Chapter 7 Bankruptcy filing and Exemptions

You can file Chapter 7 if you're in any of the situations given below:

• You don't have any cash to pay off debts.
• You don't have cosigners to repay debt.
• Your creditors may sue you.
• Some of your accounts are in collection.

You need to fulfill the following criteria in order to qualify for Chapter 7 bankruptcy.

• Credit counseling: You must have attended a credit counseling session within 6 months prior to filing chapter 7 bankruptcy.


• Means Test: You should have passed Chapter 7 bankruptcy Means Test irrespective of whether you are solvent or insolvent. Under the Means Test, if your income is less than the median income of your family size in your state, you can qualify for chapter 7. Check out how Means Test determines if you qualify for chapter 7 or 13.


• Prior bankruptcy: You haven't received a Chapter 7 bankruptcy discharge within past 8 years or Chapter 13 discharge within past 6 years.


• Bankruptcy dismissal: You have not come across a bankruptcy dismissal within the past 6 months on account of failure to appear before court or follow court orders.

The assets which are sold off to pay creditors are mainly liquid assets, that is, those which can be easily converted into cash (such as checking and savings accounts). However, you'll have to list all your assets under Chapter 7. The trustee will then decide which can be sold off to repay debt.

Assets to be listed are:

• Real property you own individually or with a co-owner
• Property received as gift, inheritance or divorce settlement
• Life insurance proceeds
• Personal property - household items, cash, retirement money etc.

Whether you'll be able to keep all the above assets will depend upon Chapter 7 bankruptcy laws regarding exempt and non-exempt assets.

Chapter 7 bankruptcy laws provide exemption on the sale of certain assets. Such assets are known as exempt assets. Bankruptcy Chapter 7 exemptions are of 2 types - Federal and state homestead exemptions (vary from state to state). Around 16 states allow debtors to opt for either the Federal exemptions or bankruptcy Chapter 7 exemptions allowed by the state itself. In other states, the debtor can avail only the state exemptions.

Exemptions on house and car:
Bankruptcy Chapter 7 exemptions apply only if you have equity (your current home value minus costs of sale less balance on mortgage or other liens) in the property. If your home equity exceeds the Federal or State exemption, whichever you choose, you may lose the home. However, if you have no equity in the house, it cannot be used to pay off your debts. In such a case, you can keep the home as long as you pay for the liens.

In case of a car too, if you have no equity, you can keep it with you. If you have equity in the car which exceeds the exemption, it can be sold off to repay your car loan. Know more on bankruptcy Chapter 7 exemptions.

If you still owe money after the property is sold off to pay your lender, then you can reaffirm the debt and remove the lien on your property (home or car).

Other Exemptions:
There are certain assets which are unaffected by Chapter 7 bankruptcy. Such assets are your Pension and 401(k) or 403(b) retirement plans protected by the Employee Retirement Income Security Act. Social security benefits are also protected from legal actions while you're in bankruptcy. Traditional and Roth IRAs (Individual retirement accounts) are exempted up to $1 Million as per bankruptcy law enforced in 2005.

Moreover, IRA assets rolled over from 401k or 403b plans come under bankruptcy Chapter 7 exemptions and have unlimited protection (not limited to $1 Million) from creditors' claims. Such protection does not depend upon the debtor's state or the value and growth of rollover assets.

However, if the debtor receives minimum distribution, hardship distribution, or 72(t) distribution, his IRA is no longer protected from creditors. Moreover, if money is withdrawn, the IRA accounts are no longer protected under bankruptcy.

Here are some of the pros and cons of filing Chapter 7 bankruptcy.

Pros:

• No Personal liability: Chapter 7 releases your personal liability towards debts. You receive a discharge order within 4 months of filing the petition.


• Exemptions: You can retain certain assets as per Exemptions under chapter 7.


• Prevents legal actions: Once you file Chapter 7, it stops legal actions taken by your creditors. Such actions can be lawsuits, judgments, foreclosure, repossession, wage garnishment and collections. As per Chapter 7 bankruptcy laws, creditors shouldn't even make harassing calls demanding payments from debtors.


• Fresh financial start: Since Chapter 7 discharges your debts, you get the chance to organize and manage your finances better.

Cons:

• Lose assets: You lose assets as they are sold off to pay your creditors/lenders.


• Retain property liens: Chapter 7 does not remove property lien due to secured debts (mortgage or car loan). So, even if you get a discharge, you'll have to pay off the lien in order to save your property from foreclosure or repossession.


• Effect on Credit Score: Your credit score drops down by 250 points or so when you file file Chapter 7 bankruptcy. The bankruptcy remains on your credit report for about 10 years.


• New credit/mortgage: It's difficult to qualify for new credit or mortgage after you file Chapter 7 bankruptcy. If the market isn't doing well, no lender would offer you a mortgage even at higher rates of interest. It'll take at least 2 years to qualify for an FHA loan and 4 years for a conventional mortgage at affordable rates of interest. Check out a forum discussion on getting mortgage after bankruptcy.

No doubt bankruptcy chapter 7 helps you eliminate debts but there are negative aspects as well. You need to understand how it can work in your favor. Only then you can use it to your benefit and lead a debt free life.