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Ch. 7 Bankruptcy: Pros & Cons

Filing for Chapter 7 bankruptcy can be an effective way for those who are struggling with debt to get a fresh financial start. In many cases, it may be possible to have eligible debts discharged within weeks or months of filing. However, it is important to understand that a Chapter 7 bankruptcy may stay on a credit report for up to 10 years, and it may not be an option for everybody.

Key Advantages of Chapter 7 Bankruptcy

A Stay on Debt Collections

When an individual files for Chapter 7 bankruptcy, creditors are generally not allowed to make contact with a debtor. This means that they cannot call, write or otherwise inquire about a debt. If a creditor or debt collector has any questions about a debt or its status, that party must generally contact the debtor's attorney or other representative.

Discharges Nearly All Debts

Nearly all unsecured debts, such as credit card or medical debt balances, can be eliminated by filing for a liquidation bankruptcy. It may also be possible to eliminate a judgment against an individual by filing for this type of bankruptcy as well. Formal or informal debts owed to friends, family members or employers may also be eliminated by filing for Chapter 7 bankruptcy. However, it may still be in that person's interest to pay off those debts at some point.

Retain Some Property

When an individual files for Chapter 7 bankruptcy, a trustee will conduct an inventory and earmark certain items for liquidation. However, state laws generally protect certain types of property or the equity that may have been accrued in an asset. For instance, New York allows debtors to retain between $75,000 and $150,000 in equity depending on where a property is located.

Halts Lawsuits

Perhaps the best reason for an individual to file for bankruptcy is that it puts a halt to existing or planned lawsuits. While a creditor is under no obligation to accept less than it is owed, bankruptcy may provide a debtor with leverage. In many cases, a creditor may accept less than what it is owed if it risks getting nothing from someone who files for bankruptcy.

Key Disadvantages of Chapter 7 Bankruptcy

Damage to Credit

Prior to filing for bankruptcy, an individual should consider that doing so could lower his or her credit score by 50, 100 or even 200 points. The exact drop depends on what a person's credit score was prior to filing. Furthermore, it may be harder or impossible to get an unsecured credit card, rent an apartment or get a mortgage for between a year to three years after filing.

A Chapter 7 bankruptcy will stay on your credit report for up to 10 years. This is longer than the seven years that all other information will remain on a credit report for. Therefore, those who file may have to explain that item for three extra years. However, most lenders only look at information from the last year, so the impact may be negligible for some.

Eligibility Requirements Exclude Some

While most people may qualify for bankruptcy protection of some kind, it may not necessarily be Chapter 7 bankruptcy. To qualify for Chapter 7, the filer must be an individual or married filing jointly or a sole proprietor with personal liability for business debts.

Furthermore, individuals are generally unable to file for Chapter 7 protection if they have had debts discharged through this chapter in the last eight years. The same is true if they have had a Chapter 7 case dismissed within the last 180 days or a Chapter 13 discharge within the past six years.

Depending on how much an individual makes per year, they may have to pass a means test prior to filing. In addition to a person's yearly income, the court may look into whether a person has sufficient assets to sell or otherwise leverage to pay their debts without getting a discharge through bankruptcy.

Some Debts Remain

There is a variety of debts that will not go away even if a person files for bankruptcy. For instance, income taxes that are less than three years old cannot be discharged in any type of bankruptcy. The same is generally true for alimony or child support payments.

Most secured debts are not eligible for discharge in a Chapter 7 case as the lender has an interest in the asset. However, filing for bankruptcy may provide time to come to new loan terms. If that doesn't work, it may be necessary to file for Chapter 13 bankruptcy instead.

Those who don't think that they can repay their debts in the next three to five years may be best served by filing for bankruptcy. However, it may be a good idea to talk with an attorney or a financial adviser prior to doing so. This may make it possible to learn more about the potential benefits and drawbacks of filing and whether it is in a person's best interest to do so.

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