What Is Bankruptcy? Chapter 7 vs Chapter 13 Explained

Bankruptcy is one of the most misunderstood financial tools out there. For many people, the word itself carries shame — like it means you’ve failed. But bankruptcy is a legal process established by federal law, designed to give honest people a fresh start when their debts become unmanageable. It’s not a moral judgment. It’s a practical option that millions of Americans have used to get back on their feet.

Let’s break down what bankruptcy actually is, how the two most common types work, and when it might — or might not — be the right move for you.

What Bankruptcy Actually Is

Bankruptcy is a federal court process governed by the U.S. Bankruptcy Code (Title 11 of the United States Code). When you file for bankruptcy, the court steps in between you and your creditors. An “automatic stay” goes into effect immediately, which means creditors must stop all collection actions — no more calls, no lawsuits, no wage garnishments — while the case is active.

A court-appointed trustee reviews your finances, and depending on which type of bankruptcy you file, your debts are either wiped out (discharged) or restructured into a repayment plan you can actually afford.

There are several types of bankruptcy, but the two that apply to most individuals are Chapter 7 and Chapter 13.

Chapter 7: Liquidation Bankruptcy

Chapter 7 is what most people think of when they hear “bankruptcy.” It’s sometimes called “liquidation” because, in theory, a trustee can sell your non-exempt property to pay creditors. In practice, most Chapter 7 cases are “no-asset” cases — meaning you don’t lose anything.

Who Qualifies

To file Chapter 7, you need to pass the means test. This test compares your household income to the median income in your state for a household your size. If your income is below the median, you qualify automatically. If it’s above, you may still qualify after deducting certain expenses — but it gets more complicated.

For example, in 2025, the median income for a single earner in Texas was about $58,000. A family of four in California had a median around $107,000. These numbers are updated regularly and vary by state.

What Happens

1. You file a petition with the bankruptcy court and submit detailed financial documents — income, expenses, assets, debts, and recent transactions.
2. The automatic stay takes effect immediately.
3. A trustee is assigned to your case.
4. About 30-45 days after filing, you attend a meeting of creditors (also called a 341 meeting). It’s usually brief — 5 to 10 minutes — and creditors rarely attend.
5. If everything checks out, the court issues a discharge order eliminating your qualifying debts.

Timeline

The entire process typically takes 3 to 4 months from filing to discharge. It’s the fastest form of bankruptcy.

What Property Is Protected

Every state has a set of exemptions — property you’re allowed to keep. Federal exemptions exist too, and some states let you choose between state and federal. Common exemptions include:

• Your home (up to a certain equity amount — varies widely by state)
• Your car (usually up to $4,000-$8,000 in equity)
• Household goods and furniture
• Retirement accounts (401(k)s, IRAs — these are almost always fully protected)
• Tools of your trade
• A portion of your wages

In many states, people filing Chapter 7 keep everything they own because their property falls within the exemption limits.

Chapter 13: Repayment Plan

Chapter 13 works differently. Instead of wiping out your debts immediately, you enter a court-supervised repayment plan that lasts 3 to 5 years. You make a single monthly payment to the trustee, who distributes it to your creditors.

Who It’s For

Chapter 13 is typically used by people who:

• Earn above the Chapter 7 means test threshold and don’t qualify for liquidation
• Want to keep assets that they’d lose in Chapter 7 (like a home with significant equity)
• Are behind on a mortgage or car loan and want to catch up on payments through the plan
• Have debts that Chapter 7 can’t discharge (like certain tax debts) and need time to pay them off

How the Payment Plan Works

Your monthly payment amount is calculated based on your disposable income — the money left after your reasonable living expenses. The plan must be approved by the court, and it prioritizes debts in a specific order:

1. Priority debts (certain taxes, child support, alimony) are paid in full.
2. Secured debts (mortgage, car loan) are addressed to keep you current.
3. Unsecured debts (credit cards, medical bills, personal loans) receive whatever’s left. In many cases, unsecured creditors get only a fraction of what they’re owed — sometimes as little as 10-20%.

At the end of the plan, any remaining unsecured debt is discharged.

Which Debts Can’t Be Discharged

Neither Chapter 7 nor Chapter 13 can wipe out every type of debt. Debts that generally survive bankruptcy include:

• Student loans (in most cases — though recent court decisions have been more willing to consider discharge in cases of undue hardship)
• Child support and alimony
• Recent income taxes (generally taxes due within the past 3 years)
• Debts from fraud or intentional harm
• Court fines and restitution
• Debts not listed in your filing
• HOA fees that come due after filing

If most of your debt falls into these categories, bankruptcy may not give you the relief you’re looking for.

Credit Impact

Bankruptcy does affect your credit, and there’s no sugarcoating that. Here’s how it breaks down:

• Chapter 7 stays on your credit report for 10 years from the filing date.
• Chapter 13 stays on your credit report for 7 years from the filing date.

Your credit score will drop — often significantly, especially if you had good credit before filing. But here’s what many people don’t realize: if you’ve already been missing payments, dealing with collections, and watching your score decline, the additional damage from bankruptcy may be smaller than you think.

And this is important — your credit starts recovering the day after your discharge. Many people who file bankruptcy see meaningful credit improvement within 1 to 2 years by using a secured credit card responsibly and keeping their finances on track.

What It Costs

Bankruptcy isn’t free, but the costs are usually manageable:

• Filing fees: $338 for Chapter 7, $313 for Chapter 13. Courts may allow you to pay in installments or waive the fee if your income is below 150% of the poverty line.
• Attorney fees: Typically $1,000 to $1,500 for Chapter 7 and $2,500 to $3,500 or more for Chapter 13. Fees vary by location and complexity.
• Credit counseling: You’re required to complete a credit counseling course before filing and a financial management course before discharge. Each costs about $15 to $50.

Some Chapter 7 attorneys offer payment plans, and many Chapter 13 attorneys fold their fees into the repayment plan so you don’t have to pay upfront.

When Bankruptcy Makes Sense

Bankruptcy is worth considering when:

• Your total unsecured debt is more than you could realistically pay off in 5 years
• You’re being sued or facing wage garnishment
• You’re using credit cards to cover basic living expenses
• Creditors are unwilling to negotiate and you’ve exhausted other options
• The math simply doesn’t work — your income minus essential expenses leaves nothing for debt payments

When to Try Alternatives First

Before filing, it’s worth exploring:

• Debt management plans through a nonprofit credit counselor, which can lower interest rates and consolidate payments
• Debt settlement for debts already in collections
• Hardship programs offered by your creditors
• A structured payoff plan using the debt snowball or avalanche method, if your debt is manageable with discipline

Bankruptcy is a powerful tool, but it should be the option you choose after others have been considered — not the first thing you try.

Frequently Asked Questions

Will I lose my house or car if I file Chapter 7?

Not necessarily. If your equity in the property falls within your state’s exemption limits, you keep it. And if you’re current on your mortgage and car payments and continue making them, you can typically keep those assets. Most Chapter 7 filers keep everything they own.

Can I file bankruptcy on just some of my debts?

No. Bankruptcy includes all your debts — you can’t pick and choose. However, certain debts (like student loans and child support) won’t be discharged even though they’re included in the filing. Secured debts like your mortgage can be “reaffirmed,” meaning you agree to keep paying them.

How soon can I rebuild my credit after bankruptcy?

You can start rebuilding immediately after discharge. Many people open a secured credit card within a few months and see noticeable improvement within a year. It takes time and consistency, but a bankruptcy filing doesn’t mean bad credit forever.

Should I talk to a lawyer before deciding?

Yes. Most bankruptcy attorneys offer free consultations, and they can review your specific situation to tell you whether bankruptcy makes sense, which chapter you’d qualify for, and what the likely outcome would be. This is one area where professional guidance is worth the investment.

Bottom Line

Bankruptcy is a federal legal process designed to help people who can’t repay their debts get a genuine fresh start. Chapter 7 discharges most unsecured debts in 3 to 4 months, while Chapter 13 restructures your debts into a manageable 3- to 5-year payment plan. Both have credit consequences, but both also offer a clear path forward. If your debts have become unmanageable and other options haven’t worked, bankruptcy isn’t failure — it’s a tool that exists specifically for situations like yours.