What Are The Differences Between Chapter 7 vs. Chapter 13 Bankruptcy?

Declaring bankruptcy is a big deal. The long-term damage it can do to your credit is such that bankruptcy only should be considered as a last resort, after credit counseling, debt management or debt settlement have either been tried or considered.

But, if bankruptcy is the only hope to get out from debt that’s grown too large for you to pay, another question remains. Should you file Chapter 7 or Chapter 13 bankruptcy?

These two sections of the U.S. Bankruptcy Code determine how individuals can settle overwhelming debt. Will you be put on a debt repayment plan, enabling you to keep your property? Or will some of your property have to be sold to pay off what you owe? You’ll need to do your research and due diligence before choosing which is right for you.

Before considering either, be aware that the following debts cannot be discharged by Chapter 7 or Chapter 13 bankruptcy, including:

• Tax debts or government fees
• Mortgages
• Child support or alimony
• Student loans
• Auto loans

Chapter 7 Bankruptcy vs. Chapter 13 Bankruptcy

The biggest differences between Chapter 7 and Chapter 13 bankruptcy are what happens to your property and who qualifies financially.

Chapter 7 requires you to sell property that isn’t exempt to pay off your debts. However, a survey done by the American Bankruptcy Institute in 2018 showed that if you file exemption paperwork properly, 93% of filers in the United States are able to protect all of their assets.

Chapter 7 bankruptcy typically discharges your obligations and allows you to get on with your life much faster than Chapter 13, which gives you a chance to maintain your property. The tradeoff for Chapter 13: You complete a court-ordered repayment plan, which can take three to five years.

Another issue to consider: Not everyone qualifies for Chapter 7 bankruptcy. You must pass a means test, which uses a formula that prevents higher-income debtors from using bankruptcy provisions to completely wipe out their debts. In Chapter 7, you must either have a below-median level income for your state or pass a means test that examines income, expenses and family size to determine whether you could reasonably repay your debts with whatever income you have after paying for essentials. Those who fail this means test may use Chapter 13.

Here are some side-by-side comparisons of the two bankruptcy methods. After the chart, we explain in more detail how Chapter 7 and Chapter 13 bankruptcy work and how to choose which option is best for you.

How Chapter 7 Bankruptcy Works

When you file for Chapter 7 bankruptcy, an order known as the automatic stay prevents most creditors from calling you anymore and continuing to collect money, including wage garnishment.

Chapter 7 bankruptcy erases debts such as medical bills, personal loans and credit card balances in about three or four months. You will not be required to pay back those creditors. Rather, a court-appointed bankruptcy trustee sells your property that can’t be protected by a bankruptcy exemption to help compensate your creditors. Most household belongings are exempt, such as clothing, furniture, retirement accounts and, within limits, homes and cars.

Chapter 7 bankruptcy is an effective tool for low-income debtors without significant assets, who can’t commit to a three-year repayment plan and don’t have debts like alimony or child support, which cannot be discharged in bankruptcy. Before choosing this approach, calculate whether the amount of debt you’d wipe out would be more than the value of the property you’d lose.

However, you may not qualify. You’ll be required to pass a Chapter 7 means test to prove that you can’t afford to pay your debts.

Drawbacks of Chapter 7 Bankruptcy

Although Chapter 7 gets you through the process more quickly, it comes at a cost.

The bankruptcy trustee can sell any property not protected by an exemption.

You may get to keep your home or car, but you’ll still be on the hook for the mortgage and/or car loan. The same is true for other non-dischargeable debt, like tax debt.

If you’re behind on mortgage payments, Chapter 7 bankruptcy won’t help you catch up. Chapter 13 bankruptcy gives you up to 5 years to bring your home loan current.

Chapter 7 bankruptcy stays on your credit report longer (10 years) than Chapter 13 (seven years).

How Chapter 13 Bankruptcy Works

If you have property you really want to keep, Chapter 13 bankruptcy gives you a chance. If you have sufficient income, it’s your best choice.

Some good news: Filing Chapter 13 can stop the foreclosure process, which can help you make up some of your overdue mortgage payments, and debt collectors can no longer come after you during the bankruptcy process.

Chapter 13 requires you to make a plan to repay all or some of your debts through a consolidated monthly payment that will be distributed to your creditors. You’ll repay your debts in three to five years. How much you’ll repay depends on your income, the size and kinds of debts you have and the property you own.

Chapter 13 works for debtors who are in arrears on alimony or child support so they can catch up over three to five years or who need to catch up on house or car payments so they can keep that property.

Although the trustee doesn’t sell your property in Chapter 13 bankruptcy, you must repay creditors an amount equal to the value of your nonexempt property. How much you pay depends on your income, expenses and the type of debt you owe.

You’ll have to pay 100% of the bankruptcy filing fees, trustee commissions and your bankruptcy attorney’s fees, as well as 100% of your arrears in child and spousal support; most tax debts;  wages, salaries, or commissions owed to employees; and contributions owed to an employee benefit fund.

To keep your home, car or other secured property, you must pay 100% of the amount in arrears, 100% of debt secured by a tax lien, and you must remain current on the monthly payment. How much you pay of your unsecured, nonpriority debts depends on your income, the length of the repayment plan and the value of your nonexempt property.

Drawbacks of Chapter 13 Bankruptcy

Although you can keep your property, Chapter 13 bankruptcy is no picnic.

• Discharging your debts can take three to five years.
• Because a lot can happen in three to five years – sickness, divorce, getting laid off – Chapter 13 bankruptcy has a high failure rate.
• The repayment will tighten your budget.
• It’s more complicated than Chapter 7, so you’ll need to hire a bankruptcy attorney, which will cost somewhere between $3,500 and $5,000.
• If you don’t keep up your repayment plan, your bankruptcy case could be dismissed or converted from Chapter 13 to Chapter 7, which means you could again be in jeopardy of losing assets like your home or car.
• Failing to file required taxes during your case or failing to pay child support and alimony could also send you into Chapter 7 bankruptcy.
• You’ll have to send a copy of your income tax return to the Chapter 13 bankruptcy trustee every year during your bankruptcy case. If you get a tax refund, that money will go to your unsecured creditors on top of your regular monthly plan payments.

When Should I File for Chapter 7 or Chapter 13 Bankruptcy?

Some things bear repeating: There are consequences of bankruptcy, so consider your options carefully. If it’s affordable, consult with an attorney. Between court fees and attorney fees, the cost of bankruptcy can be thousands of dollars.

Of the two options, Chapter 7 is more popular because filers don’t have to pay back part of their debts. Chapter 13 may be a better solution if you’re in arrears on your mortgage because you can keep your house in Chapter 13 and have time to get caught up on payments. The same is true for debts like back taxes and spousal/child support, which won’t go away in bankruptcy.

Consider:

• What kind of debt do you have? Secured? Unsecured? Dischargeable? Non-dischargeable?
• How much of your property is non-exempt, which means it can be sold to pay off debts? Non-exempt assets are typically not necessary for your home, your job or your daily life.
• Is your regular monthly income enough to cover your living expenses?
• How important is clearing the bankruptcy from your credit report, which happens faster with Chapter 13?

When to Consider Filing Chapter 7 Bankruptcy

So, when is Chapter 7 the better option?

• Your debt is mostly unsecured (medical bills, credit cards, personal loans).
• Your income isn’t enough to cover your basic living expenses.
• You don’t have enough money for a bankruptcy lawyer.
• You don’t have non-dischargeable debts that you’ll be stuck with even after bankruptcy.
• You can’t commit to at least a three-year repayment plan.

When to Consider Filing Chapter 13 Bankruptcy

When is Chapter 13 right for you?

• You have too much money to qualify for Chapter 7.
• You have property you don’t want to lose.
• You want to catch up on your mortgage so you can stay in your house.
• You have debts that can’t be discharged.
• You have more than one mortgage.
• You owe money to your ex-spouse from a property settlement.

Need Help Choosing? Get Professional Assistance

If you’re the least bit unsure whether bankruptcy is what you need, speak with a certified credit counselor. Credit counseling can:

• Clarify whether you might be able to get your finances in order without bankruptcy.
• Review your income and expenses, discuss alternatives and help you develop a personal budget.
• Help you develop a feasible repayment plan.
• Teach you how to rebuild credit after bankruptcy.
• Counsel you on other debt relief options.

If you believe you should file for bankruptcy, discuss the situation with a reputable bankruptcy attorney. Like many other complicated legal issues, expert advice can be significant, and bankruptcy attorneys have the experience and know the legal landscape to increase the odds that your bankruptcy case will be a success. Bankruptcy may be the second chance that you need.

Once you’re through the bankruptcy process, it’s important to rebuild your credit so you don’t get in the same situation again.