The Difference Between Chapter 7 and Chapter 13 Bankruptcy, and Which Chapter is Right For You
There are many chapters of the United States Bankruptcy Code. About 99% of consumers who file for bankruptcy use one of two chapters: Chapter 7 or Chapter 13. Chapter 7 is a “debt liquidation” bankruptcy. The timeline for a Chapter 7 bankruptcy from filing the bankruptcy petition in Court to receiving your discharge and the Court closing the case is about six months on average. You typically pay nothing to your “general unsecured” creditors such as credit cards, personal loans, payday loans, medical bills, deficiencies on real estate foreclosures or automobile repossessions, etc. These types of debts are called “unsecured” because they are not tied to any tangible item of value. This is in contrast to “secured” debts which are tied to a tangible item of value such as a mortgage on real estate or automobile payments on a vehicle purchase.
In a Chapter 7 bankruptcy you typically keep the secured property you are able to pay for, you are current on, and you are able to protect. You typically surrender the secured property you cannot pay for, you are not current on, or you are not able to protect. In a Chapter 7 bankruptcy you can keep these items and continue to make the payments, or surrender these items and not make the payments. But you cannot eliminate a mortgage and keep the house, nor can you eliminate the automobile installment payments and keep the vehicle. For each such item you must decide one way or the other, it cannot be both. For more information on what you are able to protect, see my articles entitled “Will I Lose My Property and My Possessions If I file for Bankruptcy – Part 1” and “Will I Lose My Property and My Possessions If I File for Bankruptcy – Part 2.” Please bear in mind that those articles as well as the present article are overviews only and do not take the place of a consultation with me based on your specific circumstances.
There are four basic requirements to qualify for a Chapter 7 bankruptcy. You can think of them as the four legs of a table that hold up a table-top: 1) Whether you have filed for a Chapter 7 bankruptcy within the last 8 years. If you file a Chapter 7 bankruptcy and receive a discharge you cannot file another Chapter 7 bankruptcy until eight years have passed from the filing of the previous Chapter 7 bankruptcy. 2) Whether you can protect the equity in your residence. See my article entitled “Will I Lose My Property and My Possessions If I file for Bankruptcy – Part 1.” 3) Whether, when you subtract your out-of-pocket expenses from your income, you have little or no ability to repay your debts over time. In my consultations with potential bankruptcy clients we produce a budget based on his or her regular monthly expenses. And 4) Whether your income is below the median income for your household size based on your income over the six months before the estimated date of filing for bankruptcy. Even if your income is slightly higher than the median income for your household size, there are “IRS Allowable Deductions” that can be used in appropriate cases to qualify you for a Chapter 7 bankruptcy.
Some people do not qualify for Chapter 7 bankruptcy because their financial facts fail to meet one or more of the above conditions. The alternative to a Chapter 7 bankruptcy is a Chapter 13 bankruptcy. Chapter 13 is a “debt repayment” bankruptcy. You pay a percentage of the debt owed to your general unsecured creditors, typically pennies on the dollar. You pay what you are able to pay over some period of time, by law not less than three years and not greater than five years. If you are below the median income for your household size you can be in a Chapter 13 bankruptcy for as short as three years. If you are above the median income for your household size your Chapter 13 bankruptcy will last five years in most cases. Unlike a Chapter 7 bankruptcy, you have an absolute right to voluntarily dismiss your Chapter 13 case at any point over the three to five year life of the case.
There are many types of debt which would indicate a Chapter 13 bankruptcy is the best fit, but the most common types of debt that indicate this are as follows. You are behind on the mortgage on your real estate, behind on automobile payments, you have past-due property taxes, or you have income tax debt which is non-dischargeable. See my article entitled, “What kinds of Debts are Dischargeable in Bankruptcy.” A Chapter 13 bankruptcy allows you to catch up on the payments over three to five years.
All things being equal, most people prefer to be in the shorter, less expensive process as opposed to the longer, more expensive process. Because of this I tend to view the financials of a potential bankruptcy client through the lens of whether they qualify for a Chapter 7 filing. If at any point in the analysis a person’s financial situation is such that they fail to meet one of the conditions needed to qualify for a Chapter 7, I transition the conversation over to what a Chapter 13 filing would look like given their unique financial circumstances. Of course, in the situation of an impending real estate foreclosure or automobile repossession the conversation immediately turns to a Chapter 13 analysis.
The above information is a general overview and is not intended to be used as legal advice. If you are considering filing for bankruptcy the best thing to do is call our office at 248-557-3645 and schedule a free consultation with me so you can receive advice which is tailored to your unique financial circumstances.
By: Michael Benkstein, Esq.
Managing Attorney, Bankruptcy Department
The Law Offices of Joumana Kayrouz, PLLC