Bankruptcy Explained: Definition, Types and What to Know

What Is Bankruptcy? Definition, Types and What to Know

Facing overwhelming debt? Learn how bankruptcy works and whether it could be right for you.

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Edited by other Updated Mar 12, 2026

Key takeaways

Bankruptcy is a legal way to deal with overwhelming debt. A lawyer can guide you through the process. Chapter 7 and Chapter 13 are the two most common types of bankruptcy for consumers, while Chapter 11 is typically used for businesses. Bankruptcy may make sense if your total debt, other than your mortgage, is more than 40% of your income, and you’re not sure how to pay it off. Filing for bankruptcy can negatively impact your credit score and will stay on your credit report for up to 10 years. However, you can begin to restore your score in months. There are less disruptive debt relief options to consider, like a debt management plan.

What is bankruptcy?

Bankruptcy is a legal process that helps people who can’t pay back debt. Depending on the type, you can erase some debts or set up a repayment plan with easier terms. When you file for bankruptcy, debt collectors must stop calling you. They also can’t sue you or garnish your wages. Overall, the process is complicated and hiring an attorney is advisable, but you’re likely to see some parts of your finances improve within six months of filing. You can take immediate steps to begin to rebuild your credit in the time that follows.

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Is filing for bankruptcy right for you?

Filing for bankruptcy is never an easy decision, and you’ll have to weigh the severity of your situation. But in general, bankruptcy may be the best option if: You see no way to pay off your debts within five years. Your amount of debt (not including a mortgage) is greater than 40% of your income. You’re paying as much as you can toward your debts but not making progress. Debt payments are preventing you from meeting other financial goals, such as saving for retirement. If you’re considering bankruptcy, get free consultations from a bankruptcy attorney and a nonprofit credit counselor to better understand your finances and whether it's the right option.

What are the types of bankruptcy?

The two most common kinds of consumer bankruptcy are Chapter 7 and Chapter 13. Chapter 11 bankruptcy is typically used by businesses.

Chapter 7 bankruptcy

Known as “liquidation” since most unsecured debts are forgiven, Chapter 7 bankruptcy is the fastest and most common form of bankruptcy. Best for: Consumers who have mostly unsecured debt, such as medical bills, credit card debt or personal loans. Best for: Eligibility You have to pass the means test, which determines whether you qualify to file Chapter 7. Can’t have had a Chapter 7 discharge in the past eight years or a Chapter 13 discharge in the past six years. Can’t have filed a bankruptcy petition in the previous 180 days that was dismissed because you failed to appear in court or comply with court orders, or you voluntarily dismissed your own filing because creditors sought court relief to recover property they had a lien on.

Chapter 13 bankruptcy

Known as a “wage earner's” plan, Chapter 13 bankruptcy lets you set up a payment plan to repay debts over three to five years. Best for: Those who have assets they want to retain, like expensive jewelry, or secured debts they want to get current on, like a mortgage. Best for: Eligibility You must have regular income. Must be current on tax filings. You cannot have filed for Chapter 13 in the past two years or Chapter 7 in the past four years. You cannot have filed a bankruptcy petition in the previous 180 days that was dismissed for certain reasons, such as failing to appear in court or comply with court orders.

Chapter 11 bankruptcy

Called a “reorganization” bankruptcy, this chapter is typically used by corporations and businesses. Best for: Businesses that want to keep operating. Best for: Eligibility Cannot have filed a bankruptcy petition in the previous 180 days that was dismissed because you failed to appear in court or comply with court orders, or you voluntarily dismissed your own filing because creditors sought court relief to recover property they had a lien on.

Do you need a bankruptcy attorney?

The short answer: Yes. Bankruptcy is a long and complicated process. Improperly filling out just one form could result in the dismissal of your case, which means you’d have to wait six months to file again. Find a bankruptcy attorney to help you navigate the process and ensure you get the paperwork right Learn about your options to help pay for bankruptcy as you get started.

How long does bankruptcy stay on your credit report?

Filing for bankruptcy will stay on your credit report for up to 10 years, depending on the type. The good news is that your credit can start to improve within months of filing. This is especially true if you were already behind on payments, because bankruptcy removes some negative marks from your report. There are other debt relief options to explore. Use this calculator to determine your debt load and explore relevant relief options. Explore more on About the author Pyles Sean Pyles, CFP®, is producer and host of NerdWallet's "Smart Money" podcast. On "Smart Money," Sean talks with Nerds across the NerdWallet Content team to answer listeners' personal finance questions. With a focus on thoughtful and actionable money advice, Sean provides real-world guidance that can help consumers better their financial lives. Beyond answering listeners' money questions on "Smart Money," Sean also interviews guests outside of NerdWallet and produces special segments to explore topics like the racial wealth gap, how to start investing and the history of student loans. Before Sean started podcasting at NerdWallet, he covered topics related to consumer debt. His work has appeared in USA Today, The New York Times and elsewhere. When he's not writing about personal finance, Sean can be found tending to his garden, going for runs and taking his dog for long walks. He is based in Portland, Oregon. Published in How to Pay Off Debt: Top Strategies for 2026 Credit Score Ranges: What They Mean and How They Work How to Budget Money in 5 Steps 28 Proven Ways to Save Money Chapter 7 vs. Chapter 13 Bankruptcy: What’s the Difference? By Sean Pyles, Lauren Schwahn, Kate Ashford, WMS™ How to Deal with Debt Collectors By Sean Pyles, Tommy Tindall, Tiffany Curtis What Is a Debt Management Plan? By Jackie Veling, Sean Pyles Debt Relief: How It Works and Options to Consider By Jackie Veling, Kate Ashford, WMS™