Chapter 7 vs. Chapter 13 Bankruptcy
by Philip Ahn, Attorney
There are more than 23,000 bankruptcies filed in the U.S. each year. Due to increased unemployment numbers and a lagging economy, economic analysts expect bankruptcies to almost double in the near term. If you are currently thinking about bankruptcy, you may be wondering, “What is the difference between a Chapter 7 and a Chapter 13 Bankruptcy?”
The major difference between the two is that Chapter 7 is considered a liquidation bankruptcy. Chapter 7 clears most of your general unsecured debt without the need to pay it back. Chapter 13 bankruptcy is a reorganization of your debts. It’s designed for debtors who have ample income to make minimum payments and pay back a portion of their debts.
While there are many types of bankruptcies, the two most popular for individuals in the U.S. are Chapter 7 and Chapter 13. Each has advantages and disadvantages. If you are unsure if bankruptcy is the right route for you or which Chapter to file, it will be helpful to consult with a bankruptcy lawyer in your area.
Learn more about the differences between Chapter 7 and Chapter 13 bankruptcy below.
Chapter 7 Bankruptcy
Low-income individuals and small business owners who can’t pay back all or part of their debts are the usual candidates for Chapter 7. Since it’s a liquidation bankruptcy, most of the filer’s property is sold (liquidated). Their debts are paid from the proceeds of the sale.
For this reason, many people who choose Chapter 7 don’t own a home. It’s important to note that some of your property can be exempt from being sold, but there are strict limits to that property’s value.
There are both federal and state exemption rules. Depending on the state where you live, you may have the ability to choose which exemption guidelines you want to use. A few federal exemption examples include:
- Homestead – Up to $23,675 for individuals
- Motor Vehicle – Up to $3,775
- Personal Property – Up to $12,625
- Retirement Accounts – Up to $1,283,025
- Health Aids – The entire value is exempted
- Jewelry – up to $1,600
Chapter 7 wipes out most forms of unsecured debt such as credit cards and medical bills without the need to pay it back. Upon filing for Chapter 7, an “automatic stay” is ordered. This puts an immediate halt to creditors from pursuing your debt. At this time, the court appoints a bankruptcy trustee to administer your case.
Their job is to review your bankruptcy documents and supporting information and then sell your nonexempt property to pay back debts. If you don’t own any nonexempt assets, your creditors will receive nothing.
Chapter 7 Qualifications
In general, if your household income is below your state’s median level, you are eligible to file for Chapter 7. If your household income is above the median, you must pass a “means test” to assess whether you have enough disposable income to pay back a portion of your debts. Individuals who have the means to pay back their debt must file for Chapter 13.
Advantages of Chapter 7 Bankruptcy
If you are drowning in debt and don’t have enough income to pay it back, there can be many advantages to filing Chapter 7. Some of the most notable pros to Chapter 7 bankruptcy are:
- Immediate relief from creditors
- Permanent discharge of qualified unsecured debt
- You will get to keep most of your property
- Improved credit and access to credit a year after filing
Drawbacks of Chapter 7 Bankruptcy
While there are many potential advantages to Chapter 7, there are also a few drawbacks. Some of the most common include:
- You can’t file for Chapter 7 if you have too much income
- Your credit score will take a temporary hit (typically for one year)
- You can lose some of your property
- It does not protect your co-signers
- Filing for Chapter 7 can be expensive
Chapter 13 Bankruptcy
Unlike Chapter 7, Chapter 13 bankruptcy does not wipe out your debt. It reorganizes it. Individuals who do not qualify for Chapter 7 and have the means to make partial payments on their financial obligations are the typical candidates for Chapter 13.
In Chapter 13 bankruptcy, you can keep all of your property. In exchange, you must pay back all or some of your debts through a repayment plan. The exact amount you’re required to pay back depends on your income, expenses, and the type of debt you have accrued.
Qualifications for Chapter 13 – Is Chapter 13 Worth it?
Chapter 13 bankruptcy is for individuals only (including sole proprietors), not businesses. General requirements for Chapter 13 bankruptcy include:
- You have a regular income above your state’s median level
- Your total unsecured debt is below $394,725
- Your unsecured debt is not backed by collateral such as your car or home
- Your total secured debt is under $1,184,200
Filing for Chapter 13 may be worth it, depending on your circumstances. For example, in Chapter 13 bankruptcy, you get to keep your house, car, etc. so long as you make monthly payments under your agreed-upon payment plan for 3-5 years.
Advantages of Chapter 13 Bankruptcy
For those who qualify, Chapter 13 bankruptcy offers many benefits. In some cases, individuals who are eligible for Chapter 7 opt to file Chapter 13 instead so they can take advantage of the unique benefits offered. Some of the most common benefits include:
- More flexibility in paying off debt
- Ability to keep the property
- Can stop creditors from aggressively pursuing debt collection action
- Can stretch and reduce payments
Drawbacks of Chapter 13 Bankruptcy
There are a few drawbacks to Chapter 13 bankruptcy. Those include:
- It can take up to five years to repay debts
- Debts must be paid with your disposable income
- You will likely lose your credit cards
- Can be challenging to get a mortgage while repaying debts
- You may be required to pay debts even beyond the terms of your repayment plan
As you can see, Chapter 13 bankruptcy is not right for everyone. Before moving forward with Chapter 13, it will be helpful to consult a knowledgeable bankruptcy lawyer to discuss your case. In some instances, the negatives might outweigh the positives.
Is it Better to File a Chapter 7 or 13?
It all depends on your specific situation. If you have a limited income and you otherwise qualify for Chapter 7, that may be the best option. However, if you do not qualify for Chapter 7 or wish to keep all of your possessions, then consider Chapter 13 as a viable option.
If you are unsure, it will be helpful to connect with a bankruptcy lawyer to discuss your options.
What Happens if You Don’t Qualify for Chapter 7 or Chapter 13?
While the two most common types of bankruptcies are Chapter 7 and Chapter 13, there are other types available. Those include:
- Chapter 11 – Large reorganization
- Chapter 12 – Family farmers and family fisherman
- Chapter 15 – Used in foreign cases
If you have enough income to pay back your debts, a judge may find that you do not qualify for any type of bankruptcy. Fortunately, there are other debt-relief options that you can pursue. Some of the most common include:
- Negotiate better terms with your creditors
- Increase your income
- Work on your budgeting
- Consider debt management
- Debt settlement options
Getting out of debt is never easy, but it’s possible. With hard work, determination, and creative solutions, you have a chance.
Do I Need a Lawyer to Help Me File for Bankruptcy?
You are not required to hire a lawyer when you file for bankruptcy. Thousands of Chapter 7 bankruptcies are filed without a lawyer each year. However, some Chapter 7 cases are more complex than others and do require a legal professional’s assistance.
In general, the simpler your bankruptcy is, the more likely it is that you can receive a successful discharge on your own. If your total household income is less than your state’s median level, you own little or no property, and you don’t have any fraudulent claims against you, you will likely be okay handling a Chapter 7 bankruptcy on your own.
Chapter 13, on the other hand, can be more complex and involved. In addition to completing the necessary paperwork, you must propose a repayment plan that satisfies the court. This can be a complex task without the help of a bankruptcy lawyer.
How Much Does it Cost to File Bankruptcy?
The total cost of your bankruptcy filing can cost between $1500 – $4,000 in court costs and upfront lawyer fees. The exact amount will depend on the type of bankruptcy you file, the state where you live, and its complexity.
If you do not have enough money to file Chapter 7, you may petition the court to eliminate or reduce your filing fees. In most cases, if you are currently paying your debts, it can be beneficial to stop paying your creditors and use that income for your court costs and attorney fees.
Contact Us To Learn About Our Affordable Bankruptcy Plans
Though it may seem counterintuitive, filing for bankruptcy can be expensive. Most lawyers charge an upfront fee that can be difficult for individuals already struggling with their finances to pay.
With us, you can pay as you go. This means that you will not have to spend thousands of dollars in upfront fees to hire a bankruptcy lawyer to handle your Chapter 7 or Chapter 13 case.
Also, you can receive legal help from the comfort of your home via virtual consultation.
Before you try and represent yourself in court, contact a bankruptcy attorney in your area who’ll provide you a free consultation and guide you through the steps to file for your legal needs today.