According to Bankrate, the average credit card balance in 2021 was $5,525 and the average consumer had three credit cards. That comes out to $16,575 just in credit card debt, never mind what you’re shelling out for car payments, student loan payments, rent/mortgage payments, etc.! Given that the average full-time salary in 2021 was around $50,000, it’s no wonder so many people feel like they’re drowning in debt.
If you earn less than that, the situation can feel even direr, and that’s why so many Americans turn to bankruptcy to help them deal with their credit card debt. In fact, 60% of bankruptcy filers earn less than $30,000 per year (which works out to less than $500 per week). So if you’re feeling desperate and like bankruptcy might be your only option, know that you are not alone.
Two main types of bankruptcy for credit card debt: Chapter 7 and Chapter 13
Both Chapter 7 and Chapter 13 can help you with your credit card debt. That said, there are some significant differences between the two choices when deciding which one to claim on your bankruptcy application. More specifically, while Chapter 7 wipes out the most debt, it can take the biggest toll on your existing assets. Chapter 13, on the other hand, allows you to pay off your debt over time. So which one should you choose?
Is credit card debt a good reason to file Chapter 7?
As you know, making the minimum monthly payments on your credit card balances doesn’t actually help you reduce your balance due. Mostly what the minimum payments do is send your money to the credit card company via the interest charges on your account. The fact is, if you only pay the minimum due, you’ll likely wind up paying hundreds — or even thousands — of dollars in interest charges.
This is why, for some people, Chapter 7 is the best option for bankruptcy. Chapter 7 stops interest from accruing and erases almost all of your credit card debt, which can be very helpful in getting you back up on your feet, financially speaking.
Credit card debt is unsecured debt
Secured debt is debt that is backed (or insured) by collateral. If the secured debt holder defaults on payments, the debt owner can use that collateral to offset the amount owed.
Pawnshops are a good example of this. You turn over your property to the pawnshop for an amount of money. If you pay that money back, your property is returned to you. If you fail to pay back the money, the shop keeps your property and can sell it to someone else to offset what you owe.
Credit card debt is “unsecured” debt. This means that the credit card doesn’t have anything it can use to offset your debt if you fail to make your payments or default on your account. Instead, the credit card company will have to sue you for payment via a debt collection lawsuit. If the company wins the lawsuit, it can take action to collect your debt. That action can include the seizure of assets and/or wage garnishment.
Are there credit card debts that Chapter 7 bankruptcy won’t erase?
It depends. It is possible that your creditors may file an objection to your debt discharge request, based on what you purchased with the card.
For example, creditors sometimes do this if the card is used to buy luxury items or to pay off non-dischargeable debts.
In other words, don’t try to get around your debt obligations by charging non-dischargeable debts to a credit card and then declaring bankruptcy.
Credit card debt for luxury goods
Bankruptcy judges have caught on to the “charge it all, then immediately declare bankruptcy to get out of paying for it” strategy. This is why, if you charge $675 or more for items or services that are considered “luxury” (i.e., anything that would not be considered an absolute necessity) within the 90-day period prior to your filing, the court may decide that those purchases are non-dischargeable.
If you have recently charged more than $675 on items that a very strict third party might deem “not absolutely necessary”, you might want to wait a few months before filing Chapter 7.
Talk to a bankruptcy attorney before you make any decisions because they’ll know which purchases might be considered “luxury.”
Credit card debt incurred to pay non-dischargeable debts
Some examples of non-dischargeable debts include:
- Child support
- IRS back taxes
- Student loan payments (unless you qualify for a hardship discharge)
If you used your credit card for any of these payments, the credit card company could object to discharging your debt.
Why file for Chapter 7 bankruptcy?
Having too much credit card debt is only one reason people choose to file Chapter 7. Other common reasons for declaring Chapter 7 bankruptcy include:
- Unemployment or a sudden drop in income
- A major accident, injury, or sudden illness that keeps you from working/earning income.
- Medical bills
- Separation or divorce
- Home foreclosure or vehicle repossession
- Debt collection lawsuits and/or personal civil judgments
- Failing to manage money properly
Debts that can be discharged in Chapter 7 bankruptcy
Filing Chapter 7 requires you to disclose all of your existing debts. Many of the unsecured debts (including credit card debts) on your list will be discharged.
In addition to credit card debts, Chapter 7 discharges:
- Utility debts
- Personal judgments
- Medical bills
- Past due rent/lease payments
Exempt and non-exempt property in Chapter 7
Bankruptcy law allows you to keep some of your property once your bankruptcy proceedings are done. The property you can keep is called “exempt” property.
Non-exempt property is property that you are required to sell. The proceeds from those sales are used to pay off as much of your debt as possible. Non-exempt property is property that the court doesn’t think is necessary for maintaining a “minimal standard of living.”
Non-exempt property in Chapter 7
Each state has different rules about what property can be exempt from liquidation. Usually, the property that is non-exempt includes:
- Homes or properties outside of your primary residence.
- Automobiles (except for the car you use to get to/from work)
- Musical instruments (unless you need them for work)
- Family heirlooms and Jewelry that have resale value
- Investments (retirement accounts, however, are exempt)
READ MORE: Pros and cons of filing for bankruptcy
Do I qualify for Chapter 7 bankruptcy?
Not everybody qualifies for Chapter 7 bankruptcy. In order to qualify for a Chapter 7 filing, you need to meet the following criteria:
- You must be an individual or a business
- You cannot have any failed attempts at declaring bankruptcy within the last six months
- You must pass a Means Test
What’s a Means Test?
The Means Test is an evaluation of your current financial situation. If you pass the test, you can declare Chapter 7 bankruptcy. There are two parts to the Means Test.
The first part compares your current income to the median income in your state. If your income is below the state’s median income, you’ve passed the Means Test.
If your income is the same as or higher than your state’s median income, you move on to the second part of the Means Test.
In the second part, you will compare your income against allowable monthly expenses determined at the federal and the state level by the IRS. Allowable expenses can include your monthly rent payments, food, clothing, car payments, etc. Any money you have leftover after paying for your allowable expenses is considered “disposable.”
If your disposable income is low enough (this varies by state), you could still qualify to file Chapter 7.
What happens if I don’t pass the Chapter 7 Means Test?
If you aren’t able to pass the Means Test, try not to panic. There are options available to you. You can wait a few months and then see if you pass the Means Test. You could also consider filing Chapter 13 bankruptcy instead of Chapter 7.
Is Credit Card Debt a Good Reason To File Chapter 13?
Some bankruptcy filers prefer Chapter 13 bankruptcy instead of liquidating assets to pay off debts. Chapter 13 allows you to keep your assets and, instead, sets you up with a three or five-year debt payment plan. The plan is based on your income, allowable expenses and other criteria determined by state and federal laws.
Once your repayment period is complete, any debt still owed is written off. The disadvantage is that your bankruptcy trustee controls the purse strings for three-to-five years until your repayment plan is complete. The trustee will allocate an amount of your salary for living expenses, so you will basically have an allowance.
Want to know more about filing for bankruptcy due to credit card debt? Check out this video:
Do I need to meet with a bankruptcy lawyer?
Yes. While it is possible to file any chapter of consumer bankruptcy without an attorney, it is highly recommended that you meet with a bankruptcy lawyer before you file. Bankruptcy court is complicated, and its rules vary from state to state. There are tons of itty-bitty details that you have to get right if you want your filing to be accepted. Get any detail wrong and you’ll either be denied or have to start all over again.
If you’re worried about your ability to afford an attorney’s fees, don’t. Many bankruptcy law firms offer free consultations to help you figure out whether or not filing is your best option and which chapter you should file. Another option is to contact your state’s Bar Association. They will match you with an attorney who offers bankruptcy services for free or at deeply discounted rates.
READ MORE: Cheap ways to file for bankruptcy
What is an automatic stay?
The automatic stay is one of the most appealing parts of filing for bankruptcy. It protects you from some creditor actions like filing lawsuits against you, foreclosing or enforcing liens on your property, repossessing collateral, etc. The automatic stay doesn’t just apply to your creditors. It also applies to debt collectors. If credit card companies are hounding you for payment, they will have to stop as soon as the automatic stay goes into effect.
Under Section 362 of the United States Bankruptcy Code, the automatic stay takes effect as soon as you file for bankruptcy. It is applicable to both Chapter 7 and Chapter 13.
The one drawback is that the automatic stay only applies to the person filing bankruptcy. It does not cover co-defendants, dependents, or guarantors.
What is a bankruptcy trustee?
A bankruptcy trustee is someone who makes sure that your bankruptcy goes according to plan. Their duties and responsibilities will depend on which chapter of bankruptcy you are filing.
If you are filing Chapter 7, your bankruptcy trustee will oversee the liquidation of your assets and make sure that your creditors get paid.
If you’re filing Chapter 13, your bankruptcy trustee will work with you to protect your assets by helping you set up a payment plan and then making sure you stick to it until your repayment period is complete.
Bankruptcy and your credit report
Make no mistake, bankruptcy does affect your credit report. Bankruptcy doesn’t just affect your ability to get new credit cards or qualify for loans. It can also affect your ability to rent an apartment, get a job, etc.
Chapter 7 will stay on your credit report for ten years. Chapter 13 stays on for seven years. These periods begin on the date of your filing, and there is no way to remove a bankruptcy from your credit report early. That said, bankruptcy has less of an effect on your score/report over time, especially if you take steps to rebuild your credit. And with patience (usually after about six months), you will eventually be able to qualify for secured credit cards and credit-builder loans, which will help you repair your credit score. There are even personal loans geared toward borrowers who’ve filed for bankruptcy.
Other options to get rid of credit card debt
Bankruptcy can definitely help you start over, especially when you are drowning in debt. Even so, it shouldn’t be your go-to solution. On the contrary, bankruptcy should be your last resort. If you can afford to do so, try one of these debt relief options to help you conquer your credit card debt before you meet with a bankruptcy lawyer.
Debt management plan
Debt management plans are debt repayment plans that are built and managed by nonprofit credit counseling agencies.
A credit counselor will look at all of your debts and put together a plan that will combine individual debts into a single account that is held and managed by the credit counseling agency. As your credit counselor is putting together your plan, they will work with your creditors to negotiate down what you owe, interest rates, etc. Their goal is to build a plan that will allow you to pay off your debt in three to five years.
Once the plan is in place, you will only have to manage one monthly debt payment. That payment gets sent to the credit counseling agency, where your counselor will distribute that payment to your creditors according to the details in the plan.
Debt management plans can affect your credit report and score, particularly in the short term. Fortunately, any damage done will be easier to repair than declaring bankruptcy.
Debt settlement is where you convince your creditors to allow you to repay them less than you actually owe. Creditors don’t love doing this, but many are more likely to allow you to do this if it means that they don’t have to sell your debt to a collection agency. After all, they’d rather get something than nothing, right?
You can settle your debts yourself, by working one-on-one with your individual creditors. The process can be complicated, though. You can also hire a professional debt settlement company to negotiate on your behalf. Many debtors find that working with a professional helps streamline the process — and can help get them better rates.
If you still have fairly good credit, you can try consolidating your credit card debt by using a personal loan to pay off your cards. The primary advantage to this is that it dramatically decreases the amount of money you’ll pay in interest charges. The reduced interest rate will make it easier to pay your debt off faster. It’s possible to save hundreds or even thousands of dollars by going this route.
Another big advantage to using a personal loan to consolidate your credit card debt is this: it has less effect on your credit than the other options presented here. It is definitely better for your credit than declaring bankruptcy.
The bottom line
If you feel like you are drowning in credit card debt, both Chapter 7 and Chapter 13 bankruptcy can provide you with the fresh start you desperately need. Bankruptcy can also wreak havoc on your credit score and report. Make sure you understand the pros and the cons of bankruptcy before you file.
Not right away. It could take several years before you qualify for an unsecured credit card that allows cash advances. In the meantime, you might be able to qualify for a secured card that offers cash advances.
If you watch TV during the daytime, you are bound to see at least a couple of commercials for bankruptcy lawyers in your area, but they may not be the best option. You need to make sure the attorney you choose offers a free consultation and is experienced with bankruptcy filings in your state. The best way to find a good match is to contact your state Bar Association and ask for a referral. This is especially helpful if you are low-income. The Bar Association can pair you with an attorney who offers free or deeply discounted services.
Debt collectors are not allowed to harass you. If a debt collector is engaging in harassing behaviors or violating the Fair Debt Collection Practices Act or the Consumer Financial Protection Act, you can file a complaint with the Consumer Financial Protection Bureau and your state’s attorney general. You can also try the debt repayment options talked about above.