Reasons to File for Chapter 7 Bankruptcy Instead of Chapter 13
When given a choice, many people prefer filing Chapter 7 bankruptcy instead of Chapter 13 because it discharges most medical bills and credit card debt. In this article, we discuss the advantages of Chapter 7 and the disadvantages of Chapter 13.
Advantages to Chapter 7 Bankruptcy
Chapter 7 bankruptcy has many advantages, which we discuss below. It's important to keep in mind, however, that Chapter 7 isn't for everyone. You must qualify by meeting an income test (called the "means test"). And for some people, debt is discharged in exchange for giving up valuable nonexempt assets. A bankruptcy trustee sells these assets to pay creditors. For this reason, Chapter 7 is sometimes called a "liquidation" bankruptcy.
1. You Receive a "Fresh Start"
The goal of Chapter 7 bankruptcy is to give you a new start. The elimination of certain debt frees you from personal liability for the discharged debt.
However, some types of debt are not dischargeable, including student loans (unless the court rules otherwise), child support and alimony, certain taxes, and debts incurred by fraud.
Certain liens on property, such as a mortgage, a tax lien, or a mechanic's lien, remain after the completion of Chapter 7 bankruptcy.
2. You Will Keep Future Income
In general, the property you acquire or will acquire after filing for Chapter 7 is not included in the bankruptcy estate.
These forms of property acquired within 180 days after filing for Chapter 7 will become part of the bankruptcy estate:
- Inherited property
- Property from a divorce decree or settlement agreement
- Death benefits
- Proceeds from a life insurance policy
3. No Limitations on Your Amount of Debt
Unlike Chapter 13 bankruptcy, Chapter 7 bankruptcy rules do not impose a limit on the amount of debt you can have.
Under Chapter 13, you cannot file for bankruptcy if secured or unsecured debt exceeds the debt limits.
4. No Debt Repayment Plan
Under Chapter 7, you do not have to repay debt in a court-approved repayment plan, unlike in a Chapter 13 bankruptcy. You are no longer responsible for repaying the debt after its discharge in Chapter 7.
5. The Discharge of Debts Occurs Quickly
In a typical case, the discharge of debt may occur in as little as three months. About 60 to 90 days after you file for bankruptcy, the court will issue a discharge order. After the trustee distributes your property to unsecured creditors, the bankruptcy court will close the case.
The Disadvantages of Chapter 13 Bankruptcy
In some cases, repaying debt over time in a court-approved Chapter 13 repayment plan provides benefits unavailable in Chapter 7. There are, however, disadvantages to Chapter 13, including:
1. Only Individuals Are Eligible (Even for Business Debts)
To petition for bankruptcy under Chapter 13, you must file as an individual. If you have personal liability for business debts, you can still file if:
- You are the sole owner of a business or have a partner, and
- You file as an individual, not as your business
2. You Must Repay Creditors
A Chapter 13 bankruptcy requires repayment to creditors using a three- or five-year repayment plan.
This means you must have enough income to pay creditors every month. You must:
- Repay priority debts and secured creditors in full
- Repay unsecured creditors an amount equal to what those creditors would have received if your trustee sold your nonexempt property in a Chapter 7 bankruptcy
3. You Must Meet Debt Limitation Requirements
You are ineligible for Chapter 13 if your unsecured or secured debt exceeds a certain amount. This amount changes year by year.
Chapter 7 does not have debt limits, so you may need to consider it if your debt exceeds these amounts.
Comparing Chapter 13 vs. Chapter 7 Bankruptcy: When to Choose Chapter 13
It may be more appropriate for you to choose Chapter 13 if:
- You do not qualify for Chapter 7 under the "means test" (if your income exceeds your state's median income).
- You have the disposable income to repay some portion of unsecured debt in a Chapter 13 repayment plan.
- You want to repay debt with monthly payments in a three- or five-year plan. Your bankruptcy trustee will handle the distribution to creditors.
- You want to save your home from foreclosure. An automatic stay will temporarily prevent a foreclosure until the court confirms your repayment plan.
- You want to stop the repossession of your car. You must repay the debt unless you bought the car at least two years before filing for bankruptcy. The amount owed on the loan may be eligible for reduction under the "cramdown" option. This allows you to pay the amount the car is worth, plus interest, in equal installments over the repayment plan term. This is beneficial when the loan is upside down – you owe more on the loan than the property is worth.
- You want to keep nonexempt property. You can keep the nonexempt property in exchange for repayment to unsecured creditors.
- You have debts that are not dischargeable under Chapter 7. Certain debts will survive a Chapter 7 bankruptcy but are eligible for discharge in Chapter 13.
- You have a nondischargeable debt that you want to repay over time.
- You have a co-debtor. Chapter 13 will protect co-debtors from liability for a joint debt if the creditor receives payment through the repayment plan. If debt remains after the plan ends, the creditor may collect the amount still owed from the co-debtor. Conversely, Chapter 7 will eliminate the filer's personal liability for a debt, but the co-debtor will remain responsible.
Keeping Your House and Car
This is one of the primary differences between Chapter 7 vs. Chapter 13 bankruptcy. Under Chapter 7, you may have to return your house or car to the creditor (e.g., the bank) or arrange to pay the item's wholesale value.
You will likely be allowed to keep the house or car if you stay current with a court-ordered payment system in Chapter 13.
A Note on Foreclosure
While both bankruptcies will temporarily stop foreclosure, Chapter 13 may be a better option for stopping it more permanently.
Once a Chapter 13 repayment plan is confirmed, you will pay back the missed payments over the life of the plan. The terms and conditions of the original agreement will govern the debtor and the lender's relationship.
Chapter 13, however, will not prevent foreclosure if you filed for bankruptcy within the past two years, and the bankruptcy court lifted the automatic stay to allow the creditor to proceed with foreclosure.
In Chapter 7, it is less likely that you can keep your home if you are behind on mortgage payments. The court can, and often will, grant a lender's request to lift an automatic stay to continue foreclosure proceedings on the home.
Debts Owed as a Result of Past Crimes
Your debts will likely not be discharged in Chapter 7 if the creditor objects and can prove you have a prior court conviction.
Although you will be required to pay for criminal debts as part of the Chapter 13 plan, the balance may be wiped out if the outstanding debts are not paid in full by the end of Chapter 13 bankruptcy.
Debts Owed for Child Support, Alimony, Student Loans
These debts will not be discharged. You cannot avoid support debts through Chapter 7 bankruptcy.
If you cannot pay these off by the end of Chapter 13 bankruptcy, you will still owe the remaining balance even after bankruptcy is over.
Nonsupport Debts Owed in a Divorce, Property Settlement, or Agreement
If a creditor (often the spouse) objects, then these debts will not be discharged unless you demonstrate that:
- You still will be unable to pay these debts after bankruptcy
- The benefit of wiping out this debt exceeds the detriment caused to the creditor
Any remaining balance at the end of Chapter 13 bankruptcy will be erased.
Not Sure Whether to File Chapter 7 or Chapter 13?
The decision to file for bankruptcy is complicated enough in itself. Choosing the appropriate form of bankruptcy and preparing to file will involve many considerations that you might not be aware of until it's too late.
Learn how an experienced bankruptcy lawyer can help guide you through the process and ensure that your bankruptcy solves your financial problems.
Contact a qualified bankruptcy attorney to find out your options for navigating the best path forward.