This is a very helpful article published in Forbes Advisor on February 11, 2022. It explains some of the complexities behind how bankruptcy can erase - or "discharge" - your debt and give you a fresh start with your finances. This article is by John Egan and Mitch Strohm.
What Is a Bankruptcy Discharge?
In a bankruptcy case, bankruptcy discharge means a judge has declared that you’re no longer responsible for paying debts. It’s a permanent action that affects some, but not all, types of debt.
Even though a discharge wipes out certain debts and can help get your finances in order, the bankruptcy remains on your credit report for seven or 10 years, depending on the kind of bankruptcy.
A bankruptcy discharge permanently prevents a creditor from trying to collect discharged debts. A discharge can happen in four types of bankruptcy cases:
Chapter 7. This is the most common form of bankruptcy for individuals. A Chapter 7 bankruptcy can clear away most of your debts through the sale, or liquidation, of many of your personal assets.
Chapter 11. Businesses typically use this type of bankruptcy, but individuals can also file. A Chapter 11 bankruptcy establishes a debt repayment plan.
Chapter 12. This kind of bankruptcy is geared toward setting up a debt repayment plan for family farmers and family fishermen.
Chapter 13. Designed for individuals, Chapter 13 bankruptcy puts a debtor on a repayment plan.
How Does the Bankruptcy Discharge Work?
Bankruptcy discharge applies only to debts you accumulated before filing for bankruptcy.
According to the United States Department of Justice, it’s important to list all of your property and debts in bankruptcy documents. If you fail to mention a debt, a judge may not discharge it. Also, a judge might refuse to discharge a debt if, for instance, you hide property or falsify records.
A Chapter 7 bankruptcy filer typically gets an automatic discharge of eligible debts, such as credit card bills, unless legal challenges have been raised about a requested discharge. Meanwhile, debts included in a Chapter 13 bankruptcy can be discharged, but normally aren’t since this type of bankruptcy generally involves debt restructuring. Chapter 7 and Chapter 13 are the two most common types of bankruptcy.
How Long Does It Take To Get a Discharge?
In a Chapter 7 bankruptcy case, a discharge can take four to six months. In other bankruptcy cases, including Chapter 13, payments are often made over a three- to five-year period, so typically, a discharge takes around four years.
Which Debts Get Discharged in Bankruptcy?
An array of debts can be discharged in a bankruptcy case. Some of these include:
Credit card bills
Debt that’s been turned over to a collection agency
Personal loans from friends, relatives and employers
Past-due utility bills
Most civil court judgments
Debts Exempt From Discharge
Not all debts can be discharged in a bankruptcy case. Some of the debts exempt from discharge include:
Most federal, state and local taxes
Most student loans
Debts secured by liens
Personal injury cases involving drunk or drugged driving
Can a Bankruptcy Discharge Be Denied?
A judge can deny a bankruptcy discharge for several reasons, such as:
Failing to maintain financial records adequately
Committing a crime related to the bankruptcy case
Failing to follow an order from the bankruptcy court
Fraudulently transferring, hiding or destroying property that is supposed to be part of the bankruptcy case
Failing to complete a court-ordered financial management course
Bankruptcy Discharge and Student Loans
You might be able to get federal and private student loan debt discharged if the bankruptcy court approves your request through what’s known as an “adversary proceeding.” In this request, a Chapter 7 or Chapter 13 bankruptcy filer states that student loan debt repayment would cause financial hardship for them and their dependents.
Positive scenarios that might arise from a hardship filing include:
Your student loan debt is completely discharged, meaning you owe none of the debt.
Your student loan debt is partially discharged, meaning you must repay some of the debt.
Your student loan debt is not discharged, but you qualify for better terms, such as a lower interest rate.
In 2021, the American Bar Association, a group for lawyers and law students, urged Congress to change the U.S. Bankruptcy Code to give borrowers the ability to discharge student loans without proving that repayment of the debt would impose an “undue hardship” on them or their dependents.
The proposed federal Fresh Start Through Bankruptcy Act of 2021 would make federal student loans eligible for discharge in a bankruptcy case 10 years after the first loan payment is due. Furthermore, the act would retain the current “undue hardship” discharge option for private student loans and for federal student loans that have been due for less than 10 years.
“Student loan debt follows you to your grave. For years, I have supported allowing struggling borrowers to discharge their loans in bankruptcy as a last resort,” said U.S. Sen. Dick Durbin, D-Illinois, a co-sponsor of the Fresh Start legislation, in a press release.
Can a Creditor Attempt To Collect a Discharged Debt?
Debt collectors can’t try to collect debts that have been discharged in a bankruptcy case. In addition, debt collectors aren’t permitted to attempt debt collection while a bankruptcy case is pending.
If you believe a creditor has violated the court’s prohibition of contacting you about a discharged debt, consider asking an attorney about your legal options. If a creditor tries to collect on a discharged debt, a debtor can report this to the bankruptcy court and request that their case be reexamined. A judge can punish a creditor who’s found to have violated the no-contact rule.
Bankruptcy Discharge vs. Dismissal
When it comes to bankruptcy, a discharge is a good thing. On the other hand, a dismissal may not be such a good thing.
A discharge in a bankruptcy case means all allowed debts have been forgiven. Meanwhile, a dismissal refers to your case’s being booted by a bankruptcy court. Reasons that your case might be dismissed include failing to submit the proper paperwork, failing to provide requested documentation or show up for a court appearance, or seeking a type of bankruptcy that doesn’t apply to you.
Bankruptcy Discharge and Your Credit
Both a bankruptcy filing and bankruptcy discharge can hurt your credit. That’s because the bankruptcy filing and discharged debts can stay on your credit report for seven or 10 years. However, a debt showing up on your credit report as discharged may be less harmful than an unpaid debt that lingers indefinitely on your credit report.
A Chapter 7 bankruptcy falls off your credit report after 10 years. For Chapter 13 bankruptcy, it’s seven years.
Keep in mind that a discharged debt might not appear on your credit report as being discharged. If you notice a discharged debt is incorrectly categorized on a credit report, notify the credit bureau that produced the report and ask that the error be corrected. Each year, you can obtain a free credit report from the three major credit bureaus (Equifax, Experian and TransUnion) through annualcreditreport.com.
Fortunately, if you handle your credit responsibly after completing the bankruptcy process, the impact of the bankruptcy on your credit score will fade over time. You may even see improvement in your credit score within 12 months of a bankruptcy case’s being wrapped up.