Many low-income debtors have to decide between filing for Chapter 7 bankruptcy and filing for Chapter 13 bankruptcy. This Upsolve guide will help you figure out which type of bankruptcy is best for you.
Choosing the right type of bankruptcy for you depends on what your goals are. Most consumers seek bankruptcy protection under one of two chapters of the United States Bankruptcy Code: Chapter 7 and Chapter 13. In a Chapter 7 bankruptcy, you ask the Bankruptcy Court to eliminate your obligation to pay most unsecured debts in a relatively short period of time. It’s a liquidation, so anyone filing bankruptcy under Chapter 7 risks losing nonexempt property to their unsecured creditors. Chapter 13 bankruptcy allows you to protect expensive property that you would lose in a Chapter 7 bankruptcy proceeding. But, instead of getting debt relief in the form of a bankruptcy discharge in as little as 3 - 4 months, a Chapter 13 bankruptcy case means you commit to paying your disposable income - what’s left of your monthly income after paying reasonable living expenses - for a minimum of 3 years before a discharge can be entered. If your monthly income under the Means Test exceeds the median household income for a household of your size, you have to commit to a 5-year Chapter 13 repayment plan. When choosing the right type of bankruptcy for you, your decision will usually depend on your goals and what you can realistically achieve with either Chapter 7 or Chapter 13. This article highlights some things to consider when whether to file Chapter 7 or Chapter 13 bankruptcy.
When Chapter 13 is Better than Chapter 7
If You Want to Keep Property.
Chapter 13 bankruptcy allows you to keep property in two different ways.
Property securing debt.
If you have a home and have fallen behind on your mortgage payments, filing bankruptcy under Chapter 13 of the Bankruptcy Code gives you the ability to stop a foreclosure. And, assuming your regular income allows you to resume making regular monthly payments on your mortgage and you have enough money left after paying living expenses a Chapter 13 bankruptcy can help you bring your mortgage current. If you own a home and have more than one mortgage, a bankruptcy proceeding under Chapter 13 may allow you to eliminate the second mortgage. If the value of your home is less than the total debt owing your first position mortgage, the bankruptcy laws allow you to both discharge your personal liability and remove the lien on your property. But only after successful completion of a Chapter 13 repayment plan. Similarly, if you have a car loan that you’ve fallen behind on, a Chapter 13 repayment plan gives you the opportunity to pay the car off as part of your case. You can even get your car back after a repossession through a Chapter 13 bankruptcy proceeding. Once the case has been filed, instead of making your monthly car payments directly to the secured creditor, you’ll most likely pay your car loan through the Chapter 13 plan.
A Chapter 13 bankruptcy case gives the filer the ability to keep nonexempt property that would be sold by the bankruptcy trustee for the benefit of unsecured creditors in a bankruptcy proceeding under Chapter 7. But, this does not come without cost. In order to keep nonexempt assets in a bankruptcy filing under Chapter 13 of the Bankruptcy Code, your unsecured creditors have to receive an amount equal to its value as part of your Chapter 13 repayment plan. For example, if you have an heirloom worth $700 that is nonexempt, your plan payments have to be high enough to pay all of your unsecured creditors a total of $700 combined. That way, your creditors are not worse off in a bankruptcy filing under Chapter 13 than they would have been in a Chapter 7 case.
You have debts a Chapter 7 doesn’t eliminate
The United States Bankruptcy Code does not discharge all types of debts and a Chapter 7 bankruptcy filing does not provide any kind of debt relief for you in the long term with respect to those debts. Of course, when your bankruptcy petition is first filed, all collection efforts, including garnishment have to stop. But, this bankruptcy protection, called the automatic stay, only lasts until your discharge is entered. Once that happens, creditors whose claims did not get discharged can resume their collection efforts because the bankruptcy protection you’ve been granted in the form of your Chapter 7 discharge does not affect them. Common examples of debt a Chapter 7 doesn’t eliminate are recent income taxes, alimony, child support, and debts secured by property you’re keeping under the terms of a reaffirmation agreement. A Chapter 13 repayment plan gives you the chance to pay off the debt that would survive a Chapter 7 bankruptcy case over a period of time, giving you total debt relief. So, the $6,000 in income taxes the United States government wants you to pay now gets stretched out over 5 years, resulting in a much more manageable monthly payment. At the end of your Chapter 13 repayment plan, your priority claims will be paid in full and you’ll truly be debt free, other than your student loans, if any. This can be much more meaningful debt relief than a quick Chapter 7 liquidation followed by months and months of dealing with priority creditors that want you to pay them right away. Some debts that are not dischargeable in a Chapter 7 bankruptcy can be discharged in a Chapter 13 proceeding, such as debts arising from property settlements that were part of a divorce proceeding. Other debts can be discharged under either type of bankruptcy proceeding, but you have a co-signer you don’t want to leave with the debt. In that case, Chapter 13 allows you to pay off this creditor, even if the creditor has a nonpriority unsecured claim. This protects your co-signer from collection efforts both during and after your bankruptcy filing. In a Chapter 7 bankruptcy, your co-signers do not receive any bankruptcy protection and continue to be responsible for paying the debt.
You’re not eligible for Chapter 7 bankruptcy.
If your regular income is too high and you fail the Means Test, you’re not be able to file bankruptcy under Chapter 7 of the Bankruptcy Code unless you fall under one of the very limited exceptions. In that case, filing a bankruptcy petition under Chapter 13 and proposing a repayment plan based on your disposable income provides you with debt relief both in the short term (your repayment plan is based on how much you can afford to pay) and in the long term, when your discharge is entered.
Downsides of Chapter 13
Most People Can’t Complete the Repayment Plan
Chapter 13 has about a failure rate of about 67%. This is because most people are unable to complete the 3-5 year repayment plan. Because your debts are only forgiven upon completion of the plan, people who default often end up back at square one. An unsuccessful attempt at Chapter 13 bankruptcy can actually leave you in worse shape than before you filed. This is because the interest has continued to add up, you’ve now spent money on a bankruptcy lawyer, filing fees and bankruptcy Trustee fees. And, you’ve inherited the seven year flag on your credit report and resulting hit to your credit score — all without achieving the main goal of any bankruptcy option: debt relief.
You’ll Likely Need to Pay an Attorney + It’s Expensive.
Unlike Chapter 7 cases, the low success rate of Chapter 13 cases shows that it is a good idea to have a bankruptcy lawyer when filing Chapter 13 bankruptcy. Only about 1 - 2 % of Chapter 13 bankruptcy cases filed without the help of a bankruptcy lawyer succeed. The problem is that bankruptcy attorneys are expensive. On average, you could look to spend around $3,000 in attorney fees. Although this fee can be paid over time, it’s important to note that the attorney fees for Chapter 13 are over twice as much as Chapter 7. Bear in mind, that’s not because bankruptcy lawyers are greedy. It’s because a Chapter 13 bankruptcy proceeding is typically a 3 - 5 year commitment not only for you, but also for your lawyer.
You can have too much debt for Chapter 13.
The United States Bankruptcy Code limits the total debt a filer under Chapter 13 can have. If either your secured debts, such as your mortgage(s) and car loan(s) or your unsecured debts exceed the total debt limit, you are not eligible for debt relief under Chapter 13. In the era of 6-digit student loan debt, this can prevent even the most typical consumer from filing a Chapter 13 bankruptcy.
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When Chapter 7 Is Better Than Chapter 13
If your total debt is credit cards, medical bills, personal loans, or other unsecured debts that are not connected to any property, a Chapter 7 is likely a better option for you. This is especially true if you don’t have any nonexempt property that you might lose to a bankruptcy Trustee in a Chapter 7 case. Some of the distinct advantages of a Chapter 7 vs. Chapter 13 bankruptcy are as follows:
Relief Comes Quickly.
Chapter 7 bankruptcy can get you a fresh start in as little as 3 to 4 months. And, although it takes a few months for your debts to be fully erased, you will actually start getting relief as soon as you file because it immediately blocks all bill collectors from contacting you. This is called an automatic stay.
Chapter 7 relieves you from having to pay off your credit card debt and most debts you owe. Unlike Chapter 13's repayment plan, it's not a debt consolidation but it erases your debts so that you can get a fresh start without committing to 3 to 5 more years of payments.
You Can Keep Most Property.
A common misconception about Chapter 7 bankruptcy is that you get your property taken away. Although it is true that expensive property like a home or a luxury car can be taken, most day-to-day personal property like clothes, electronics, furniture, and cars are actually protected by applicable bankruptcy exemptions. In 96% of Chapter 7 bankruptcy proceedings, the filer keeps all of their property even after filing their case.
You can keep property securing a debt.
If you’re up-to-date on the payments and can commit to staying on top of them, you are able to keep property securing the debt. This is true for both car loans and mortgages. To ensure your fresh start is as impactful as possible, you should only keep property securing debt if your regular income is enough to pay for your living expenses and the car payment or mortgage payment.
It Has Consistent Results.
Of all the types of bankruptcy, Chapter 7 bankruptcy has a comparatively high success rate, with most Chapter 7 cases resulting in a discharge.
Downsides of Chapter 7
No relief from nondischargeable debts.
Some debts can’t be erased. This includes most student loans, child support, and mortgages. Chapter 13 bankruptcy often provides for the full payment of the total debt that would otherwise survive the bankruptcy case.
You could lose expensive property.
If you have valuable nonexempt property, the bankruptcy Trustee will sell the property and distribute the proceeds to your creditors.
You can’t use it to catch up on mortgage payments or car loans.
While Chapter 7 bankruptcy will temporarily postpone a foreclosure or repossession, it does not give you an opportunity to bring your payments current the same way a Chapter 13 does.
You can’t make too much money.
You’re eligible to file for Chapter 7 only if you pass the Means Test. You can qualify either because your household income is below the median income in your state, or, if your income is too high, by showing that your allowed living expenses do not leave you with any disposable income that could be used to fund a Chapter 13 repayment plan. If your income is too high to qualify for Chapter 7, keep in mind that this means you’re better off than many. Speak to an experienced bankruptcy lawyer in your area to learn more about how Chapter 13 bankruptcy proceedings work in your district. Bottom line, if the amount you spend paying your creditors every month is less after filing your bankruptcy petition than it was before, your monthly income will go further than it does now. Debt relief, while not immediate, is still attainable.
Which type of bankruptcy will provide you with the debt relief you are looking for depends on many factors. If you have regular income, filing a Chapter 13 bankruptcy may be better in the long run. Of course, to give yourself the best possible chance in a Chapter 13 reorganization, you should hire a bankruptcy lawyer for your bankruptcy case. If you’re struggling mostly with unsecured debts and qualify for Chapter 7 relief, it will likely get you back on your feet much quicker. Plus, if you can’t afford a bankruptcy lawyer for your Chapter 7 bankruptcy there are legal aid organizations and free filing services like Upsolve that can save you the money you would spend for a Chapter 7 attorney.