Chapter 7 Vs. Chapter 13 – Forbes Advisor
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Choosing to file for bankruptcy is a big decision, but it is the first of many that filers will encounter during the process. One of the most important decisions you will make is what type of bankruptcy to file. Generally, individuals can file either a Chapter 7 liquidation bankruptcy or a Chapter 13 reorganization bankruptcy, but which one is best for you depends on your needs and circumstances. It is wise to learn about both types of bankruptcy before making a decision.
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The Bankruptcy Code, which governs all US bankruptcies, specifies six types of bankruptcy, each named after a chapter of the code. They are similar in that they can all protect overburdened debtors from creditors, allowing debtors to avoid repaying some or all of their debts. They differ in that they are each intended for certain categories of debtors, and each type of bankruptcy has a different process.
Individuals typically file under Chapter 7 or 13 since these types of bankruptcy are more focused on individual debtors. Chapter 11, although primarily used by businesses, may be appropriate for sole proprietors and certain other people in business. Municipalities can file under Chapter 9 to reorganize debt and Chapter 12 is a type of bankruptcy for family farmers and fishers. Chapter 15 bankruptcy is used when filings involve parties from multiple countries.
Chapter 7 Bankruptcy
The characteristic feature of Chapter 7 is that the assets of the filer are liquidated, which is why it is also known as liquidation bankruptcy. Any non-exempt property is turned over to a trustee, who sells the assets and distributes the proceeds to creditors. At the end of the liquidation and distribution process, the depositor owes nothing to the creditors.
Certain assets are exempt from liquidation. The list of exempt assets varies by state, but generally includes personal clothing, household furniture and, up to a certain dollar value, an automobile. In practice, most Chapter 7 filers only have exempt assets, so nothing is liquidated. In these so-called non-asset cases, the creditors do not receive any reimbursement.
With or without repayment to creditors, an individual’s debts are always eliminated or, in bankruptcy parlance, discharged. The debtor no longer owes these debts and the creditors must stop trying to collect. Chapter 7 generally automatically discharges qualifying debts. However, only certain debts are eligible. Non-dischargeable debts typically include most tax debts, student loans, child support, and alimony debts.
Also, while Chapter 7 may release you from liability to pay a secured debt, such as your mortgage or car loan, you generally won’t be able to keep the property unless you repay the lien.
In Chapter 7, debtors must pass what is called a means test. To pass, the filer must not have a household income above the median income for their state. Alternatively, the bankruptcy court may order the debtor to file under another chapter, usually Chapter 13.
Chapter 7 filings also have other requirements. For example, debtors must take a course in credit counseling from an approved provider as part of the process. Without this, discharges will not be granted.
While Chapter 7 generally erases all dischargeable debts, some filers may volunteer to pay off one or more debts, a process called reaffirmation. With the reaffirmation, the debtor undertakes to pay all or part of the amount due, and the creditor undertakes not to repossess or repossess the property as long as the debtor continues to pay. For example, a debtor may want to avoid having an automobile seized for non-payment. The debtor can continue to make payments and keep the car by reaffirming the debt.
Chapter 7 is the simplest type of bankruptcy and some debtors choose to represent themselves without an attorney, known as pro se. However, due to the long-term financial and legal consequences of bankruptcy, it is highly recommended to hire a lawyer before filing for bankruptcy.
Chapter 13 Bankruptcy
Chapter 13, also known as a salaried plan, is generally for people who have regular income from employment. This chapter allows filers to maintain valuable assets, such as a home, and develop a plan to pay off debts over time. Chapter 13 also provides discharge for certain types of debts, including those resulting from divorce and certain tax liabilities.
The downside of Chapter 13 is that the debtor must repay all or part of the debt. As part of the process, the filer must submit and have the court approve a three to five year debt repayment plan. Debts are only discharged after the last payment.
Under the repayment plan, the debtor can request lower interest rates and even get part of the balance forgiven. Creditors can object to the plan, but once approved they must agree to it.
Similar to the means test limits on who can file under Chapter 7, a debt cap limits Chapter 13 availability. Only debtors with unsecured debts under $394,725 and secured debts under $1,184,200 $ are eligible to file a claim under Chapter 13. Amounts are adjusted periodically for inflation.
Due to the complexity of preparing a repayment plan, Chapter 13 filers are generally more likely to hire attorneys to help them through the process. This increases the chances of a successful filing, but attorney fees will often be higher than with a Chapter 7 case.
Summary of Chapter 7 vs. Chapter 13
Here is a summary comparing the main features of these two chapters:
Which chapter suits you?
It all depends on individual circumstances, but, for certain broad categories of debt, one chapter is more likely to be better than another:
- Chapter 7. This is generally best for filers with limited income and only unsecured debt, such as credit cards and personal loans. Chapter 7 is also a better choice for a filer who wants to get the process done quickly and may not have the money to hire a lawyer.
- Chapter 13. This is probably the smartest type of bankruptcy for a filer who has a steady, reliable income, wants to keep some of their assets, and can pay off their debts over time. Chapter 13 filers must be prepared to meet the repayment plan, which can take three to five years, and will usually need the money to pay for an attorney.
Credit Implications of Chapter 7 vs. Chapter 13
Filing for bankruptcy, in general, has a negative impact on your credit, whether you file Chapter 7, Chapter 13, or another type of bankruptcy. Filing for bankruptcy can make it harder and more expensive to borrow money in the future.
A Chapter 7 filing stays on your credit report for up to 10 years, while a Chapter 13 filing can stay on your report for up to seven years. Notably, the seven-year period under Chapter 13 does not begin until after the completion of the repayment plan, which, as mentioned above, typically takes three to five years.
Lenders may view a Chapter 13 filing as less of a negative than a Chapter 7 filing. Indeed, a filer who completes a Chapter 13 bankruptcy has reliably made payments for several years and ultimately repaid all. or most of its debts. This can reassure a lender that the loan is likely to be repaid.
Either way, you can do a lot to rebuild your credit after bankruptcy. By using secure credit cards, co-signers, and making payments on time, people who have filed for bankruptcy can regain their old credit rating.
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A feature of all bankruptcies filed under any chapter share is a certain amount of stigma. Bankruptcy is rightly seen as a last resort. But this is not the end. There is a long list of well-known people who have filed for bankruptcy protection and succeeded, including former President Abraham Lincoln, musician Cyndi Lauper, and entrepreneur and former boxer George Foreman.
Bankruptcy does not need to be a decisive financial act. By freeing filers from unsustainable debt, bankruptcy offers a way to build a new and more prosperous future.