What happens when you file for bankruptcy?

When bills are piling up and there isn’t a clear way forward, filing for bankruptcy may help people get a fresh start. But it’s often a last resort and can hurt credit. Read on to learn more about what happens when someone files for bankruptcy, the different types and the potential consequences. 

Key takeaways

• Chapter 7 and Chapter 13 bankruptcies are the most common types for individuals who are struggling with debt. 
• A Chapter 7 bankruptcy may discharge unsecured debt, while a Chapter 13 bankruptcy will set up a new repayment plan.
• Both types of bankruptcies can help give individuals a fresh start, but they can also damage credit for years.   

While federal courts govern the bankruptcy process across the country, the exact steps for declaring bankruptcy can depend on the type of bankruptcy. State laws can also determine the types and amount of personal property individuals can keep.

Individuals will generally start by completing a mandatory credit counseling course with a court-approved credit counselor before filing for bankruptcy. The bankruptcy filing triggers an automatic stay. That means creditors are temporarily prohibited from trying to collect on debts.

A court-appointed trustee or administrator will oversee the bankruptcy—and the individuals who file may actually never appear in court. Depending on the type of bankruptcy, the trustee or administrator can sell the individual’s nonexempt property to their creditors or oversee their repayment plan. At the end of the process, the court discharges the debts included in the bankruptcy. 

Chapter 7 vs. Chapter 13

Two common types of bankruptcies for individuals are Chapter 7 bankruptcy and Chapter 13 bankruptcy. 

• Chapter 7. A Chapter 7 or liquidation bankruptcy is available to individuals who don’t have enough income to repay their creditors. A Chapter 7 bankruptcy involves selling nonexempt property and having the remaining unsecured debts that aren’t attached to collateral discharged. The process typically takes a few months. Exemptions determine which types of personal property and how much of it individuals can keep, such as their cars or work-related tools. 
• Chapter 13. A Chapter 13 bankruptcy could be a good option for individuals who want to keep their home and other property. If an individual has a regular income and exceeds the maximum debt limits to file Chapter 7, Chapter 13 may be appropriate. With this type of bankruptcy, individuals will start a three- to five-year repayment plan and make payments to the trustee or administrator, who will forward the money to the creditors. The remaining unsecured debts included in the repayment plan are discharged once the plan is completed.

Filing for bankruptcy can be a complicated process. While hiring a bankruptcy attorney is not required, an attorney can help individuals decide if filing makes sense, determine which type of bankruptcy to file and assess how the bankruptcy will affect assets and debts. 

With a Chapter 7 or Chapter 13 bankruptcy, the process typically involves the following steps:

• Pre-filing credit counseling. One of the first steps is to complete a credit-counseling course with a court-approved credit counselor online or by phone. Once the course is complete, individuals receive a certificate of completion that is valid for 180 days.  
• File the necessary forms. These forms require information about finances, property, debts and creditors. After the filing, individuals may also have to send copies of financial documents—such as tax returns—to the trustee or administrator.
• Attend a 341 creditor meeting. Individuals will have a meeting with their trustee or administrator and creditors to discuss the bankruptcy. Individuals who file for bankruptcy will answer questions under oath about their finances and filing. These are called 341 meetings, named after Section 341 of the Bankruptcy Code. 

The next steps can vary. 

With a Chapter 7 bankruptcy, individuals have to take a financial management course and send the certification of completion to the court within 60 days. The trustee will assess the debtor’s assets and debts and determine if any distributions will be made to creditors. The court may then discharge the debtor’s remaining unsecured debts. 

With a Chapter 13 bankruptcy, individuals will start making monthly payments to the trustee or administrator. Unless the court doesn’t approve the repayment plan or the creditors object, these payments will continue. Once payments are complete and a debtor education course has been completed, the court may discharge the debtor’s remaining unsecured debt.

While bankruptcy can be helpful for individuals who are overwhelmed by debt, there are several disadvantages to consider.

Impact to credit scores

Filing for bankruptcy may have a negative impact on credit scores. The bankruptcy filing is added to the public records section of credit reports and will continue to affect scores while it’s listed on someone’s credit reports. The major credit bureaus may leave bankruptcy filings on credit reports for up to 10 years from the filing date, but they typically remove a discharged Chapter 13 bankruptcy seven years after it’s filed. 

Other financial and personal impacts of filing bankruptcy

Creditors consider various factors when deciding who to lend money to and the terms to offer. Even if credit scores improve, bankruptcy filing is considered a negative mark on credit reports. 

Individuals may find it more difficult to get approved for a loan or line of credit after filing bankruptcy, and even if they are approved, they may be offered less favorable interest rates and terms. It could also be more difficult to rent a home after filing for bankruptcy. 

Additionally, a bankruptcy won’t necessarily discharge all debt. For example, court-ordered alimony or child support and most student loans are not usually discharged during a bankruptcy. And if someone else co-signed for a debt that was included in an individual’s bankruptcy, the co-signer may be responsible for repaying some or all of that debt.

While a bankruptcy can hurt credit, the impact can diminish over time, and individuals can take steps to improve their credit over time by using credit responsibly. That can mean making on-time payments and not getting close to their credit limit. Individuals might also want to consider applying for a secured credit card or a credit-builder loan to build credit.

Bankruptcy may be a last resort, but it can be helpful in certain circumstances. If you’re considering bankruptcy, it’s a good idea to do as much research as you can about the filing process and consequences of the different types of bankruptcy so you can weigh the pros and cons. You may also want to consult with an attorney who can offer advice based on your situation. And know that your credit will be affected, but you can take steps to improve your credit over time.