Chapter 7 vs 13 Bankruptcy

Bankruptcy is a much-feared process, beset by myths and misunderstandings. For many people, the common understanding of bankruptcy is that you lose everything, from assets to debt. It is basically financial death.

Nothing can be further from the truth. Bankruptcy in the United States generally takes one of two forms for individuals (not businesses): a Chapter 7 debt elimination filing or a Chapter 13 reorganization filing that allows the consumer to pay back much of what she owes.

While it may sound more appealing to simply wipe the debt out, one should understand the differences between the two options, especially with regards to eligibility and benefits, before deciding on one option or the other. After all, though total debt elimination may sound like the obvious choice, about one-third of filings in the US are Chapter 13 repayment plans. 

Eliminate Debt: Chapter 7 Filings

The more common choice in bankruptcy is the Chapter 7 filing. This allows you to eliminate most of your debts while preserving nearly all of your assets. Sounds appealing, right?

There is certainly a catch. In a Chapter 7 filing, the court may sell off excess assets to pay back some of your debt. According to a study by the American Bankruptcy Institute in 2018, this is a rarity — 93% of filers were able to protect all of their assets. But, that analysis does not factor in the people who looked at bankruptcy as a possible solution and decided against it because they had assets that they could not, or would not part with.

Another catch is that filing for a Chapter 7 will not help you if you are past due on your mortgage. You will have to find some other way to refinance, restructure with the lender, or catch up on your payments. (Chapter 13, because it is a repayment plan, does help with the mortgage.)

The last thing to know about Chapter 7 filings is that you will have to be eligible to file, meaning you must first pass the Means Test. The Means Test looks at your income to determine if you make too much money to file for a Chapter 7. For those making less than the median income for their area, they automatically pass without further examination. For those with an income above the median, there is a rigorous examination of income, reasonable living expenses for your area, and however much disposable income is left after those expenses. Depending on how much disposable income you have, you may not be eligible for a Chapter 7 and may have to convert to a Chapter 13 repayment plan.

If you are banking on Chapter 7, no pun intended, and you are concerned that your income may be too high to qualify for bankruptcy, it is very important to coordinate with an attorney first in order to make sure your income and expenses are classified correctly. The Means Test is a place where the court pays extra attention to make sure the numbers are reasonable for your area and are not exaggerated or tinkered with in order to make you eligible for filing.

Pay it Back: Chapter 13 Filings

For those who are ineligible for a Chapter 7 filing, or for those who find a repayment plan more appealing, Chapter 13 is their path forward out of unmanageable debt.

One huge benefit of Chapter 13 is that it helps you to catch up on your mortgage. For many people, their mortgage is their largest monthly payment and if they have lost their income for a period of time, they quickly fall behind. Their home is also, in all likelihood, their most important asset and expense. Preserving it is their top priority. Chapter 13 gives them the plan and path to catch up on that mortgage.

Another benefit of Chapter 13 is that it is much more simple to qualify for this type of filing. There is no means test, and you do get to keep your assets.

And lastly, a Chapter 13 filing comes off of your credit report faster than a Chapter 7. While Chapter 7 stays on your report for 10 years, Chapter 13 falls off in only seven years.

Of course, there are drawbacks to Chapter 13. For one, you are paying back much of your debt, if not all of it. It is meant to be a reorganization plan to give you some relief, but it does not eliminate most of your debt. Further, it is a much longer process if you factor in the 3 to 5 years you will spend making payments to catch up on your reorganization plan, compared to the 3 to 5 months it takes for a Chapter 7 filing.

Weighing Your Choices? Consult With an Attorney

If you thought bankruptcy was simply wiping your debt clear, you probably now have more questions than answers. Do you qualify for both options? Which assets would you have to give up, if any? Like many things in life, if you are struggling with a massive decision such as filing bankruptcy, your best path forward is to talk it through with someone who has experience in the area. A bankruptcy attorney who has handled these filings and talked many people through their financial crises, can weigh your options with you and answer your pressing questions about assets and exemptions and means tests.