Chapter 7 and Chapter 13 Bankruptcy: What are the Differences?
Chapter 7 and Chapter 13 Bankruptcy: What are the Differences?
Declaring bankruptcy can be complicated. One of the most important choices you will have to make is deciding on the type of bankruptcy to file. The two common types of bankruptcies for individuals are Chapter 7 and Chapter 13. They get their respective names from the chapters of the United States Bankruptcy Code describing them.
While both Chapter 7 and Chapter 13 bankruptcy aim to address financial distress, they differ significantly in eligibility requirements, debt repayment plans, and long-term impacts on credit and assets. Generally, the type of bankruptcy you choose will determine how you will pay your debts, if at all, and what will happen to your assets. It is, therefore, critical to know about both types of bankruptcy and their differences.
In this article, we will explore the differences between Chapter 7 and Chapter 13 bankruptcy to help you make an informed decision depending on your needs and financial situation.
Chapter 7 Bankruptcy
Chapter 7 bankruptcy, also known as a ‘liquidation’ bankruptcy, focuses on disposing of unsecured debts, including credit cards, medical bills, and personal loans.
The Chapter 7 process involves the court appointing a trustee to review your assets and debts. Sometimes, it requires the sale of certain assets to repay your debts or a portion of them. Most times, however, it does not obligate you to liquidate your assets because federal or state exemption laws exempt certain assets from liquidation.
If the money raised through the sale of your non-exempt assets is insufficient to repay all your debt, Chapter 7 will ‘forgive’ or discharge your remaining debt while stopping all debt collection activities by creditors. Some debts, however, are non-dischargeable in Chapter 7, including, child support, alimony, and most tax debts. Chapter 7 will not eliminate your responsibility to pay these debts.
Chapter 13 Bankruptcy
Chapter 13, also known as ‘reorganization bankruptcy,’ allows individuals with a regular income (the concept of ‘regular income’ is quite flexible) to keep their assets while repaying some or all their debt over time. Debtors, essentially, reorganize their finances by proposing a three (3) to five (5) year debt repayment plan that gets approved by the bankruptcy court.
Generally, a court-appointed trustee, i.e. the Chapter 13 standing trustee, uses a certain formula, taking into consideration your income, monthly expenses, dependents, and non-exempt assets, to determine the proportion of your debts that get repaid. After making monthly payments for the required 3 to 5 year period, you get discharged from your debt obligations. Although a Chapter 13 bankruptcy allows you to keep your assets, the court will dismiss your bankruptcy if you fail to adhere to the repayment plan.
Key Differences
While Chapter 7 and Chapter 13 share many characteristics, some major differences inform an individual’s bankruptcy choice. The following are some of the major differences:
A. Type of Bankruptcy
Chapter 7 bankruptcy does not require a payment plan, but in rare instances, the sale or liquidation of your (non-exempt) assets is necessary to repay creditors. Chapter 13 is a reorganization bankruptcy and usually does not involve the sale of assets. Chapter 7 works well for individuals with limited income and significant unsecured debt. Chapter 13 is designed for people with a regular income who can afford to repay some of their debt over time. It also serves as a means for individuals with secured debts – mortgages, car loans, etc. – to catch up on their payments without having their residence foreclosed or car repossessed.
B. Repayment Plan and Discharge Duration
Chapter 7 discharges all your debt without a repayment plan. It takes about four to five months for the Chapter 7 process to run its course and discharge your debt obligations, assuming there are no complications. In contrast, a Chapter 13 bankruptcy allows you to reorganize your debt obligations using a court-approved repayment plan. It normally takes three to five years before a Chapter 13 bankruptcy discharges your debt obligations.
C. Who Can File and Eligibility Requirements
Both individuals and businesses are eligible to file for Chapter 7 bankruptcy. However, only individuals may file for Chapter 13. Married couples are permitted to file together in both chapter 7 and 13 bankruptcies. To qualify for Chapter 7, you must pass a means test determining whether you have enough disposable income to pay your creditors, although some exceptions remove the means test requirement. To qualify for Chapter 13 bankruptcy, you must have at most $465,275 in combined unsecured debts and no more than $1,395,875 in secured debt (as of April 2022).
D. What Happens to Property You Own
Chapter 7 provides for the sale of non-exempt assets to repay creditors. However, many states have laws allowing individuals to protect certain assets, such as a primary residence, vehicle, or household items, up to a specified value. In Pennsylvania, individual debtors have a choice between the state exemptions and the federal bankruptcy exemptions. Depending on the type and value of your assets, or the equity in them, you might keep everything by choosing federal instead of state exemptions, or vice-versa. While Chapter 13 also allows for the sale of non-exempt assets, you can choose to keep all your assets if you adhere to the repayment plan and fulfill your obligations.
E. Impact on Credit Score
There’s no beating around the bush when it comes to bankruptcy and credit. Chapter 7 bankruptcy remains on a credit report for up to ten years, making it harder to obtain new credit. A Chapter 13 bankruptcy typically remains on your credit report for seven years from the date of filing. However, you can start to rebuild your credit shortly after filing if you adhere to your repayment plan and pay your expenses on a timely basis. Keep in mind, also, that most individuals filing for bankruptcy protection have already experienced a major impact to their credit score.
Benefits and Drawbacks
The differences between Chapter 7 and Chapter 13 bankruptcies help highlight their respective pros and cons, especially when choosing which type of bankruptcy to file. For instance, Chapter 7 can be beneficial as it allows debtors to resolve their debt issues quickly and get a fresh start. However, it does not allow individuals to restructure their secured debt, including giving them more time to repay creditors while avoiding repossession or foreclosure.
On the other hand, Chapter 13 can be beneficial as it allows debtors to catch up on missed debt payments without risking foreclosure or repossession. However, it requires individuals to commit to a three to five year payment plan.
Bottom Line
This article is not meant to provide an exhaustive list of differences between Chapter 7 and Chapter 13 bankruptcy. Each has benefits and drawbacks. Your specific needs and financial situation will determine which type of bankruptcy suits you.
With the choice between the two depending on factors like income, debt type, asset ownership, and your long-term financial goals, it is critical to make an informed decision. A bankruptcy attorney can help you make the appropriate choice based on your circumstances.
For more information on Bankruptcy, visit here.