Ultimate Overview of Bankruptcy - Difference Between Chapter 7 and Chapter 13
The word ‘bankruptcy’ is inherently scary to people, as many of us associate the term with absolute financial ruin from which it can be very difficult if not impossible to recover from.
In reality, however, bankruptcy does not necessarily mean that your life is fully ruined financially. In fact, many people don’t even know the details of what bankruptcy is and what it isn’t, and many also don’t know that there is more than just one kind of bankruptcy as well.
Educating yourself about the different kinds of bankruptcy and the details of each one is important in order to become more financially literate and informed, even if bankruptcy is not something on your horizon.
But if bankruptcy is something that is unfortunately looking like an increasing possibility for you, then receiving education on this subject will be even more important for you. Filing for bankruptcy is a very serious conversation just as much personally as it is financially, and it’s important to know the details of it just as to research your other options as well.
In this article, we are going to outline and discuss the details of the two basic bankruptcy options before you: Chapter 7 and Chapter 13.
Yes, there’s also Chapter 11 bankruptcy as you may have heard, but that exists only for businesses. As an individual, Chapter 7 and Chapter 13 are your two primary options, although there is also a Chapter 12 for farmers and fishermen.
What Is Bankruptcy?
Before we cover what Chapter 7 and Chapter 13 bankruptcy are, we should first define what bankruptcy is to begin with.
Basically, filing bankruptcy in court means that you are telling the government you are unable to pay your debts.
The judge and a court trustee will proceed to conduct an overview of your liabilities and your assets to determine if you are unable to pay them back or not.
If the court agrees with you that you are unable to pay back the debt, then bankruptcy is officially declared by filing paperwork with the bankruptcy court.
Declaring bankruptcy will then cancel many of your debts, and can stop wage garnishment and home foreclosure.
But it can’t typically clear taxes, government fines, child support, alimony, student loans, or expensive items that you’ve purchased before filing such as a new car.
In addition, when you file for bankruptcy to begin with, your creditors will not be able to attempt to collect money from you. This means that they won’t be able to sue, e-mail, write, text, or call you after you have filed.
Take note that this doesn’t mean that you are automatically relieved of your debts to those creditors, because as we will soon see, the government can require you to pay back some or all of your debts.
What Will Happen When You File For Bankruptcy?
What can you expect to happen to you when you file for bankruptcy? First and foremost, it’s going to really affect you psychologically, and in a negative way to say the least. Many people who have filed for bankruptcy report that it has a very similar effect as having a business failure or filing for divorce.
Something else that will happen is your bankruptcy will become public domain. Your name will be in the court records, which the general public will then be able to access. In other words, your bankruptcy is not going to be something that you can keep a secret. Not even close.
Filing for bankruptcy is also going to show up on your credit reports for a minimum of seven years, and generally speaking, it can take up to four years before lenders will allow you to qualify for a mortgage loan. This means that securing loans for a new house, car, or anything else major is going to become very difficult over the next few years.
Last but not least, filing bankruptcy is not cheap. There are court fees, plus you’ll pay hundreds if not thousands of dollars in fees for an attorney.
Your First Option: Chapter 7 Bankruptcy
The first bankruptcy option on the table for you will be to file Chapter 7 bankruptcy. In short, Chapter 7 bankruptcy is where the courts will sell some or all of your assets to pay back as much of your debt as you can. Any unpaid debt remaining will then be erased.
Chapter 7 bankruptcy is also commonly referred to as liquidation bankruptcy. Its primary purpose is to eliminate your unsecured debt such as medical bills and credit card debt, and without having to pay the debt back with a repayment plan.
That being said, Chapter 7 bankruptcy will also only be an option for you of if you don’t make enough money to pay back the debts you owe. You will have to meet income requirements in order to qualify. If you make too much income, you’ll have to file for Chapter 13 instead, which we’ll talk about in a bit.
When you file for Chapter 7 bankruptcy, but before bankruptcy is officially declared, an automatic stay order will be given by the court that will stop creditors from attempting to collect from you.
Your case will also be administered by a bankruptcy trustee, who will overview your financial situation and your bankruptcy papers before choosing which of your property will be sold in order to pay back the creditors.
Filing for Chapter 7 bankruptcy will be the best choice if you own little property, and if you don’t make a lot of monthly income (specifically if your income is not exceeding the median family income in your state).
In fact, if your income is at or below the average for a family of your same size in your state, you should automatically qualify for Chapter 7 bankruptcy.
If your income is higher than the average, the only way you’ll be able to qualify at that point is if you subtract court allowed expenses, such as tax debts, secured debts (i.e. your mortgage), and child support payments and then the left over income is below the statewide average.
Your Second Option: Chapter 13 Bankruptcy
Chapter 13 bankruptcy means that the court will develop and approve a repayment plan that will enable you to pay back your debt over five years or less. You’ll be able to keep your property and your assets, and you’ll also be allowed to bring your mortgage up to date as well.
You’ll have to pay back the debt according to the repayment plan on a monthly basis, and you’ll also need to adhere to a very strict budget as determined by the court to ensure that you can afford to pay each month as well.
In contrast to Chapter 7 bankruptcy, which is also commonly known as liquidation bankruptcy, Chapter 13 is often referred to as reorganization bankruptcy. This is because it is intended for debtors who are making a regular income and therefore have enough money left over to work towards paying back their debts each month.
Chapter 13 offers a number of advantages over Chapter 7 as well, with the most notable being that you’ll get to keep all of your assets and property and catch up on any mortgage payments that you’ve missed.
Chapter 13 bankruptcy will be the best choice for those of who you do not qualify for Chapter 7 bankruptcy because you make too much monthly income, but still need debt relief. In addition, it’s also the better choice if you have fallen behind on house or car payments and want to catch up on those payments while also keeping your property.
Which Option Is Better For Filing Bankruptcy?
Generally speaking, is it wiser to file Chapter 7 bankruptcy or Chapter 13?
As we have covered previously, it really comes down to the amount of money that you are making, because only if your monthly income is below the state average will you even be able to qualify for Chapter 7.
But beyond that, if both options are on the table for you, which is the better choice?
In general, here are the key advantages of filing for Chapter 7 bankruptcy over Chapter 13:
- It’s quicker
- There is no three to five year payment plan involved
- You might actually get to keep most of your property (this one really depends on your situation)
- Most if not all of your debt will get wiped out, which means you can emerge debt free other than for taxes, child support, and student loans (these are typically non-dischargeable debts)
Many people erroneously believe that filing for Chapter 7 bankruptcy automatically means that they are going to lose all of their assets and property.
But this is very rarely true. In fact, it could be that you’ll end up keeping all of your property. The courts will allow you to keep most of your necessities, and if you don’t have very many assets worth of value, then your property can be exempted, including your car and/or your house.
That being said, Chapter 7 bankruptcy is not going to get rid of all of your debts, and it’s not always the best option to follow even if you do have very limited income each month.
Here are the primary benefits to filing Chapter 13 bankruptcy over Chapter 7:
- You will for sure get to keep all of your property and assets
- You’ll have a payment plan in place to pay back all of your debts within a three to five year period
- It will be your only choice if you make too much income
- It will clear other debts that Chapter 7 bankruptcy won’t cover
What Do You Need To Do Before Filing For Bankruptcy?
Regardless of whether you file for Chapter 7 or Chapter 13 bankruptcy, there are a series of steps that you are going to need to follow before you officially file with the courts.
The first step is you are going to need to make a complete list of all of the debts that you owe, and verify the amount of each debt with official paperwork.
Next, you’re going to need to take a pre-bankruptcy credit counseling course at an approved agency before you can officially file. This has been mandated by the United States Federal government since 2005. The purpose of the counseling is to determine if filing for bankruptcy is even the right course of action for you to take and to determine if there are any other steps you can take to pay back your debts instead. This is the course that CC Advising provides, and the certificate you receive after taking our course is valid for 180 days.
Remember, bankruptcy is never your only choice no matter how much debt you are in. You can try lowering your interest rates, developing a debt management plan with a credit counseling agency, consolidating your debt, or simply cutting back on your daily expenses and using the money leftover to pay back your debts.
You may also want to try working with a professional financial coach before you follow any of the above steps at all, especially if you are highly stressed and are at a loss for what you need to do. A financial coach will discuss with you all of your alternative plans and will even develop a good financial plan as well, not to mention that they can provide you with some badly needed encouragement.
We highly recommend meeting with a competent bankruptcy attorney to discuss your options as well. You definitely do not want to file bankruptcy on your own. Being represented by an attorney is the best way to make sure your financial interests are protected as you go through the process. It’s also reassuring to have someone to call to help guide you when you have questions.
In conclusion, if you are in serious debt and bankruptcy is looking like it’s your only option, then the Chapter 7 and Chapter 13 bankruptcy options are the two choices available before you.
Yes, there is also Chapter 11 bankruptcy, but that exists only for businesses as was noted previously.
To summarize what we have covered, Chapter 7 bankruptcy is also referred to as liquidation bankruptcy and is where your property will be sold by the government to pay back your various debts. It’s the better option if you have very limited income coming in.
Chapter 13 bankruptcy is also called reorganization bankruptcy and is where you will have to complete a repayment plan as organized and ordered by the court, so you won’t lose your property.
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