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 you recover financially.
The Differences Between Chapter 7 and Chapter 13 Bankruptcy
Even though Chapter 7 and Chapter 13 bankruptcy share some similarities, the two bankruptcy chapters work differently and provide unique benefits. In Chapter 7 bankruptcy, you don’t repay your creditors. In Chapter 13 bankruptcy, you must make monthly payments to your creditors for three or five years.
So, how do you know which chapter you must file? If you earn too much to qualify for Chapter 7, you must file for Chapter 13. However, sometimes people who qualify for Chapter 7 choose Chapter 13 when they're behind on a house or car payment and want to save the property, which can only be done in Chapter 13.
How Chapter 7 Bankruptcy Works
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. You get to keep the property on your state’s exemption list, called “exempt property.” The bankruptcy trustee—the person responsible for your case—sells any “nonexempt property” that isn’t on your state’s exemption list and distributes the proceeds to your creditors.
Once your bankruptcy is over, your “dischargeable debt”—such as credit card balances, medical bills, and personal loans—gets wiped out. You'll remain responsible for paying any nondischargeable debt, such as recent tax debt, student loans, and support arrears. If everything goes right, your case will take about four months from start to finish.
However, not everyone is eligible for a Chapter 7 discharge. To qualify, you must pass the Chapter 7 means test. Learn more about the Chapter 7 process.
Do You Qualify for Chapter 7 Bankruptcy?
Even though most people would prefer filing for Chapter 7 bankruptcy, not everyone can pass the Chapter 7 means test. You'll qualify automatically if you make less than your state’s median income for a household of your family’s size. (You can check by comparing your gross income to the U.S. Trustee Program website figures.) If your income is too high, you'll deduct allowed expenses to determine whether you have enough disposable income to pay creditors a reasonable amount through a Chapter 13 plan.
When Chapter 7 Might Not Be for You
Even if eligibility isn’t an issue, Chapter 7 isn’t always the best bet. Chapter 7 bankruptcy works well if you have little money and own few extravagant or nonessential belongings.
You'll want to be sure you understand what will happen to your property in bankruptcy. For instance, if you want to keep your house or car, you must be able to exempt all equity, and your payments must be current when you file.
You'll also want to ensure that all your debts are dischargeable because some obligations aren’t eliminated in bankruptcy. Examples of “nondischargeable debt” include income taxes, child and spousal support, and student loans.
These vital questions will help you decide if it’s right for you:
- Do you own much property?
- Are you current on your house and car payments?
- Are you okay with returning the property if you’re not current or can't exempt the equity?
- Are your debts dischargeable in Chapter 7 bankruptcy?
Because there are many factors to weigh and balance, it's best to meet with a local bankruptcy lawyer.
Do You Need to File for Chapter 7 Bankruptcy?
Even more important, be sure you 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 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, creditors might be out of luck if your debts are old. Most debts have an expiration date, which arrives when the “statute of limitations” has run. 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. However, 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. Still, 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 Joseph’s creditors could no longer sue him according to state law. 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 determine how particular issues might impact your Chapter 7 bankruptcy filing, see How to Choose the Right Bankruptcy Chapter: When Chapter 7 Makes Sense.
How Chapter 13 Bankruptcy Works
When you have “disposable income" or money left over after paying your household expenses, you won't qualify for a Chapter 7 discharge. Instead, if you want bankruptcy relief, 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 completing your repayment plan, any outstanding balances on your nonpriority unsecured debts, such as credit card balances, medical bills, and personal loans, are discharged.
Is Chapter 13 Right for You?
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 nonexempt property you'd lose in Chapter 7?
- 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. To learn more about these factors, see How to Choose the Right Bankruptcy Chapter: When Chapter 13 Makes Sense.
When Should You File for Chapter 11 Instead of Chapter 7 or 13?
It’s unlikely that you’d choose to file for Chapter 11 voluntarily. Chapter 11 is used primarily by businesses struggling financially. This type of business bankruptcy allows a company to reorganize debt and stay in business. Individuals sometimes file for Chapter 11, but it's rare. Most individuals who file a Chapter 11 case do so only when their debts exceed Chapter 13 limits.
How Chapter 11 Bankruptcy Works
When you file a Chapter 11 bankruptcy case, you might feel overwhelmed by the requirements. But you’ll get the benefit of the automatic stay. The stay will delay collection actions, lawsuits, and other debt collection efforts, giving you time to negotiate repayment with your creditors. The automatic stay remains in effect until the court approves your reorganization plan.
Here’s a synopsis of what you can expect.
- Negotiating with creditors. After you file your Chapter 11 case, you’ll disclose your income, assets, and debts on official bankruptcy forms and begin negotiating your reorganization plan. If you’re wondering why your creditors would be willing to negotiate with you, they know that if they’re too aggressive, they might force you into Chapter 7 liquidation and receive little or nothing.
- Preparing your plan of reorganization. Unlike a standardized Chapter 13 plan that requires you to pay a particular amount to certain types of creditors, a Chapter 11 reorganization plan is a customized document designed to solve your unique financial problems. As a Chapter 11 filer, your job is to propose a plan that preserves important assets while allowing you to pay your debts over time using your available income.
- Voting on your plan. Once you have negotiated a manageable plan, you’ll file it with the court, and your creditors will vote on whether to accept or reject it. Not all creditors will negotiate easily. If a reluctant creditor refuses a reasonable restructuring of its claim, you might be able to “cram down” a plan over the creditor’s objection if you can prove to the judge that your proposed treatment of that creditor’s claim is fair and reasonable.
- Confirmation of your plan. To be confirmed (approved by the court), a Chapter 11 plan must be accepted by at least one-half of the number of creditors in each class of claims and two-thirds of the dollar amount of claims in each class. Once accomplished, you’ll receive a court order confirming your reorganization plan and agreed-upon debts will be discharged. The confirmation essentially creates a new contract.
Overall, Chapter 11 has been too costly for many small businesses. However, a new version known as "Chapter 11, Subchapter V" adopts many of the simpler procedures of Chapter 13. As of the writing of this article, Chapter 11, Subchapter V, has been available for four years and is proving to be a welcome bankruptcy option.
Meet With an Attorney
Choosing the best bankruptcy chapter can be difficult, especially if you have multiple debt problems. A knowledgeable bankruptcy attorney can review your case and explain which bankruptcy chapter is right for you.