Although there are 5 categories of bankruptcy, only two are typically options for regular consumers- chapter 7 and chapter 13 bankruptcy. Chapters 9, 11 and 12 of the bankruptcy code typically only apply to farmers, municipalities and businesses. So how do you choose between chapter 7 versus chapter 13? Neither is simply better than the other, rather each provides distinct benefits to different situations.
Chapter 7 vs Chapter 13
Perhaps the most important questions when filing bankruptcy is why you are filing bankruptcy, and what you hope to accomplish. At their core, chapter 7 and chapter 13 bankruptcies differ in what they achieve. Chapter 7 is a liquidation bankruptcy, while chapter 13 is an adjustment or reorganization bankruptcy.
When most people think of bankruptcy, they likely think along the lines of chapter 7 bankruptcy: you lose most of your assets and in return have most of your debts discharged immediately. Chapter 13, on the other hand, enters you into debt repayment plan which lasts between 3 and 5 years. Only after this plan is completed can your remaining debts be discharged. In return for repaying your debtors what the court deems appropriate, you do not forfeit any of your property in a chapter 13 bankruptcy.
Generally speaking, chapter 13 bankruptcy is designed for people with higher income who simply need their debts reorganized while chapter 7 is designed for people who simply can not pay back their debt. Chapter 7 bankruptcy has income limits limits built in for this reason. If you have a higher income, these limits may immediately limit you to chapter 13 bankruptcy. The income limits vary from state to state and depend on your household size, but they generally fall between $40,000 and $70,000 for families of one or two.
If you don’t qualify for chapter 7 bankruptcy because of income limits, you will most likely qualify for chapter 13. In fact, while chapter 13 bankruptcy does not have an upper income limit, it does require that you at least make enough to be able to make payments on your debt re-payment plan. This amount depends on how much debt you have.
Property Exempt from Forfeiture
Since chapter 13 bankruptcy is simply re-organization, you do not forfeit any of your property. However, even under chapter 7 bankruptcy, some of your property is exempt from forfeiture. Generally speaking, any property that is reasonable or not excessive is exempt from forfeiture. For example, your home, retirement accounts, appliances, and one vehicle are all exempt. However, an RV, expensive jewelry, non-retirement assets and a second vehicle would all be non-exempt and subject to seizure by the court-appointed trustee.
If any of this exempt property is being used as collateral for debt, however, you can not simply have the underlying debt discharged and keep the property. Home mortgages and vehicle loans are two common examples of this. With each of these, the home or the vehicle are collateral for the debt. Even under chapter 7 bankruptcy, the claim on the property still remains. You can re-affirm the debt, meaning that the debt survives the bankruptcy. You can forfeit the property and have the debt discharged with the rest of your debts. Or you can redeem the property by paying off the balance of the debt.
What Debts are Discharged Under Chapter 13 Bankruptcy
The goal of chapter 13 bankruptcy is to be fair to lenders while also lending a helping hand to debtors. Because of this, debts are not immediately discharged, but are rather consolidated into the 3-5 year repayment plan. However, once this repayment plan is completed, much of your remaining unsecured debt gets discharged. Keep in mind that not all repayment plans will have unsecured debt left over. Since chapter 13 bankruptcy requires all of your discretionary income dedicated to the repayment plan, a larger income may very well mean that your repayment plan successfully repays all your unsecured debt.
Who Should File For Chapter 7 Bankruptcy
Chapter 7 bankruptcy is best for people with a limited income, and mostly unsecured debt, and limited (and mostly exempt) assets. Joe, for example, is a blue collar worker who just lost his job and is now scraping by on part-time work. He is already behind on utility payments and medical bills, and 5,000 in credit card debt. He also has a 2,000 car loan. With his part-time income, there is no way he can feed his family, keep up on rent, and make payments on all his debt. Joe’s best option is filing for chapter 7 bankruptcy. A $20,000 annual income is well below the income limit. Joe’s most significant asset is his vehicle, which is exempt property. And, Joe’s credit card debt, medical bills and past-due utility payments will be discharged. Joe will most likely opt to re-affirm his vehicle loan since he needs his vehicle to get to work. Chapter 7 bankruptcy allows Joe start over with a relatively clean slate.
Who Should File for Chapter 13 Bankruptcy
A chapter 13 bankruptcy is best for people with a larger, more stable incomes, and with significant assets that would not be exempt from chapter 7 bankruptcy. Bill, for example, is an executive at a large company. However, due to cutbacks at his firm, his salary has dropped from 150,000 to 100,000, making it impossible for him to keep up on his debt payments. Bill has several credit cards with balances, 2 vehicles, both financed, a vacation home, and his primary residence, both financed. Bill has already fallen behind on his primary mortgage and is facing the prospect of foreclosure. While Bill will likely see little of his debt erased, a payment plan will consolidate his loan payments, relieve him of the high interest on his credit cards, can give him more time to pay off his debts and will save his home from foreclosure. By filing chapter 13 bankruptcy, Bill saves his second car, vacation home and any other assets from forfeiture.
Consider your Circumstances
When deciding between chapter 7 and chapter 13 bankruptcies, don’t jump to conclusions. Don’t assume that just because chapter 7 is swift that it is necessarily better, or just because chapter 13 saves all your assets that your assets would not also be exempt under chapter 7. Rather, consider your particular circumstances and how each one would affect your finances in the long term.