Does filing for bankruptcy eliminate debt?

Sometimes life doesn’t always work out the way we intended, and that’s especially true when it comes to our finances. In fact, it’s very common to end up with unsustainable amounts of debt, even through no fault of your own. When that happens, bankruptcy may feel like a necessary last resort to help you get a fresh start. 

Bankruptcy isn’t a cure-all for every debt scenario, though. It doesn’t eliminate all types of debt. The types of debt you can clear depend on factors like where you live, what type of bankruptcy you file, the types of debt you have, your home equity and assets, and more. 

A good bankruptcy attorney can provide specific advice for your situation, but to see whether it’s even worth thinking about, we’ll provide you with a general rundown of when a bankruptcy filing can eliminate your debts. 

Bankruptcy basics: A quick overview

Bankruptcy is actually a legal process that goes through a special bankruptcy court, unlike other ways of paying down your debt, such as a debt consolidation loan from a lender. You can technically do it yourself, but it’s generally best to hire an attorney, because the bankruptcy code and procedures can be complex and difficult to follow.

In the U.S., individuals can file one of two types of bankruptcy:

• Chapter 7: A “liquidation bankruptcy,” available to people who can pass a means test. You may be able to keep certain assets outlined by your state’s laws, such as your house. Everything else may then be sold by the bankruptcy court and distributed to your creditors, with any remaining debts being discharged. The end result in a Chapter 7 bankruptcy case takes up to six months.
• Chapter 13: A “wage earner’s plan,” this works more like a debt repayment plan. You’ll make monthly payments for three or five years, and after that time, the remaining debts on your bankruptcy petition may be discharged. 

A few important things happen immediately after you file for bankruptcy. You’ll get an automatic stay on any collection actions from your creditors, such as wage garnishments or harassing phone calls. It doesn’t eliminate your personal liability for repaying those debts, but it does buy you time to decide on a way to handle those debts, which can include catching up on missed payments during bankruptcy proceedings. 

Does filing for bankruptcy eliminate debt?

Yes, bankruptcy can eliminate some or all of your debt, but only if you follow the rules and meet eligibility requirements. You’ll need to declare all of your debts on your bankruptcy petition when you submit it to the court. Any undeclared debts you leave out are not eligible to be cleared by the bankruptcy court. 

From there, the courts will sort out your debts into one of three different categories, based on a hierarchy of who gets paid:

Priority debts

Certain rules protect some debts, and they must be repaid in full under most, if not all, circumstances. This includes things like:

• Alimony
• Child support
• Student loans
• Recent trust fund and income taxes
• Government fines, penalties, and tickets
• Property taxes and other non-income taxes

Secured debts

These debts are attached to your property as collateral for repayment. Some secured debts you voluntarily entered into, such as a mortgage or auto loan, while others — like tax liens — may have been placed on your assets for not paying a debt. Collateral for secured debts can be repossessed even in bankruptcy, unless you pay back overdue amounts in a Chapter 13 case or sign a reaffirmation agreement to keep repaying the debt as per usual in a Chapter 7 case. 

Unsecured debts

Unsecured debts aren’t attached to any collateral and can be more easily extinguished by a court order — which is exactly what happens in a textbook bankruptcy case. Any remaining funds left over after satisfying priority and secured debts, if anything, are used to pay back your unsecured debts. 

Unsecured debts that can typically be discharged in bankruptcy include things like:

• Credit cards
• Medical bills
• Personal loans
• Unpaid utility bills
• Private loans from friends and family

Alternative debt solutions

It’s always important to explore your alternatives, but especially when it comes to bankruptcy. Once you file for bankruptcy, there are no 30-day money-back guarantees like some finance companies offer for debt management tools. 

• Debt settlement: You can negotiate with creditors to accept a lower lump-sum payment, or hire a company to do it for you (for a high fee, of course). Forgiven portions of your debt are taxable, however, and the impact on your credit report can sometimes be more significant than filing for bankruptcy. 
• Lender programs: Bankruptcy loss is expensive for lenders, and so many are willing to work with you one-on-one to find a payment solution that’ll ensure they’re repaid. You may be able to extend your loan term, get lower interest rates, have late fees waived, etc. 
• Credit counseling: Nonprofit credit counseling agencies offer free support in navigating your debt challenges and can help guide you to your best options. Some of the services they offer are paid, but at a low cost, such as a debt management plan. 
• Debt management plan: Credit counseling agencies can act as a middleman between you and your lender to negotiate payment support so that you repay your debts in full. It’s often a cheaper and less damaging option than using a for-profit debt settlement company. 
• Home equity investment: If you have sufficient equity, this finance tools allow you access to a lump sum of funds that you can use for almost anything, including paying off overdue debts. It requires no monthly payments over a 30-year term length, after which time you’ll repay the amount you borrowed, plus a share of your home’s future equity growth. 

Is filing for bankruptcy a good option for me?

Only you and a legal or financial professional can determine whether bankruptcy is the best way to handle your debt. However, here are some common signs that bankruptcy might be a good solution for you:

• You’ve investigated each of your other options and ruled them out.
• You have enough funds to hire a bankruptcy attorney to advise you.
• You’re able to weather a significant credit hit for the next seven to 10 years.
• Your loan co-signers, if any, are able to handle repaying your shared debt on their own if needed. 
• The types of debts you’re struggling with are eligible for discharge in bankruptcy proceedings. 
• If your debt came from unsustainable spending practices, you’ve developed strong systems to avoid debt in the future, such as budgeting or avoiding credit cards.

Frequently asked questions

Does bankruptcy clear debt?

Yes, it’s possible to discharge tax debt, medical bills, unsecured debts, and even some secured debt in a bankruptcy filing. Some debts aren’t able to be discharged in bankruptcy, though, such as overdue child support payments and alimony, unpaid property taxes, and most student loans. 

Can I file for bankruptcy on my own?

Yes, you can serve as your own legal representative during bankruptcy proceedings. However, given the complexities of the federal bankruptcy code, the interplay with state law, and the significant potential for harm if you get it wrong, virtually everyone — even the courts themselves — advises you to hire an attorney who can guide you. 

Can IRS debt be discharged in Chapter 7?

Federal or state income taxes qualify for discharge in a chapter 7 bankruptcy case, but only in certain cases. The income tax return must have been due at least three years ago, and you’ll have to have actually filed the tax return at least two years ago. In addition, the income tax debt must have been due at least 240 days before you filed for bankruptcy, unless you had a formal offer in compromise agreement in place. 

Can judgments be discharged in Chapter 13?

Yes, discharging debts from prior judgements against you may be possible in many cases, as long as they don’t stem from “willful or malicious injuries to person or property,” in the eyes of the bankruptcy courts. 

Can student loans be discharged in bankruptcy?

In most cases, no. Student loan debts for Chapter 7 and Chapter 13 bankruptcy can generally only be discharged if you meet the burden of proof for “undue hardship” caused by the debts, which is a much higher standard than for discharging other debts. 

What are my other options besides bankruptcy?

Talking to a credit counseling agency can help you identify potential options, such as a debt management plan. Debt settlement is also a possibility, but it carries significant risks. Some options, such as home equity investments, may help you repay debts and regain a solid financial footing without the need for monthly payments.  

Final thoughts

Bankruptcy carries a negative stigma in our society, but — under the right circumstances — it can provide a lifeline. It often allows people to keep their homes, put an end to creditor harassment, and move on with their lives in a way that no other debt management strategy can offer. 

Of course, it’s not without significant drawbacks, though. Bankruptcy stays on your credit report for seven to 10 years, and can limit your options in the meantime. It’s also complicated and expensive, and doesn’t apply to all types of debts equally. That’s why experts recommend thoroughly vetting out all your other options before choosing bankruptcy.