What Are the Downsides to Filing Chapter 7 Bankruptcy?

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Chapter 7 bankruptcy helps some debtors clear out old debts to start fresh, but it isn't a perfect solution to every person's debt problems. First, the debtor must meet certain income guidelines to file this type of bankruptcy case, and even if she does qualify, it may not be in her best interests to use Chapter 7.

The Debtor's Assets May Be Sold

Chapter 7 is often referred to as liquidation bankruptcy, because the debtor's nonexempt assets are sold by a court-appointed bankruptcy trustee who uses the sale proceeds to pay down the debtor's debts. Though many assets qualify for exemptions based on state or federal laws, each debtor's circumstances are unique. For example, a debtor might be able to keep one vehicle but be forced to give up another one to the trustee if he can't exempt the equity. At that point, he must either buy his own car from the trustee or let the trustee sell it.

Other types of bankruptcy, such as Chapter 13, do not require the sale of non-exempt assets; instead, the debtor must pay his creditors what they would have received if he had filed Chapter 7. Rather than giving up the car, he simply pays the non-exempt equity into a repayment plan.

Not All Debts Can Be Discharged

The biggest benefit of Chapter 7 is the discharge, or erasure, of the debtor's liability for certain debts. Generally, the bankruptcy process allows the debtor to retain some necessary assets while erasing some of his outstanding debt. However, the Chapter 7 discharge does not apply to all debt, and you could leave the bankruptcy case owing nearly as much as you owed to begin with, depending on the type of debts you have. Debts you cannot discharge include family support obligations, government-backed student loans, and certain types of taxes. If the debt load primarily consists of such debts, Chapter 7 may not be the best choice for that debtor.

Read More: How Long Before Debt is Discharged After Bankruptcy?

Time Limits on Multiple Chapter 7 Filings

Although you can file for bankruptcy more than once, Chapter 7 bankruptcy rules allow a discharge only once every eight years. Thus, a debtor cannot regularly file for bankruptcy to continue discharging debts as she accumulates them. Mandatory credit counseling helps debtors learn skills to avoid getting back into debt, but if a debtor falls on hard times again, she may struggle financially before she is allowed to file a Chapter 7 bankruptcy case again.

Negative Impact on Credit Rating

Any bankruptcy case will be reported to the three major credit bureaus, and lenders can see it on the debtor's credit report. This hurts the debtor's credit rating significantly, and it may be difficult for him to obtain credit during the first few years after the bankruptcy case. Thus, even if the debtor is in better financial shape after his bankruptcy, he may not be able to get a new credit card or obtain a home loan until several years have passed. He can rebuild his credit score after bankruptcy by making timely payments on his remaining debts, such as rent or home mortgage payments. Bankruptcy stays on credit reports for 10 years.

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