Is It Better to File Chapter 7 or 13?

Bankruptcy provides a legal path for individuals to address overwhelming debt. This federal court process offers a financial “fresh start” by allowing debtors to either eliminate certain debts or reorganize them into a manageable repayment structure. The legal framework aims to relieve individuals from existing obligations, enabling them to move forward with a clearer financial standing, unburdened by past financial distress.

Understanding Chapter 7 Bankruptcy

Chapter 7 bankruptcy, often called liquidation bankruptcy, involves selling a debtor’s non-exempt assets to pay creditors. This process primarily discharges unsecured debts for individuals. To qualify, debtors must pass a “means test” that evaluates their income and expenses. This test compares current monthly income to the state’s median income for a similar household size. If the debtor’s income falls below this median, they qualify. If above, a more detailed calculation of disposable income is performed, subtracting allowed expenses, to determine eligibility.

Filing a Chapter 7 petition triggers an “automatic stay,” which immediately halts most creditor collection actions. This legal injunction prevents lawsuits, wage garnishments, and repossessions, providing debtors crucial relief while their case proceeds.

A bankruptcy trustee is appointed to oversee the Chapter 7 case. The trustee reviews the debtor’s financial information, including assets, liabilities, and income. They identify and liquidate any non-exempt assets to distribute proceeds among creditors. Many Chapter 7 cases are “no asset” cases, meaning all property is exempt or subject to valid liens, so no assets are liquidated for creditors.

Debtors must attend a meeting of creditors, or 341 meeting, about one month after filing. At this meeting, the trustee examines the debtor under oath regarding their financial affairs and the accuracy of their bankruptcy documents. Creditors are invited to attend and ask questions, though they rarely do.

Debts commonly discharged in Chapter 7 include unsecured obligations such as credit card balances, medical bills, and personal loans. However, certain debts are generally not dischargeable, including most student loans, recent tax debts, and domestic support obligations like child support and alimony. The bankruptcy discharge releases the debtor from personal liability for these qualifying debts. The entire Chapter 7 process typically concludes within three to five months from the filing date.

Understanding Chapter 13 Bankruptcy

Chapter 13 bankruptcy, a “wage earner’s plan,” allows individuals with regular income to create a court-approved repayment plan for their debts. This enables debtors to retain their property while making payments to creditors over an extended period. Eligibility requires a stable income source, such as wages, social security, or pension.

Specific debt limits apply: unsecured debts must be less than $526,700 and secured debts less than $1,580,125. Debtors must also complete a credit counseling course within 180 days before filing and have filed all federal tax returns for the four preceding years.

Similar to Chapter 7, filing a Chapter 13 petition triggers an automatic stay, which immediately stops most creditor collection activities. A unique aspect of the Chapter 13 stay is its protection for co-debtors on consumer debts, generally prohibiting creditors from collecting from them unless the court permits it.

The core of a Chapter 13 case is the repayment plan, outlining how debts will be paid over three to five years. The plan’s duration depends on the debtor’s income relative to their state’s median income.

A Chapter 13 trustee administers the plan, reviewing it for compliance and ensuring accurate financial disclosures. The trustee collects monthly payments from the debtor and distributes funds to creditors.

The repayment plan prioritizes certain debts. Secured debts, like mortgages or car loans, and priority unsecured debts, such as recent tax obligations or child support, are generally paid in full. General unsecured debts, like credit card debt, receive a pro rata share of remaining disposable income. Eligible unsecured debts are discharged upon successful completion of the plan.

Comparing Chapter 7 and Chapter 13

Chapter 7 and Chapter 13 bankruptcy offer distinct approaches to debt relief. Chapter 7 is a liquidation process for individuals with limited income and assets, where non-exempt property may be sold. Chapter 13 is a reorganization process, allowing debtors with regular income to repay debts over time while retaining their property.

Eligibility differs significantly. Chapter 7 requires passing a means test based on income and disposable income. If a debtor’s income is too high for Chapter 7, Chapter 13 may be an alternative, as it requires sufficient regular income to fund a repayment plan. Chapter 13 also has specific debt limits for both secured and unsecured obligations, which Chapter 7 does not.

Asset treatment is a key difference. In Chapter 7, a trustee may liquidate non-exempt assets. While many Chapter 7 cases are “no asset” cases due to exemptions, there is a possibility of losing property. Chapter 13 allows debtors to keep all their property by adhering to their court-approved repayment plan. This distinction is particularly relevant for individuals who wish to protect specific valuable assets, such as a home or vehicle.

The timing of debt discharge varies. Chapter 7 discharges eligible unsecured debts within a few months of filing, offering a relatively quick resolution. Chapter 13 discharge occurs only after successful completion of the entire repayment plan, which spans three to five years. While both chapters discharge common unsecured debts, Chapter 13 can also address certain debts not dischargeable in Chapter 7, such as some property settlement debts from divorce.

Secured debt handling also differs. In Chapter 7, a debtor can choose to surrender secured property and discharge the associated debt, or reaffirm the debt and continue payments to keep the property. If behind on payments, Chapter 7 offers limited time to catch up. Chapter 13 provides a mechanism to cure past-due payments on secured debts, like mortgages or car loans, by incorporating the arrears into the repayment plan over several years. This feature allows debtors to prevent foreclosure or repossession and retain their assets.

Factors Guiding Your Decision

Choosing between Chapter 7 and Chapter 13 bankruptcy depends on your financial situation and goals. Your income level is a primary factor; those below their state’s median income who pass the means test often qualify for Chapter 7. This chapter suits individuals with few assets and primarily unsecured debts, seeking a swift discharge without a long-term repayment plan.

The desire to retain specific assets is also important. If you have non-exempt property you wish to protect, or are behind on secured debts such as a mortgage or car loan, Chapter 13 may be more appropriate. Chapter 13 allows including past-due amounts on secured loans in your repayment plan, providing an opportunity to prevent foreclosure or repossession. This contrasts with Chapter 7, where remaining current on secured debt payments is generally necessary to keep the asset.

The types of debt you carry influence the choice. Chapter 13 can benefit those with non-dischargeable debts or significant priority debts, such as recent tax obligations or domestic support arrears, which must be paid through a structured plan. If you have a steady income and can commit to regular payments over three to five years, Chapter 13 provides a structured path to address these obligations while managing other debts.

Your ability to make regular payments is a practical consideration. Chapter 13 requires consistent income to fund the repayment plan, while Chapter 7 is for those unable to repay debts. The choice also impacts how long the bankruptcy filing appears on a credit report: Chapter 7 for up to 10 years, Chapter 13 for up to seven years. Consulting a qualified legal professional is recommended to assess your situation and determine the most suitable course of action.