Understanding Bankruptcy and Debt
- Bankruptcy is a legal tool used to get out from under overwhelming debt.
- Chapter 7 bankruptcy can wipe out debts, while Chapter 13 bankruptcy requires a repayment plan.
- Alternatives to bankruptcy include debt management plans, refinancing, and debt settlement.
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When your goal is debt freedom, it's smart to use all of the tools and resources at your disposal to reach that goal. Bankruptcy can be a powerful tool for debt relief, potentially helping you get out from under crushing debt.
The key to using bankruptcy effectively is to understand how bankruptcy works and what you can expect from the process. Let's go over what bankruptcy is, how it works, and when it may be the right option.
What Is Bankruptcy?
Bankruptcy is a legal option for debt relief that takes place in the bankruptcy court system. When you file for bankruptcy, a bankruptcy judge will examine your debts and assets. Then they’ll issue a court order that determines which debts can be discharged (forgiven) and which you must repay.
Not all bankruptcies are the same. The type of bankruptcy you file will depend on your personal circumstances and qualifications. The two most common types of personal bankruptcy are Chapter 7 and Chapter 13.
Chapter 7 bankruptcy
Chapter 7 bankruptcy is often the preferred type to file since it can wipe out eligible unsecured debts with little or no repayment. However, you may be required to give up some of the things you own. In all states, there are things you’re allowed to keep. Those are called bankruptcy exemptions. Anything else would be called a nonexempt asset. Nonexempt assets typically include things like a second car or rental property. You might even have to sell your home if you have more equity than what your state allows you to keep in a bankruptcy. Nonexempt assets are sold and the money is given to your creditors.
You must pass a means test to be eligible for Chapter 7. The means test tells the bankruptcy judge whether you can afford a monthly payment. If you can, you may not be eligible for Chapter 7. Chapter 7 is best for people who have a lot of unsecured debt, like credit card debt, few or no nonexempt assets, and income that doesn’t leave a lot leftover after covering basic necessities.
Chapter 13 bankruptcy
Chapter 13 bankruptcy is used by people who don't qualify for Chapter 7, or who want to protect their nonexempt assets. It’s a way to stop a home foreclosure, at least temporarily. Chapter 13 is for people who can afford a payment and can repay at least some of their debts.
Some debts could be discharged through Chapter 13. You'll have to agree to a structured repayment plan approved by the court. You’ll make payments for five years (three years if you’re low income). At the end of your repayment plan, the remaining unsecured debt is discharged.
How Bankruptcy Works, Step by Step
Every bankruptcy can vary a bit, but in general, the process goes like this:
Consult a professional. You can file for bankruptcy on your own, but it's recommended that you consult a bankruptcy attorney to understand your options and ensure you're meeting all necessary requirements. People who hire a bankruptcy attorney have better outcomes, on average, than people who don’t. That’s especially true for Chapter 13 cases.
Determine the type of bankruptcy you want to file. This will depend on your needs and qualifications. If you're unsure, a bankruptcy attorney can help you figure it out.
Take your pre-bankruptcy credit counseling course. Most folks will be required to take an approved credit counseling course no more than 180 days before filing for bankruptcy.
Gather your information and documents. You'll list all of your assets, debts, income, and expenses. You should also gather financial documents like W-2s, tax returns, and bank and investment account statements.
File your bankruptcy petition. The bankruptcy process doesn't officially start until you (or your attorney) file your petition with the bankruptcy court. This involves a lot of paperwork and paying some fees.
The automatic stay goes into effect. Filing for bankruptcy typically gets you an automatic stay. This is a legal order that makes debt collectors stop trying to collect on any debt. It can also freeze foreclosure or eviction proceedings. The automatic stay does not excuse you from paying your mortgage. If you don’t make your payments, your mortgage lender could ask the judge to lift (cancel) the automatic stay for that debt.
The court assigns a bankruptcy trustee. When you file, the court will assign a trustee to oversee your case. This is the person who will review your petition.
Attend the 341 (creditors') meeting. About a month after filing, you'll attend a 341 meeting, also called a creditors' meeting. At the meeting, they’ll confirm your identity and you'll answer questions about your petition.
Complete your debtor education course. Before you can get your final discharge, you'll need to take an approved debtor education course. (This is different from the pre-bankruptcy credit counseling course.) The debtor education course needs to be done within 60 days of the 341 meeting or your case will be dismissed.
Wait for the court's decision. Bankruptcy isn't an overnight process. It can take several months to get a final decision from the court after filing your petition.
Follow your bankruptcy plan. Filers of Chapter 13 bankruptcy will receive a debt repayment plan as part of their bankruptcy. These plans typically take five years to finish. If you filed Chapter 7 bankruptcy, many of your unsecured debts may have been discharged by the bankruptcy.
Bankruptcy and Your Credit
The impact bankruptcy has on your credit will depend a lot on the state of your credit before you file. If your credit is already impacted by missed payments, collections, or a foreclosure, then filing for bankruptcy may not make it much worse.
Once your bankruptcy discharge is completed, you can begin rebuilding your credit. Most negative items will age off your credit report after seven years, and Chapter 7 bankruptcy will fall off after 10 years. However, the impact they have will diminish as they age, a process you can help by building a new positive payment history and avoiding credit card debt.
Secured credit cards can be a great option for rebuilding credit after bankruptcy. You can find secured cards with no annual fee that report to all three credit bureaus. Make your payments on time every month and pay your balances in full to avoid accumulating new debt.
When to Choose Bankruptcy
Bankruptcy might be the right choice for you if:
You have unmanageable credit card debt. Unsecured debts, like credit cards, are some of the most commonly discharged debts during bankruptcy.
You're overwhelmed by medical debt. Medical bills are generally dischargeable, meaning you can potentially get rid of them through bankruptcy.
You're unemployed and can't make debt payments. Bankruptcy may help you get rid of debt and reset your finances while you start over.
You're facing foreclosure. Chapter 13 bankruptcy may help you restructure your debts and save your home.
You've tried other debt relief options without success. Bankruptcy can be an effective tool for debt relief when other options haven't worked.
Alternatives to Filing for Bankruptcy
Bankruptcy isn’t the right path for everyone. Consider all of your options before making a plan for managing your debt.
Financial coaching
There's a reason that the bankruptcy process starts with a required credit counseling course: Sometimes all you need is help and guidance. If you have the income to pay your debts but are still struggling, a financial coach or financial counselor may be able to help you get back on track.
Debt management plans (DMPs)
Many nonprofit credit counseling agencies offer debt management plans. A DMP is a structured repayment plan. You'll make a single payment to the credit counselor, who then pays your creditors. Part of setting up the DMP will involve negotiating with your creditors for lower interest rates and fee waivers. You don't get to pick your monthly payment, and it’ll be high enough to pay off all of your unsecured debt in three to five years.
Refinancing and consolidation
Refinancing your debt means taking on new debt to pay off your old debt. This is useful if you can get a lower interest rate on the new debt, which can reduce the interest fees you pay. If you use the new debt to pay off multiple existing debts, you'll also consolidate your debts into one monthly payment. This strategy requires good credit scores.
Debt settlement
Debt settlement is the process of negotiating with your creditors to settle, or get rid of, your debt for less than you owe. This may be an option if you can afford to repay some, but not all, of your debt. You can attempt debt settlement on your own or you can hire a professional debt settlement company.
Debt relief stats and trends
We looked at a sample of data from Freedom Debt Relief of people seeking a debt relief program during August 2025. The data uncovers various trends and statistics about people seeking debt help.
FICO scores and enrolled debt
Curious about the credit scores of those in debt relief? In August 2025, the average FICO score for people enrolling in a debt settlement program was 600, with an average enrolled debt of $25,949. For different age groups, the FICO scores varied. For instance, those aged 51-65 had an average FICO score of 596 and an enrolled debt of $28,694. The 18-25 age group had an average FICO score of 569 and an enrolled debt of $15,215. No matter your age or debt level, it's reassuring to know you're not alone. Taking the step to seek help can lead you towards a brighter financial future.
Personal loan balances – average debt by selected states
Personal loans are one type of installment loans. Generally you borrow at a fixed rate with a fixed monthly payment.
In August 2025, 44% of the debt relief seekers had a personal loan. The average personal loan was $10,718, and the average monthly payment was $362.
Here's a quick look at the top five states by average personal loan balance.
| State | % with personal loan | Avg personal loan balance | Average personal loan original amount | Avg personal loan monthly payment |
|---|---|---|---|---|
| Massachusetts | 42% | $14,653 | $21,431 | $474 |
| Connecticut | 44% | $13,546 | $21,163 | $475 |
| New York | 37% | $13,499 | $20,464 | $447 |
| New Hampshire | 49% | $13,206 | $18,625 | $410 |
| Minnesota | 44% | $12,944 | $18,836 | $470 |
Personal loans are an important financial tool. You can use them for debt consolidation. You can also use them to make large purchases, do home improvements, or for other purposes.
Tackle Financial Challenges
Don’t let debt overwhelm you. Learn more about debt relief options. They can help you tackle your financial challenges. This is true whether you have high credit card balances or many tradelines. Start your path to recovery with the first step.
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Author Information
Written by
Brittney Myers
Brittney is a personal finance expert and credit card collector who believes financial education is the key to success. Her advice on how to make smarter financial decisions has been featured by major publications and read by millions.
Reviewed by
Kimberly Rotter
Kimberly Rotter is a financial counselor and consumer credit expert who helps people with average or low incomes discover how to create wealth and opportunities. She’s a veteran writer and editor who has spent more than 30 years creating thousands of hours of educational content in every possible format.
Will filing bankruptcy mean owing more taxes?
The debts discharged during your bankruptcy aren't considered taxable income by the IRS, so you won't need to claim them as income on your taxes.
Can you declare bankruptcy for credit card debt?
Yes, filing bankruptcy for credit card debt is a choice you can make to get rid of credit card debt if your debts are unpayable. You can choose Chapter 7 or Chapter 13 bankruptcy.
Chapter 7 bankruptcy will typically discharge (get rid of) all your credit card debt, unless the debts were incurred as a result of fraud, if you used credit cards to purchase luxury items, or if you used the cards to pay nondischargeable debts like tax debt. You might have to give up some of the things you own.
With Chapter 13 bankruptcy, the court will require you to pay off your debts, but you can reorganize to an affordable repayment plan. After filing Chapter 13 bankruptcy, you will be given a five-year schedule to repay your debts (three years if you’re low-income). Secured debts like a home mortgage or auto loan get higher priority. Unsecured debts, which include credit card debt, are lower on the repayment priority list.
Once you complete your Chapter 13 payment plan, remaining eligible debts are forgiven.
What is bankruptcy credit counseling?
You can't file a bankruptcy petition without first completing credit counseling with an approved provider. When you finish the required session, you'll get an authenticated certificate to file with the bankruptcy court.
Pre-bankruptcy credit counseling covers these topics: Your personal finances, bankruptcy alternatives, and personal budget. You can receive your counseling in person, by phone, or online. Sessions normally take an hour. Counseling costs about $50, but you can request a fee waiver if you can't afford the service.
What is the difference between credit counseling, debt settlement, and bankruptcy?
Credit counseling is a form of debt relief that typically involves a debt management plan. The credit counseling agency works with your creditors to lower your interest rates and create a three to five year payoff plan. This could help you simplify debt repayment and get professional guidance on money management while you’re in the plan. When you use a debt management plan, credit counselors control when and how your payments get paid to your creditors.
Debt settlement means convincing your creditors to accept less than you owe as payment in full. Your creditors might be willing to settle your debts if you cannot afford to repay the full amount. With a professional debt settlement program like Freedom Debt Relief, you approve all settlements and have more control over your money compared to credit counseling. For example, although expert negotiators will guide and advise you, Freedom Debt Relief does not decide when or how your money gets paid to creditors. All these final decisions must be approved by you, the consumer.
Bankruptcy is a court-ordered plan that lets you get some but possibly not all debts discharged, but you might have to give up some of the things you own or agree to an aggressive repayment plan. If you want to avoid bankruptcy, credit counseling or debt settlement programs could be better options.
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