If your main intention is to keep secured non-exempt property and catch up on past due-payments, a Chapter 13 might be the better choice.
Written by Attorney Eva Bacevice.
Updated July 22, 2020
Deciding to file for bankruptcy is a big decision. You want to carefully examine the pros and cons as well as make certain that you are filing the right type of bankruptcy for you. The reality is that there isn’t usually a right or a wrong choice. It’s about what is right for you in your current circumstances so long as you are keeping your priorities in mind. In this article we will examine the two types of bankruptcy that you will need to decide between, as well as lay out circumstances that help answer the question: which is right for you?
Chapter 7 vs Chapter 13
To start, there are two main types (or chapters) of bankruptcy available to individual consumer debtors, chapter 7 and chapter 13. A chapter 7 is what you think of as a traditional bankruptcy, that is a liquidation of your assets (non-exempt only) resulting in a discharge of your debts, allowing you to walk away from (most) financial burdens and get a “fresh start.” Chapter 7 cases are relatively quick, and will on average complete within four to six months of filing, with only one court hearing to attend.
Chapter 13, by contrast, is often called a “reorganization” or a “wage earners” bankruptcy, wherein you pay back some or all of the debts you owe to your creditor over a specific period of time (three to five years) through a chapter 13 plan.
When you initially look at it just in these simple terms it seems like a chapter 7 is an obvious better choice. It’s faster, you don’t need to make payments, and you can get on with the rest of your life sooner. But this is not always the case.
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Chapter 13 by necessity
Income is too high/unable to pass the means test
First of all, you may not be able to choose to file a chapter 7 case if you do not qualify to do so. In order to be able to file a chapter 7 case you must either have an average household income which is below median income for a family of your size in your state. If you do not immediately qualify because of your household income, you need to be able to pass a means test. If you do not qualify under either of these scenarios then you are not qualified to file a chapter 7 case and will have to consider a chapter 13 instead if you are seeking the relief and protection that filing bankruptcy provides.
Timing prohibits a chapter 7
You would also be limited to filing a chapter 13 case if you have previously filed a chapter 7 case that completed (i.e. received a discharge) within the past 8 years. You can, however, file a chapter 13 case four years after receiving a chapter 7 discharge.
Chapter 13 by choice
Avoid a foreclosure or repossession
There are also a number of scenarios where you would choose to file a chapter 13 case over a chapter 7. Most commonly this is when you are behind on a secured debt (like a house or a car) that you wish to keep and want to avoid foreclosure or repossession. Filing for bankruptcy creates an immediate automatic stay which will stop any foreclosure or repossession action.
You can then include in your chapter 13 plan both the ongoing regular payments as well as any arrearage (missed payments, late fees and interest) and catch up over the length of the plan. This is usually a better option than negotiating directly with your creditor because a chapter 13 plan runs for a minimum of three years (maximum of 5) which is a considerable amount of time to pay off the arrearage, and, even better, there is no interest accruing or further late fees to worry about. There’s also do potential of only having to pay back a small portion of your unsecured debt (credit cards, medical bills, etc.).
Seeking to keep non-exempt property and/or luxury items
Chapter 13 is also a better choice if you have non-exempt property you want to keep. When you file a bankruptcy, whether chapter 7 or 13, you can protect your property up to varying amounts by using exemptions. In a chapter 7 if there is non-exempt property you can be reasonably certain that the chapter 7 trustee is going to sell that property as part of the bankruptcy estate and distribute the proceeds to your creditors. One scenario that this can impact is if you own more than one house, perhaps using the additional house(s) for rental income. The trustee in a chapter 7 would likely assert that it is only reasonable to have one house and that the sale of any other(s) could provide funds to your creditors. Another scenario that puts you at risk for losing property is when you have equity in the property above the allowed exemption amount.
If you file a chapter 13 there is a much greater chance of being able to keep the non-exempt property. In your chapter 13 plan there will be funds that are going to your unsecured creditors, and the higher that percentage is the more likely you are able to keep non-exempt property or luxury items. Luxury items are those that a trustee can assert are not necessary, for instance you probably do need a car but you do not have to have a high end model with a large monthly payment.
The best likelihood of keeping these items is to (presuming you are able) fund a 100% chapter 13 plan (i.e. all creditors, including unsecured ones are getting what you owe in full). Essentially you want to take away the trustee’s argument to sell any assets - your creditor cannot receive more than 100% of what they are owed so there are no reasonable grounds for a trustee to take and sell the property to benefit your creditors. You also benefit as well because even though you are paying back everything you owe there are no more late fees, no interest will be accruing and you will likely have lower monthly payments (on these debts) over the lifetime of the plan than you would otherwise.
Allow for a payment plan on non-dischargeable debt
Chapter 13 may also be preferable if you are behind on non-dischargeable debt, like child support, student loans or some back taxes. These are debts that you would not be able to walk away from in a chapter 7. In a chapter 13 you can incorporate these debts into you plan.
The right bankruptcy to file is the one that is right for you, based on your financial circumstances and your priorities for filing in the first place. If your main intention is to keep secured property and catch up on arrearages, a Chapter 13 is likely the better choice.