When you file for bankruptcy, no single party pays off your debts on your behalf. What happens instead depends on which chapter you file. Under Chapter 7, a court-appointed trustee sells your non-exempt property and distributes the proceeds to creditors in an order set by federal law. Under Chapter 13, you keep your property and pay creditors from your future income over three to five years. Whatever qualifying debt remains after that process is discharged, and the creditor absorbs the loss. Co-signers and joint borrowers, however, generally stay on the hook for anything left unpaid.
Chapter 7: A Trustee Sells Your Non-Exempt Property
Filing a Chapter 7 case creates a bankruptcy estate that includes essentially all of your property and financial interests as of the filing date.1Office of the Law Revision Counsel. 11 USC 541 – Property of the Estate A trustee takes control of that estate, reviews what you own, and identifies anything that can be sold to raise money for your creditors.2Office of the Law Revision Counsel. 11 USC 704 – Duties of Trustee
You don’t lose everything. Federal and state exemption laws let you protect certain property. Under the federal system, you can shield up to $31,575 of home equity, up to $5,025 in a vehicle, and up to $16,850 in household goods, with a per-item cap of $800. A wildcard exemption of $1,675 plus up to $15,800 of any unused homestead amount can be applied to any property you choose.3Office of the Law Revision Counsel. 11 USC 522 – Exemptions States can require their own exemption system instead, and those amounts vary widely. Some states protect unlimited home equity; others offer no homestead protection at all.
Once the trustee sells anything that isn’t exempt, the cash is paid out in a specific order. Domestic support obligations such as child support and alimony come first. Certain tax debts and the administrative costs of the bankruptcy itself follow.4Office of the Law Revision Counsel. 11 USC 507 – Priorities General unsecured creditors, meaning credit card companies, medical providers, and personal lenders, sit near the bottom. In many Chapter 7 cases there simply aren’t enough non-exempt assets to pay these lower-priority creditors anything at all.
Chapter 13: You Pay Creditors From Future Income
Chapter 13 works differently. You keep your property and commit to a court-approved repayment plan lasting three to five years. The plan lays out how much you’ll pay each month and typically requires you to devote all of your projected disposable income, meaning what’s left after necessary living expenses, to paying down debt.5Office of the Law Revision Counsel. 11 USC 1322 – Contents of Plan
You send your monthly payment to a standing trustee, who distributes the funds to creditors according to the plan. The trustee is paid for administering the case out of what you pay in; that fee can run up to 10 percent of your payments.6Office of the Law Revision Counsel. 28 USC 586 – Duties and Supervision by Attorney General If you pay $800 a month toward your debts, as much as $80 of that can go to the trustee rather than to your creditors. The plan must also guarantee that creditors receive at least as much as they would have gotten if you had filed Chapter 7 and your non-exempt assets had been liquidated.
At the end of the plan period, any remaining qualifying unsecured debt is discharged. People often choose Chapter 13 because they want to catch up on mortgage arrears, keep property that would otherwise be sold in Chapter 7, or shield a co-signer.
Creditors Absorb the Rest
After a Chapter 7 liquidation or the completion of a Chapter 13 plan, the court issues a discharge order. That order permanently cancels your personal obligation on any remaining qualifying debt and functions as a court injunction: creditors can never again call, sue, garnish wages, or otherwise try to collect the discharged balance from you.7Office of the Law Revision Counsel. 11 USC 524 – Effect of Discharge In a Chapter 7, the discharge typically arrives three to four months after filing.8Office of the Law Revision Counsel. 11 USC 727 – Discharge
The creditor writes off the discharged balance as a loss. For unsecured lenders such as credit card issuers and hospitals, that write-off is a cost of doing business, and it’s priced into the interest rates and fees they charge everyone else. General unsecured creditors often collect only pennies on the dollar through the bankruptcy distribution, or nothing at all.
Debts That Bankruptcy Won’t Pay Off
Not every debt can be discharged. Federal law carves out categories that survive the bankruptcy and remain your full responsibility no matter which chapter you file.9Office of the Law Revision Counsel. 11 USC 523 – Exceptions to Discharge The most common ones:
- Domestic support obligations, including child support and alimony.
- Most recent income taxes, and taxes for which no return was filed or a fraudulent return was filed.
- Student loans, unless you bring a separate court action and prove that repaying them would impose an undue hardship on you and your dependents. That standard requires showing you can’t maintain a minimal standard of living while repaying and that your situation is unlikely to improve.
- Debts obtained by fraud or false representations. Luxury purchases over $500 made within 90 days of filing and cash advances over $750 taken within 70 days are presumed nondischargeable.
- Debts for death or personal injury caused by operating a vehicle while intoxicated.
- Debts arising from willful and malicious injury to another person or their property.
- Most criminal fines and government-imposed penalties.
If a large share of what you owe falls into one of these categories, bankruptcy may not deliver the relief you’re expecting. It’s worth mapping your debts against this list before filing.
Co-Signers and Joint Borrowers Still Owe
Your discharge protects you. It does not release anyone else who signed for the debt. A co-signer, joint account holder, or guarantor remains fully liable for whatever balance is left after your bankruptcy.10Office of the Law Revision Counsel. 11 USC 524 – Effect of Discharge If a parent co-signed a $15,000 personal loan for their child and the child files bankruptcy, the lender can pursue the parent for the entire unpaid amount. The collection tools available against the co-signer include lawsuits, wage garnishments, and bank levies.
Chapter 13 Adds a Temporary Co-Signer Shield
Chapter 13 offers something Chapter 7 doesn’t. When you file, a special co-debtor stay automatically protects anyone who’s liable with you on a consumer debt. During your case, the creditor cannot contact or sue that person.11Office of the Law Revision Counsel. 11 USC 1301 – Stay of Action Against Codebtor The protection lasts as long as your plan is in effect.
It has limits. A creditor can ask the court to lift the co-debtor stay if your plan doesn’t propose to pay the co-signed debt, if the co-signer received the actual benefit of the loan rather than you, or if the creditor would be irreparably harmed by continued protection. The stay also ends if your case is dismissed or converted to Chapter 7. Once it’s gone, and if dischargeable debt remains unpaid, the creditor can go after the co-signer.
Keeping Secured Property Means Continuing to Pay
If a debt is secured by collateral you want to keep, such as a car loan or a mortgage, bankruptcy alone won’t pay it off, and it won’t strip the lender’s lien. To keep the property, you have to keep dealing with the lender. In Chapter 7, you generally have three options.
You can reaffirm the debt by signing a new agreement that keeps you personally liable despite the bankruptcy. The agreement goes to the court, and if you’re not represented by an attorney, a judge must approve it after finding it doesn’t create an undue hardship.12Office of the Law Revision Counsel. 11 USC 524 – Effect of Discharge You can cancel any time before your discharge is entered or within 60 days after the agreement is filed, whichever is later. The upside is that ongoing payments get reported to credit bureaus and help rebuild credit. The downside is that if you later fall behind, the lender can repossess and sue you for any remaining balance, because you’ve given up the discharge on that debt.
You can redeem tangible personal property used primarily for personal or household purposes, most often a car, by paying the lender the current value of the property in a single lump sum, even if you owe more than that.13Office of the Law Revision Counsel. 11 U.S. Code 722 – Redemption Owe $12,000 on a car worth $7,000? You can keep it by paying $7,000, and the remaining $5,000 is discharged. The hard part is coming up with the cash, though some specialized lenders finance redemptions.
You can surrender the property to the lender. The lender sells it and applies the proceeds to the loan. Any deficiency left after the sale is typically included in your Chapter 7 discharge, so you walk away owing nothing. Surrender usually makes sense when the debt exceeds the property’s value.