Declaring bankruptcy is a big deal. The long-term damage it can do to your credit is such that bankruptcy only should be considered as a last resort, after credit counseling, debt management or debt settlement have either been tried or considered. Show
But, if bankruptcy is the only hope to get out from debt that’s grown too large for you to pay, another question remains. Should you file Chapter 7 or Chapter 13 bankruptcy? These two sections of the U.S. Bankruptcy Code determine how individuals can settle overwhelming debt. Will you be put on a debt repayment plan, enabling you to keep your property? Or will some of your property have to be sold to pay off what you owe? You’ll need to do your research and due diligence before choosing which is right for you. Before considering either, be aware that the following debts cannot be discharged by Chapter 7 or Chapter 13 bankruptcy, including:
The biggest differences between Chapter 7 and Chapter 13 bankruptcy are what happens to your property and who qualifies financially. Chapter 7 requires you to sell property that isn’t exempt to pay off your debts. However, a survey done by the American Bankruptcy Institute in 2018 showed that if you file exemption paperwork properly, 93% of filers in the United States are able to protect all of their assets. Chapter 7 bankruptcy typically discharges your obligations and allows you to get on with your life much faster than Chapter 13, which gives you a chance to maintain your property. The tradeoff for Chapter 13: You complete a court-ordered repayment plan, which can take three to five years. Another issue to consider: Not everyone qualifies for Chapter 7 bankruptcy. You must pass a means test, which uses a formula that prevents higher-income debtors from using bankruptcy provisions to completely wipe out their debts. In Chapter 7, you must either have a below-median level income for your state or pass a means test that examines income, expenses and family size to determine whether you could reasonably repay your debts with whatever income you have after paying for essentials. Those who fail this means test may use Chapter 13. Here are some side-by-side comparisons of the two bankruptcy methods. After the chart, we explain in more detail how Chapter 7 and Chapter 13 bankruptcy work and how to choose which option is best for you.
How Chapter 7 Bankruptcy WorksWhen you file for Chapter 7 bankruptcy, an order known as the automatic stay prevents most creditors from calling you anymore and continuing to collect money, including wage garnishment. Chapter 7 bankruptcy erases debts such as medical bills, personal loans and credit card balances in about three or four months. You will not be required to pay back those creditors. Rather, a court-appointed bankruptcy trustee sells your property that can’t be protected by a bankruptcy exemption to help compensate your creditors. Most household belongings are exempt, such as clothing, furniture, retirement accounts and, within limits, homes and cars. Chapter 7 bankruptcy is an effective tool for low-income debtors without significant assets, who can’t commit to a three-year repayment plan and don’t have debts like alimony or child support, which cannot be discharged in bankruptcy. Before choosing this approach, calculate whether the amount of debt you’d wipe out would be more than the value of the property you’d lose. However, you may not qualify. You’ll be required to pass a Chapter 7 means test to prove that you can’t afford to pay your debts. Drawbacks of Chapter 7 BankruptcyAlthough Chapter 7 gets you through the process more quickly, it comes at a cost. The bankruptcy trustee can sell any property not protected by an exemption. You may get to keep your home or car, but you’ll still be on the hook for the mortgage and/or car loan. The same is true for other non-dischargeable debt, like tax debt. If you’re behind on mortgage payments, Chapter 7 bankruptcy won’t help you catch up. Chapter 13 bankruptcy gives you up to 5 years to bring your home loan current. Chapter 7 bankruptcy stays on your credit report longer (10 years) than Chapter 13 (seven years). How Chapter 13 Bankruptcy WorksIf you have property you really want to keep, Chapter 13 bankruptcy gives you a chance. If you have sufficient income, it’s your best choice. Some good news: Filing Chapter 13 can stop the foreclosure process, which can help you make up some of your overdue mortgage payments, and debt collectors can no longer come after you during the bankruptcy process. Chapter 13 requires you to make a plan to repay all or some of your debts through a consolidated monthly payment that will be distributed to your creditors. You’ll repay your debts in three to five years. How much you’ll repay depends on your income, the size and kinds of debts you have and the property you own. Chapter 13 works for debtors who are in arrears on alimony or child support so they can catch up over three to five years or who need to catch up on house or car payments so they can keep that property. Although the trustee doesn’t sell your property in Chapter 13 bankruptcy, you must repay creditors an amount equal to the value of your nonexempt property. How much you pay depends on your income, expenses and the type of debt you owe. You’ll have to pay 100% of the bankruptcy filing fees, trustee commissions and your bankruptcy attorney’s fees, as well as 100% of your arrears in child and spousal support; most tax debts; wages, salaries, or commissions owed to employees; and contributions owed to an employee benefit fund. To keep your home, car or other secured property, you must pay 100% of the amount in arrears, 100% of debt secured by a tax lien, and you must remain current on the monthly payment. How much you pay of your unsecured, nonpriority debts depends on your income, the length of the repayment plan and the value of your nonexempt property. Drawbacks of Chapter 13 BankruptcyAlthough you can keep your property, Chapter 13 bankruptcy is no picnic.
When Should I File for Chapter 7 or Chapter 13 Bankruptcy?Some things bear repeating: There are consequences of bankruptcy, so consider your options carefully. If it’s affordable, consult with an attorney. Between court fees and attorney fees, the cost of bankruptcy can be thousands of dollars. Of the two options, Chapter 7 is more popular because filers don’t have to pay back part of their debts. Chapter 13 may be a better solution if you’re in arrears on your mortgage and don’t want to lose your house because you will have time to get caught up. The same is true for debts like back taxes and spousal/child support, which won’t go away in bankruptcy. Consider:
When to Consider Filing Chapter 7 BankruptcySo, when is Chapter 7 the better option?
When to Consider Filing Chapter 13 BankruptcyWhen is Chapter 13 right for you?
Need Help Choosing? Get Professional AssistanceIf you’re the least bit unsure whether bankruptcy is what you need, speak with a certified credit counselor. Credit counseling can:
If you believe you should file for bankruptcy, discuss the situation with a reputable bankruptcy attorney. Like many other complicated legal issues, expert advice can be significant, and bankruptcy attorneys have the experience and know the legal landscape to increase the odds that your bankruptcy case will be a success. Bankruptcy may be the second chance that you need. Once you’re through the bankruptcy process, it’s important to rebuild your credit so you don’t get in the same situation again. Which is better Chapter 13 or Chapter 7?Most people prefer Chapter 7 bankruptcy because, unlike Chapter 13 bankruptcy, it doesn't require you to repay a portion of your debt to creditors. In Chapter 13 bankruptcy, you must pay your creditors all of your disposable income—the amount remaining after allowed monthly expenses—for three to five years.
What is the main difference between Chapter 7 and Chapter 13 bankruptcy?Chapter 7 and Chapter 13 are very different types of bankruptcy. The critical difference is that Chapter 7 revolves around the liquidation of assets to repay debts. In contrast, Chapter 13 is a debt restructuring option that can make it easier to manage your outstanding debts.
What will I lose in Chapter 13?A Chapter 13 bankruptcy can remain on your credit report for up to 10 years, and you will lose all your credit cards. Bankruptcy also makes it nearly impossible to get a mortgage if you don't already have one.
Are Chapter 13 bankruptcies worth it?The main advantage to pursuing a Chapter 13 bankruptcy resolution is the fact that this form of bankruptcy generally offers much more flexibility and freedom than a Chapter 7 bankruptcy resolution. Under Chapter 7, you will need to liquidate most of your assets and sell off property to pay a lump sum resolution.
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