Does Bankruptcy Clear All Debt?

Filing for bankruptcy doesn't clear all types of debt. Exceptions include student loans, alimony and child support. But bankruptcy can protect you from other types of debt, including mortgages, car loans and medical debt.

Of course, exactly what happens to you once you file for bankruptcy will differ depending on your financial situation and the type of bankruptcy. We’ve provided an overview of what bankruptcy is, how it works, and the types of debt that gets cleared.

What Bankruptcy Is And How It Works

Bankruptcy is a type of legal process for those who are experiencing insolvency, meaning, they can no longer pay their debt or loan obligations. Think of bankruptcy as a "fresh start" for those who are struggling financially for an opportunity to get back on their feet.

There are a lot of factors to consider, such as the possibility of repossession and other collection actions regarding both your secured debt and unsecured debt. Depending on what type of bankruptcy you file, you may be beholden to certain obligations, such as giving up certain assets or using non-exempt property to pay back creditors. The process to file for bankruptcy starts by you (typically referred to as the debtor) filing a petition to the bankruptcy courts.

Your case will then be handled under the U.S. Bankruptcy Code in federal courts. Before filing bankruptcy, you are required to complete a credit counseling course that's approved by the Department of Justice. The course needs to be completed within 180 days before you file your bankruptcy petition — the court will ask for a Certificate of Credit Counseling. Once you file for bankruptcy, the courts will automatically enact a stay prohibiting debt collectors from contacting you about your debts. It can stop any foreclosures and wage garnishments.

You need to pass a means test before being allowed to move onto the bankruptcy filing process. As in, the courts are looking to determine whether you don’t have enough disposable income (what you earn after taxes and certain expenses) to be able to pay back your loans and afford the daily necessities.

In essence, you will need to provide paperwork showing your annual disposable income is lower than your state's median income. You will also need to show a detailed list of your necessary expenses (the courts usually determine what is considered "allowable expenses"). If you don’t pass the means test, you may qualify for Chapter 13 bankruptcy, or wait at least 6 months before reapplying if you want to qualify for Chapter 7 bankruptcy.

The individual or couple who files for bankruptcy will also have to provide a list of their assets, such as their home, cars, investments, and bank accounts. These assets are then used to determine whether you need to go through liquidation proceedings, such as selling or giving up certain assets to pay back debt collectors.

When all your paperwork is submitted, a bankruptcy trustee will be appointed to represent your estate. Then the judge and trustee will handle most of the case (including determining whether you pass the means test). In most cases, you don’t need to appear in court for the proceedings. However, you will need to attend a 341 meeting, or a meeting with your creditors around a month after your petition is filed. This is where the creditor can ask you or your court trustee (if present) any questions about your bankruptcy case.

Since filing for bankruptcy means you will have to navigate through potentially complex laws and provide a lot of paperwork, it may be a good idea to consider consulting with a bankruptcy attorney. In some cases, it may be best to file for bankruptcy through an attorney instead of doing it yourself.

Types Of Bankruptcy For Individuals

The two different types of bankruptcy available to individuals are Chapter 7 and Chapter 13 bankruptcy. Each differs in terms of the types of debt you can clear based on bankruptcy laws and a bankruptcy lawyer can help walk you through this.

Chapter 13

Also called a wage earner's plan, Chapter 13 bankruptcy offers the opportunities for those who didn't pass the means test to establish a repayment plan with their creditors. More specifically, you will negotiate a payment plan to pay back your loan in installments within 3 – 5 years. Within the approved repayment period, creditors you’ve worked with aren’t allowed to move your debt into collections. In most cases, you may be able to keep your assets or property, including ones that are normally nonexempt.

Chapter 7

A Chapter 7 bankruptcy is where the courts will gather and sell off what's called non-exempt assets and use the proceeds to pay back your creditors. Or you may be able to keep the property if you are able to negotiate how you can keep current on loans (as long as you are following the bankruptcy laws). You are usually allowed to keep non-exempt property, though you may still have to sell off all or part of certain assets in order to keep it. The courts will also determine what debts can be discharged, effectively giving you a fresh start to your finances. However, Chapter 7 has the most serious effect on your credit report.

Debts That Bankruptcy Clears

If your bankruptcy case is approved for Chapter 7, then you are most likely able to discharge the following debts:

• Mortgage loans
• Credit card debt
• Medical bills
• Personal loans
• Car loans
• Personal loans
• Unpaid utility bills
• Phone bills
• Judgements from unpaid unsecured debt
• Loan balances after your property is foreclosed on or repossessed

Debts That Bankruptcy Doesn’t Clear

Even if you face undue hardship, there are debts that you can’t clear, or are considered non-dischargeable. These debts include:

• Student loans
• Child support
• Alimony
• Fraudulent debts
• Tax debt from the last 3 years
• Debts that are related to divorce proceedings
• Debts due to personal injuries you caused while under the influence of alcohol or drugs
• Court fines or penalties
• Money owed to the government

What Filing For Bankruptcy Does To Your Credit

While your financial situation may need a fresh start, keep in mind that if you do file for bankruptcy, it will show up on your credit report as a negative remark. As such, your credit score could be negatively affected— it remains on your credit report for up to 7 years for Chapter 13, and up to 10 years for Chapter 7. Part of the reason is because it shows that you're not paying your debts in full as you had originally agreed. Considering your payment history is one of the most important factors affecting your credit score, having a negative payment history could drastically lower it.

You may find it difficult to apply and be approved for any new loan or credit applications you submit. Even if there is a lender that is willing to work with you, the loans you may qualify for could have higher than average interest rates and less favorable terms. Since bankruptcy could have a huge effect on your financial life, it’s wise to consider carefully (including alternatives) before filing a petition.

Alternatives To Bankruptcy

Some alternatives to bankruptcy to consider include:

• Go to credit counseling: Working with a reputable counselor who can help you work out a debt management plan may be better if you’re not interested in giving up any of your assets or property. Or, you would rather not have extremely negative consequences to your credit score.
• Negotiate payment plans directly with creditors: Depending on the types of loans you owe you may be able to plead your case directly with your creditors to come up with repayment plans.
• Take out a consolidation loan: If you can qualify for a lower interest rate, consider taking out a consolidation loan to get a handle on debt management. You will use the loan proceeds to pay off your other unsecured debts, leaving you with one monthly payment. Ideally, it’ll help you simplify your debt repayment and owe less in interest overall.

FAQs: Does Filing For Bankruptcy Eliminate Debt?

Which type of bankruptcy clears all debts?

Chapter 7 bankruptcy will clear most of your debts, though not all.

Which debts will bankruptcy not erase?

Debts that bankruptcy won’t erase include student loans, alimony, child support, tax debts and any debt related to divorce proceedings.

How much does filing for bankruptcy cost?

Filing for bankruptcy can cost several hundred to several thousand dollars depending on your state and whether you file it yourself or by hiring an attorney. The more complex your bankruptcy case, the more it could cost.

What is the downside of filing for bankruptcy?

Filing for bankruptcy can be an expensive and time-consuming process, since you will most likely need to consult an attorney and have to take the time to provide a ton of documentation.

How will filing for bankruptcy hurt my credit score?

Filing for bankruptcy will negatively impact your credit score because there will be a negative remark on your credit report. Filing for Chapter 7 bankruptcy shows that you didn’t pay back your debts as promised, negatively impacting your payment history, which is a major factor in calculating your credit score.

The Bottom Line: Bankruptcy Doesn't Discharge All Debts

Filing for bankruptcy should be seen as the last resort due to the financial consequences you may face. For one, your credit score could be negatively impacted, whether you successfully filed for Chapter 7 or Chapter 13 bankruptcy. As such, your credit score could go down significantly, affecting your chances of qualifying for a loan, or one with more favorable interest rates and terms. Plus, Chapter 7 means you may be forced to sell off your property in order to pay back your creditors. If there is property you want to keep and it doesn’t fall under the non-exempt property, you may be out of luck.

If you’re not sure whether bankruptcy is the path for you, consider alternatives first. You can even consult a bankruptcy attorney — there may be low-cost or free services available depending on your income — to determine what is best for your financial situation. Even if you do determine that bankruptcy is best, you can start taking steps now to help you improve your financial situation as soon as bankruptcy proceedings are done.

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