Choosing the Right Type of Bankruptcy: Chapter 7 or 13

By Cara O'Neill, Attorney
Whether you'll qualify to have your debt wiped out in a Chapter 7 bankruptcy, or be required to enter into a Chapter 13 repayment plan, depends on how much money you make.

Whether you’re at the tail end of a divorce or find yourself sidelined by a medical emergency, the stress of being unable to meet your bills each month is significant. Both Chapter 7 bankruptcy and Chapter 13 bankruptcy might offer solutions to help get you back on your financial feet.

The Difference Between Chapter 7 and Chapter 13 Bankruptcy

Even though Chapter 7 and Chapter 13 bankruptcy share some similarities—for example, your state’s exemption statutes allow you to keep, or “exempt,” the same amount of propertyno matter which bankruptcy type you file—the two chapters work differently. In Chapter 7 bankruptcy, you don’t pay anything back to your creditors. In Chapter 13 bankruptcy, you must make monthly payments to your creditors for either three or five years. So how do you know which chapter you must file? It comes down to the amount of money you make.

Chapter 7 Bankruptcy

Most people want to file for Chapter 7 bankruptcy if possible because it’s quick and doesn’t require you to commit to a repayment plan. To qualify, you must make less than your state’s median income for a household of your family’s size. You get to keep the property on your state’s exemption list, called “exempt property.” The bankruptcy trustee—the person responsible for finding money for your creditors—sells any nonexempt property (property not on your state’s exemption list) and distributes the proceeds to your creditors. Once your bankruptcy is over, your “dischargeable debt”—credit card balances, medical bills, and personal loans—gets wiped out. If everything goes right, your case will take about four months from start to finish.

Even though most people would rather file for Chapter 7 bankruptcy, not everyone qualifies. And, even if eligibility isn’t an issue, it isn’t always the best bet. These vital questions will help you decide if it’s right for you:

  • Is your income is low enough to qualify for Chapter 7 bankruptcy?
  • Do you have much money left over each month after paying for your monthly living expenses?
  • Do you own much property?
  • Are you current on your house and car payments?
  • If you’re not current, are you okay with giving the property back?
  • Are your debts dischargeable in Chapter 7 bankruptcy?

Simply put, Chapter 7 bankruptcy works if you don’t have a lot of money—especially at the end of the month—and you don’t have a lot of belongings that you can sell to pay your bills. And, even more important, it’s the method of choice if all of your debts will go away. Keep in mind that some obligations don’t get wiped out. Examples of “nondischargeable debt” include income taxes, child and spousal support, and student loans. If you meet these criteria, then Chapter 7 might make sense for you. Before making that decision, however, be sure you understand that if you want to keep your house or car, your payments must be current when you file.

Even more important, be sure that you really need to file for bankruptcy. You might not need to if you are “judgment-proof,” which means that creditors couldn’t collect from you even if they tried every legal way to do so. A variety of situations might cause you to become judgment-proof. For example, you may not have any income for a creditor to attach. Or, you might not own property that a creditor can take, such as money in a bank account, or equity in a house. And a creditor can’t take everything. If you’re barely getting by when a collector tries to levy on what property you do have (or tries to garnish your modest income), you can ask a judge to stop it by filing paperwork with the court. If you’ll remain in this position for the foreseeable future, a creditor isn’t going to be able to collect anything from you, and filing for bankruptcy would be unnecessary

You might also be judgment-proof if you are a senior citizen receiving Social Security payments. Creditors aren’t allowed to take Social Security funds unless you owe money to the government. For example, Social Security benefits can be garnished to pay student loans, because the federal government guarantees them. (For more information about bankruptcy in the golden years, see Bankruptcy and Senior Citizens.)

Finally, If your debts are old, creditors might be out of luck, as well. Most debts have an expiration date, which arrives when the “statute of limitations” has run. (A statute of limitations is a period of years, usually two-to-four, depending on state law.) The creditor must file a lawsuit within the time required by the statute of limitations. If this period passes, your creditor won’t be able to sue you and collect the balance you owe. Note, however, that a statute of limitations will not apply to priority debts, such as student loans, taxes, and unpaid family support.

Example. Joseph wanted to reenter the job market after being ill for many years, but he knew he had a lot of unpaid bills, and he worried that a creditor might garnish his wages. So Joseph sought help by meeting with a bankruptcy attorney. When his credit report revealed he hadn’t made payments on multiple credit card accounts in over five years, the attorney explained that according to state law, Joseph’s creditors could no longer sue him. The “statute of limitations”—the amount of time a creditor has to file a lawsuit—had already expired, making filing for bankruptcy unnecessary. John could look for and take a job without fear that those old creditors would immediately garnish his wages.

To find out how particular issues might impact your Chapter 7 bankruptcy filing, see How to Choose the Right Bankruptcy Chapter: When Chapter 7 Makes Sense.

Chapter 13 Bankruptcy

When you have “disposable income”— money left over after paying your household expenses—you cannot file for Chapter 7 bankruptcy. Instead, you must file for Chapter 13 bankruptcy and pay that extra income to your creditors over a three- or five-year repayment plan. As with Chapter 7 bankruptcy, you can exempt a certain amount of property; however, bankruptcy trustees handle your property differently in a Chapter 13 bankruptcy.

In Chapter 13 bankruptcy, the trustee doesn’t sell your property. Instead, you pay the equivalent value of your nonexempt property to your creditors in your repayment plan. The more property you have, the higher your monthly payment will likely be. After successfully completing your repayment plan, any outstanding balances on your nonpriority unsecured debts—such as credit card balances, medical bills, and personal loans—are discharged.

Here’s a list of questions that might help you decide whether to file for Chapter 13 bankruptcy:

  • Do you make too much money to qualify for a Chapter 7 bankruptcy?
  • Do you want to keep your nonexempt property?
  • Do you need to save your house from foreclosure or your car from repossession?
  • Do you have debts that won’t go away in Chapter 7 bankruptcy (nondischargeable debts)?
  • Did you file a Chapter 7 bankruptcy within the last eight years?

If you answer any of these questions affirmatively, filing for Chapter 13 bankruptcy rather than Chapter 7 might be the right choice for you. To find out more about these factors, see How to Choose the Right Bankruptcy Chapter: When Chapter 13 Makes Sense.

If you have multiple debt problems and aren’t sure what to do, a knowledgeable bankruptcy attorney can review your case and explain which bankruptcy chapter is right for you.

Questions for Your Attorney

  • Will all of my debts be wiped out if I file for Chapter 7 bankruptcy? If not, should I file for Chapter 13 bankruptcy?
  • Has my state’s statute of limitations run out on my debt?
  • If I filed for Chapter 7 bankruptcy several years ago, will I receive a discharge if I file for Chapter 13 bankruptcy?

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