All You Need to Know About the Differences Between Chapter 7 and Chapter 13 Bankruptcy

Apr 13, 2021 | Bankruptcy

If you’ve decided to deal with your debt by filing for bankruptcy after going through credit counseling or contacting an attorney, it is normal to wonder which path to take next. At this stage, individuals and small business owners are typically presented with two alternatives – file for bankruptcy under chapter 7 or chapter 13.

What Are the Differences Between Chapter 7 and Chapter 13?

Chapter 7 bankruptcy is commonly referred to as liquidation bankruptcy, and chapter 13 as reorganization or wage earners bankruptcy. If you file for chapter 7, you may look forward to a discharge of all your unsecured debt. With chapter 13, you need to repay your creditors partially or completely through a repayment plan.

The corresponding table highlights other key differences between both types.

Chapter 7

Chapter 13

Eligibility

Individuals and businesses with  incomes low enough to pass the Chapter 7 Means Test

Individuals and sole proprietors with maximum secured debt of $1,257,850, and maximum unsecured debt of $419,275

Time frame

Three to four months

Three to five years

Income

You might not qualify if you have high income

You need a regular income to make revised monthly repayments

Effect on foreclosure

Temporary pause – foreclosure proceedings to continue if you cannot get current

Cease on foreclosure proceedings, ability to get current through a repayment plan

Effect on property

You get to keep exempt property, whereas a trustee sells nonexempt property to repay creditors

No liquidation of property

Is lien stripping allowed?

No

Yes

Complexity in filing

Possible to file on your own if you have a simple case, might require submitting multiple forms and navigating legal challenges

Most cases require hiring attorneys and submitting repayment plans in courts

Which Type is Right for You?

How much money you earn and the assets you own have a significant bearing on which type of bankruptcy might be right for you. For example, high income might keep you from filing for chapter 7. On the other hand, you get to protect the property you might lose through chapter 7 by filing for chapter 13. Depending on whether you meet some conditions, you get additional benefits through chapter 13, that you don’t through chapter 7. These include:

  • Reducing the amount you owe toward an investment property mortgage or an auto loan
  • Saving a home from foreclosure or a vehicle from being repossessed by playing catch up with repayments
  • Eliminating unsecured junior liens and second mortgages

Possible Scenarios

Whether one should file for chapter 7 or chapter 13 bankruptcy depends on individual circumstances. Here are a few possible scenarios.

  • You are currently unemployed and have little to no assets. In this case, chapter 7 is the way to go
  • You are currently unemployed but have significant equity in your home. The answer depends on where you live. If your state’s homestead exemption covers the equity you’ve built, chapter 7 might work well for you. In addition, you would not qualify for chapter 13 if you’re unemployed.
  • You are currently employed and facing foreclosure. Chapter 13 is the best way forward because you may use a repayment plan to get current with your mortgage. You might also get rid of a lot of your unsecured debt and benefit through lien stripping.

Conclusion

Filing for bankruptcy is a major decision and can come with severe consequences. This requires that you consider all your other options ahead of time. For instance, you might benefit by going the debt relief way and not need to file for bankruptcy at all.

If you have not seen a credit counselor yet, that should be your first move. You may also consider getting advice from an attorney who specializes in handling bankruptcy-related cases.