What Is a Bankruptcy Discharge?

How Does a Bankruptcy Discharge Work?

Bankruptcy is a process designed to protect borrowers overwhelmed with debt from being sued into financial ruin by creditors they owe money. If you file for bankruptcy protection and fulfill the requirements of the court, eligible debts will be discharged. You will no longer be legally obligated to repay them, and your creditors may no longer seek to collect them.

All bankruptcy proceedings require you to complete a credit education course. Other requirements for debt discharge depend on the type of bankruptcy protection you seek:

• Chapter 7: To file Chapter 7 bankruptcy, also known as a liquidation bankruptcy, you must demonstrate through a means test that your income falls below the median for your state, and then forfeit any property you cannot exempt under your state laws. A court-appointed trustee will see to the sale of that property and distribute the proceeds among your creditors, repaying designated priority debts first, and distributing any remaining funds to the rest of your creditors. Once this process is complete—typically within four to six months—any eligible debts that remain unpaid will be discharged.
• Chapter 13: If a means test finds you have sufficient income, a Chapter 13 bankruptcy proceeding will establish a payment plan lasting either three or five years, during which you will make regular fixed payments to a bankruptcy trustee. The trustee will distribute the funds among your creditors. At the end of the repayment period, if you’ve kept up with your payments, any eligible debts that remain unpaid will be discharged.

Note that not all debts can be discharged, and that bankruptcy therefore cannot provide relief from all forms of debt.

What Debts Can Be Discharged?

With exceptions designated for each chapter of the federal bankruptcy code, the majority of consumer debts are dischargeable through bankruptcy, including:

• Unpaid balances on credit card accounts, personal loans and most other unsecured debt
• Medical bills
• Loans from family or friends
• Outstanding utility bills
• Attorney fees
• Contractual debts
• Civil court judgments
• Missed rent payments
• Certain unpaid taxes

In addition, the following obligations can be discharged in Chapter 13 bankruptcy (but not Chapter 7), unless a creditor successfully petitions a court to have them declared nondischargeable:

• Unpaid restitution or damages awarded in a civil case for willful or malicious actions by the debtor that cause personal injury
• Debts for money or property obtained by false pretenses
• Debts for fraud or misappropriation of funds while acting in a fiduciary capacity

What Debts Can’t Be Discharged?

Debts that cannot be discharged through bankruptcy include:

• Unpaid alimony and child support
• Certain taxes
• Federal student loans
• Debts for death or personal injury caused by the debtor’s operation of a motor vehicle while intoxicated or impaired

Other debts may be nondischargeable as well, depending on the type of bankruptcy filing:

Chapter 7

Additional nondischargeable debts under Chapter 7 bankruptcy include:

• Debts for willful and malicious injury by the debtor to another entity or to the property of another entity
• Debts for certain criminal restitution orders

Chapter 13

Additional nondischargeable debts under Chapter 13 bankruptcy include:

• Debts for restitution or a criminal fine as part of a criminal conviction
• Debts for willful and malicious injury to property
• Debts incurred to pay nondischargeable tax obligations
• Debts arising from property settlements in divorce or marital separation

What Happens After a Bankruptcy Discharge?

When the bankruptcy court issues a discharge order, notification is sent to you, your lawyer, all creditors whose debts have been discharged, the trustee overseeing your case and the trustee’s lawyer.

The notice tells creditors they can no longer contact you seeking payment on discharged debts. This makes permanent a temporary ban on debt collection contact that was put in place when you filed for bankruptcy. If a creditor persists in contacting you after a discharge notice is issued, you can file a court motion that could bring them sanctions.

Within a few months of the order, your credit reports should be updated to reflect zero balances on discharged credit card and loan accounts.

In some instances, creditors who issued you secured debt—loans or credit that use property as collateral—can legally seize that property after a discharge is issued. Those creditors, who may include mortgage issuers and auto finance lenders, may no longer seek delinquent payments from you, but they may still have the right to seize collateral (including your house or car) in accordance with your loan agreement and local laws.

If you are concerned this could happen to property you wish to keep, ask a bankruptcy attorney about reaffirming those debts as part of your bankruptcy—before a discharge is finalized. Reaffirming your debt means you promise to repay the debt in exchange for the lender allowing you to keep the property—but act fast. Once a discharge order is entered in your bankruptcy, you can no longer sign reaffirmation agreements and your property could be seized.

How a Bankruptcy Discharge Affects Credit

In itself, a bankruptcy discharge doesn’t affect your credit, but the act of filing bankruptcy has a long-lasting impact on your credit reports and credit scores. A Chapter 13 bankruptcy appears on your credit report for up to seven years from the date you first file for protection with the court, while a Chapter 7 bankruptcy appears for up to 10 years from the filing date.

A bankruptcy may be the most severe negative event that can appear on your credit reports, and it hurts your credit scores until it expires. The number of points by which a bankruptcy lowers your credit scores may not be large, but only because missed payments, collection accounts and other negative events that commonly precede bankruptcy typically lower scores so much that there may not be very many points left to lose.

As with all negative credit report entries, the credit score impact of a bankruptcy will diminish over time, but some lenders refuse to work with applicants whose credit reports show a bankruptcy, no matter their credit scores.

How to Improve Your Credit After Bankruptcy

Bankruptcy, and the credit missteps that lead to it, can do great harm to your credit. But that isn’t permanent, and you can start rebuilding your credit as soon as you file bankruptcy. Possible steps include:

• Pay your bills on time. If you’ve filed bankruptcy, there’s a good chance your credit reports reflect some late payments, and it’s in your best interest to commit to paying your bills on time from here out. The single most important factor affecting credit scores is payment history. Regular on-time payments of bills for loans, credit cards and other debts helps build strong credit scores, and just one payment that’s overdue by 30 days or more can hurt your scores significantly.
• Get a secured credit card. Making timely debt payments can be challenging in the months (or years) after filing bankruptcy. Card issuers may have canceled old accounts and you may not qualify for new ones—unless it’s a secured credit card. With a secured card, you put down a cash deposit—typically a few hundred dollars—and that amount serves as the card’s borrowing limit. The card issuer will keep the deposit if you don’t pay your bills. Using the card regularly and paying your bills on time each month can promote credit score improvement.
• Consider a credit-builder loan. Available from some credit unions, online lenders, community banks and lending circles, a credit-builder loan is designed to help you save a little money as you work to improve your credit. The loan is for a small sum (typically less than $1,000), with a repayment term that’s usually six to 24 months. When you’re issued the loan, instead of giving you the cash, the lender places it in an interest-bearing savings account you cannot touch. If you make all your payments as agreed, you’ll build a positive payment history and the money (plus interest) will be yours when the loan is repaid in full.
• Avoid repeating past missteps. Take some time, perhaps with the guidance of a certified credit counselor, to review the decisions that led to bankruptcy, and commit to adopting new habits so you won’t get in over your head again.

The Bottom Line

Pursuing bankruptcy is never an easy decision, but a bankruptcy discharge can be a great starting point for rebuilding your credit. Three to six months after you receive a discharge, it’s smart to check your credit reports at the three national credit bureaus (Experian, TransUnion and Equifax) to make sure your discharged accounts are updated accurately. If not, you have the right to dispute your credit reports to have them corrected. Checking your FICO Score from Experian is a great way to track your progress as you begin your journey back to healthy credit.