When you are facing debt you can’t repay, you may decide that bankruptcy is your best option. But that is just the first step to deciding when and how to file. Choosing between a Chapter 7 vs Chapter 13 bankruptcy is just as important. Which one is best for you depends on your assets, your income, and your timeline.
This blog post will discuss the differences between a Chapter 7 vs Chapter 13 bankruptcy. It will explain who might be better off using each type and what happens to your debt after each process is completed. There are more differences between the two types than are covered here, but these are some of the biggest factors to choosing which type is right for you.
Chapter 7 and Chapter 13 bankruptcy are actually different things. Chapter 7 is a liquidation. It sells your non-exempt property to pay off your debts and discharges the rest (except for nondischargeable debts). Chapter 13 is debt reorganization. It gives you time and a structure to pay back your debt to the extent you are able, then forgives the remaining balances on many of those accounts.
This creates one of the biggest questions when choosing between Chapter 7 vs Chapter 13 bankruptcy: do you have non-exempt property that you need to protect? If so, you may want to go with a Chapter 13 bankruptcy. Otherwise, a Chapter 7 may be right for you.
Many people who file for bankruptcy can protect all of their assets through state or federal exemption laws. These are exceptions to the “sell everything” mandate given to bankruptcy trustees. They are designed to keep debtors from becoming destitute when they file for bankruptcy. Depending on whether you and your spouse (if you are filing jointly) claim state or federal exemptions, you may be entitled to protect:
But if you own more than will fit underneath this umbrella, you may want to see if you qualify for a Chapter 13 bankruptcy to protect that nonexempt property.
Both Chapter 7 and Chapter 13 bankruptcies have limits on who is eligible to file. But they work in opposite directions. In a Chapter 7 bankruptcy, you must earn less than the median household income in your state or be able to pass a means test designed to exclude people who have too much income compared to their debts. For Chapter 13, you must be able to show you have enough regular income to pay back at least a portion of your debts.
Because these two tests work in opposite ways, your income is another important factor in deciding between Chapter 7 vs Chapter 13 bankruptcy. Without a reliable source of income, Chapter 7 may be your only option. But if you make too much, you may be forced into a Chapter 13 repayment plan.
The difference between Chapter 7 liquidation and Chapter 13 repayment is most obvious in how long they take from start to finish. In a Chapter 7 bankruptcy, you and your bankruptcy attorney may spend some time gathering documentation and completing the paperwork. But in most cases, there will only be one trip to court (the Creditor’s Meeting), and then your debt will be discharged. That means most Chapter 7 bankruptcies are finished in 4-6 months.
In contrast, filing a Chapter 13 bankruptcy is a promise that you will stick to a repayment plan over the next 3 - 5 years. And that is after you have done the work to file everything properly. During that time, you promise not to take on additional debt without court approval. You will also be required to complete semi-annual statements and could be required to appear in court if you aren’t able to keep up with your planned payments.
The difference between six months and up to six years makes timing a crucial part of deciding whether to file a Chapter 7 or Chapter 13 bankruptcy. Your bankruptcy attorney will help you take a look at your life, including when you might next need to take on new debt (like student loans or a new car payment) to see whether you need a fast solution, or can take the time to complete a repayment plan.
Even though a Chapter 13 bankruptcy takes far longer to complete, it also can sometimes cover debts not discharged in a Chapter 7 filing. The Bankruptcy Code excludes certain debts from being forgiven in a Chapter 7 bankruptcy. This includes secured debt (where you put up some property to ensure you pay what you owe), like mortgages, home equity loans, and car loans. It also includes so-called “non-dischargeable” debts, including:
That means after your Chapter 7 bankruptcy is final and all your other unsecured debt is discharged, you will still need to make payments on these non-dischargeable debt.
But some of those non-dischargeable debts can be included in a Chapter 13 repayment plan. You may be able to put a hold on collections for these debts during the 3-5 years your bankruptcy is pending, or include back-owed mortgage payments and other secured debt in your repayment schedule. Depending on your circumstances, this can mean you may be able to pay off the non-dischargeable debt during your Chapter 13 bankruptcy, and not have to deal with it later.
All of this means you will want to discuss what types of debt you have with your bankruptcy attorney before deciding whether to file a Chapter 7 vs Chapter 13 bankruptcy. If most of your debt unsecured and dischargeable, a Chapter 7 bankruptcy could keep you from paying as much to your creditors. However, if most of your debt is non-dischargeable, you may be better off with a Chapter 13 payment plan, or even a non-bankruptcy option.
There is no single best choice between a Chapter 7 vs Chapter 13 bankruptcy. Which process is best for you will depend on what you owe, what you earn, what you own, and how long you have to finish the process. There are pros and cons to both strategies. At John A. Steinberger & Associates, P.C., we are a full-service bankruptcy law firm in Southeast MI. We serve debtors and families in Southfield, throughout Metro Detroit, and in the surrounding communities. We will help you review your options and choose the bankruptcy strategy that is right for you. Call us toll-free at (866) 690-2140 or contact us online to schedule a free initial consultation.