Chapter 7 or Chapter 13: Comparing The Two Main Types of Bankruptcy

bankruptcy textbookBankruptcy can be a powerful way to get back on track, especially if life has given you responsibilities that you can’t afford to ignore. If you have kids to care for, for example, or if you have a job you can’t lose, you need to know that your vehicle and your home are not in jeopardy. Bankruptcy, if done right, can play a central role in financial recovery, while protecting the property that you need to keep.

Generally, the initial purpose of filing for bankruptcy is to halt collection and get a fresh start on debts, while protecting your vehicle, your home, and other valuable property from creditors.  This step is often taken when there is a threat from creditors looming or when calls from harassing creditors make immediate relief absolutely necessary.  After the initial immediate relief, bankruptcy helps individuals to achieve a long-term solution by eliminating debts or reducing the monthly payment of many debts.

Two Main Types of Bankruptcy

chapter 13 bankruptcy paperworkThere are two main bankruptcy routes available for consumers and small businesses: Chapter 13 and Chapter 7. Chapter 7 and Chapter 13 bankruptcies share many similarities; for example, both forms of bankruptcy allow you to keep property that is considered “exempt”. Examples include reasonable clothing, household appliances, tools used for your trade, and public benefits. Read more about exempt property here.

In addition, both types of bankruptcy require that you file a specific set of schedules and forms. Both kinds of bankruptcy cases require you to follow the federal and local rules of procedure. The local rules followed here in Bexar and surrounding counties are posted and a printable copy can be found in the court's website here in San Antonio.

Despite the similarities, there are key distinctions that you should consider when deciding on what type of bankruptcy plan is right for you.

Chapter 13 - How It Works

A Chapter 13 plan is designed for individuals or couples who have a regular source of income but have fallen behind on his or her debts. Generally speaking, when you file for a Chapter 13 plan, you get to keep all of your property but must create a repayment plan explaining, in detail, how you will repay your creditors over the next three to five years.

Once a plan is approved by the bankruptcy court, it becomes an order for all creditors to stop soliciting payments from you. They must go through your attorney if they want to collect any payment on past due debts. Any agreement will be listed in the bankruptcy plan, which becomes enforceable nationwide.  

This means you continue to receive protection from most lawsuits, wage garnishments, and other collection efforts for debts you had when you filed, throughout the length of your 3 to 5 year plan.

Once completed, your plan may allow you to discharge (or eliminate) remaining general unsecured debts (usually credit card balances, medical debts, and the like) which were owed when you filed. This is called the “fresh start”.  

What about wealthy people? Well, not surprisingly, some people either make too much or own too many assets and therefore they are the ones who pay most or all of their debts back, including the unsecured debts. However, even in these cases the interest is usually reduced and they get a longer period of time in which to pay them. Either way, a Chapter 13 plan is designed to give folks a second chance, to stop the harassment, and to save property from foreclosure or repossession.

Chapter 7 - How It Works

A Chapter 7 is simpler than a Chapter 13 plan. The case can be over in under 6 months, and the relief is usually instantaneous upon filing. There is no repayment plan, and you simply disclose everything you have of value and apply for your discharge.  You do generally pay back your secured debts (like car notes and home mortgage) and some debts won’t go away (like certain IRS debt and student loans).  But the discharge through Chapter 7 is what you’re after, and that order of discharge wipes out (eliminates) most unsecured debt. (i.e. credit cards, signature loans, payday loans, and medical bills.  

Keep in mind that, in exchange, you’ll need to disclose all your assets, all the real estate (if any) and personal property you own.  In 95% of cases, everything you own fits well within your exemptions.   Meeting with a good attorney will enable you to know if you’re one of the 95% or whether you’d end up having to let something go to the trustee to be sold so those funds could be used to pay some of the debts.

There are some kinds of debts that are considered “non dischargeable”, meaning you will still owe them after the Bankruptcy plan is filed with the court. Some examples of these kind of debts include child support, student loans, and some federal income taxes.

Qualifying For Chapter 7 Bankruptcy

Finally, not everyone qualifies for Chapter 7.  Individuals and couples would need to be generally unable to pay all bills and pass the means test (unless exempt).  How do you pass the means test?  Well, there are 3 ways.  In a nutshell,

  1. You pass if your household income (over the past 6 months) is below the median level in Texas.
  2. If not, you still may pass if you are able to show that your budget is extremely close to $0.00 when considering all the allowances and expenses on the long form version of the means test.
  3. Finally, even if you don’t pass the above two ways, if you have a substantial change of circumstances rendering you unable to pay bills, then providing such evidence could enable you to qualify for Chapter 7.

After meeting with your attorney, you will generally know in advance whether you have too many assets, or whether you make too much income for chapter 7 to be realistic. If this option works for you, Chapter 7 is usually preferred because it’s typically much less expensive and a much shorter process.  The initial effects on your credit history are similar, but what’s important is how fast you can rebuild after you are out of bankruptcy.

Which Option  Is Right For You?

If you are considering Chapter 7 or Chapter 13, the most important thing is to ask your attorney to explain the options in a clear and straightforward manner. Make sure you obtain representation from people willing to not only render excellent legal services but also treat you with understanding and compassion.

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