How to Choose the Right Type of Bankruptcy: Chapter 7 vs. Chapter 13

When you're facing overwhelming debt, filing for bankruptcy may provide the relief you need. However, understanding the differences between Chapter 7 and Chapter 13 bankruptcy is crucial. This educational guide is not intended as legal advice. In this article, we’ll briefly review the differences between Chapter 7 and Chapter 13 bankruptcy, examining key factors like assets, debts, and income. Remember, the right choice depends on your financial situation. To avoid costly mistakes, consult with a bankruptcy attorney. Most attorneys offer an initial free consultation.

What Is Chapter 7 Bankruptcy?

Chapter 7 bankruptcy, often called “straight bankruptcy” or "liquidation bankruptcy," may involve selling nonexempt property to repay creditors. Under Chapter 7, a court-appointed trustee manages the liquidation of assets to pay both secured and unsecured creditors. After selling nonexempt assets (if applicable), remaining unsecured debts, such as medical bills, credit card debt, and personal loans, are discharged.

To qualify, you must pass a “means test” that compares your income to household expenses to determine if your income qualifies for debt discharge under Chapter 7. If your income exceeds a certain threshold based on your household size and state, you may need to file for Chapter 13 instead.

Who Should Consider Chapter 7?

• Individuals with limited income who can't afford a repayment plan
• Those with primarily unsecured debt, like credit cards and medical bills
• Individuals looking to retain exempt property

What Is Chapter 13 Bankruptcy?

Chapter 13 bankruptcy, also known as "reorganization" or the “wage earner’s plan,” allows debtors to reorganize debts without liquidating assets. Instead of selling property, you propose an installment payment plan over three to five years to repay a portion of your debts. A bankruptcy court must approve this repayment plan, during which you make monthly payments to a trustee who then distributes them to creditors.

Chapter 13 is typically an option for individuals with regular income who want to keep assets such as homes or cars. It's frequently used by homeowners who are behind on mortgage payments or individuals with secured debts they want to restructure.

Who Should Consider Chapter 13?

• Individuals with a steady monthly income who can afford monthly payments
• Homeowners behind on mortgage payments who wish to keep their homes
• Debtors with valuable assets they wish to protect from liquidation

The Role of the Bankruptcy Trustee

In both Chapter 7 and Chapter 13 cases, a bankruptcy trustee plays an essential role. Appointed by the court, the trustee ensures compliance with bankruptcy rules and oversees the distribution of funds to creditors when necessary. Acting as a neutral party, the trustee’s responsibility is to protect the interests of both the debtor and the creditors.

Key Differences Between Chapter 7 and Chapter 13

When deciding between Chapter 7 and Chapter 13, consider how they differ in terms of asset handling, debts, and repayment:

• Debt Relief
  • Chapter 7: Most unsecured debts are discharged within a few months.
  • Chapter 13: Repayment occurs over three to five years, offering gradual relief.
• Impact on Assets
  • Chapter 7: Nonexempt property may be sold to repay creditors.
  • Chapter 13: Allows you to retain property if you follow the repayment plan.
• Income Requirements
  • Chapter 7: Requires passing a means test to qualify based on income level.
  • Chapter 13: Requires sufficient regular income to maintain a repayment plan.
• Unsecured Debt
  • Chapter 7: Discharges most unsecured debts like medical bills and personal loans.
  • Chapter 13: Allows partial repayment of secured and unsecured debts through an approved repayment plan.

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Pros and Cons of Chapter 7 Bankruptcy

Pros:

• Fast debt relief, offering a quick way to eliminate most unsecured debts
• No monthly repayment plan required
• Provides a fresh start by discharging eligible debts
• Initiates an automatic stay to stop creditor actions

Cons:

• Potential loss of nonexempt assets to repay creditors
• Secured debts, such as mortgages or car loans, may not be discharged
• Significant credit score impact
• Limited eligibility based on the "means test" income thresholds
• Some debts, like student loans and child support, cannot be discharged

Pros and Cons of Chapter 13 Bankruptcy

Pros:

• Can prevent foreclosure or repossession of assets
• Allows retention of assets by including them in a structured repayment plan
• Stops creditor harassment upon filing
• Allows catching up on past-due secured debts
• May protect co-signers from liability on certain debts

Cons:

• Requires a 3-5 year repayment commitment
• Income consistency is necessary to fulfill payment obligations
• Significant impact on credit score
• Involves detailed financial disclosure and possible need for legal assistance
• Certain secured debts, such as mortgages, may not be fully discharged

Consulting an Experienced Bankruptcy Attorney

Before making a decision, it’s essential to consult an experienced bankruptcy attorney who can review your financial situation and explain the pros and cons of each option. An attorney can clarify how bankruptcy laws apply to your case in your state, provide information on filing and court fees, and represent you in bankruptcy court.

Credit counseling is typically required before filing, ensuring you've explored other debt-relief options. A counselor can also help you understand the long-term effects of bankruptcy on your credit and overall financial health.

How Bankruptcy Affects Your Credit Report

Filing for Chapter 7 or Chapter 13 bankruptcy impacts your credit report significantly, affecting your ability to obtain credit for several years. Chapter 7 remains on your credit report for up to 10 years, while completed Chapter 13 cases stay for 7 years.

While obtaining new credit may be challenging during this period, credit scores often improve over time with sound financial practices, such as paying bills on time and managing credit responsibly.

Conclusion

Deciding between Chapter 7 and Chapter 13 bankruptcy is an important decision with long-term financial implications. Consulting with an attorney is invaluable, providing guidance and ensuring you make informed decisions for your financial future. If you’re considering filing for bankruptcy, our certified counselors are here to help. Schedule a free consultation today to explore your options and start your journey toward financial recovery.

Visit our Bankruptcy Counseling Services to learn more.

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