? Take out a personal, home equity or construction loan? Do you need to have a credit card in order to cover unexpected expenses that come up for you or your family? Do you have cosigners? If you are likely to need financing and you do not have potential cosigners with a good credit rating, you may want to avoid bankruptcy.
  • Step 7 Consult the professionals, including lawyers that specialize in bankruptcy, accountants, and financial advisors. They can help you understand your options and select the best course of action.

Filing for Chapter 7 bankruptcy is a complex process, and not one that should be entered into lightly. It is imperative to conduct thorough research into the applicable State and Federal laws, and to take a detailed look at one’s credit history, assets, and liabilities.

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