Chapter 7 vs. Chapter 13 Bankruptcy Protection
In this article, you will learn how to deal with debt lawsuits.
Table of Contents
- Which type of bankruptcy is right for me?
- Chapter 7 Bankruptcy or the Fresh Start Bankruptcy
- Chapter 13 Bankruptcy
- Bankruptcy and credit score
- Benefits and Downsides of Chapter 7 Bankruptcy
- Benefits and Downsides of Chapter 13 Bankruptcy
- Eligibility requirements for Chapter 7 vs. Chapter 13 Bankruptcy
Which type of bankruptcy is right for me?
It depends on the filer’s income, debt profile, assets, and the applicable exemption laws. It also depends on whether the filer is facing foreclosure, repossession, or any other type of aggressive collection effort by lenders.
Generally, Chapter 7 bankruptcy is used to eliminate unsecured debt, whereas Chapter 13 bankruptcy is used to protect property from foreclosures and repossessions. Chapter 13 is also suitable for households with high incomes.
Chapter 7 Bankruptcy or the Fresh Start Bankruptcy
Chapter 7 bankruptcy is also called the Fresh Start bankruptcy because it eliminates most unsecured debts, including credit card debt, medical bills, personal loans, and repossessions. Student loans are also unsecured debt, but they are often not discharged in a chapter 7 bankruptcy. In theory, nonexempt assets can be sold off by the chapter 7 bankruptcy trustee to satisfy at least some of the outstanding debt. In reality, not all assets, but assets that are not protected (nonexempt property), could be sold off.
Many articles that discuss Chapter 7 bankruptcy online suggest that in a chapter 7 bankruptcy, the chapter 7 trustee liquidates the filer’s assets. Again, that is seldom the case. Before filing, a competent bankruptcy lawyer will ask about her client’s nonexempt asset to hypothetically apply bankruptcy exemptions to see what’s unprotected. Filing a chapter 7 bankruptcy may not be the best option if there is a real liquidation risk. It is essential to understand that nothing is liquidated in most chapter 7 bankruptcies since a competent bankruptcy attorney will assess the client’s entire financial situation beforehand. If there is enough risk of liquidation, an experienced bankruptcy lawyer will suggest a different type of bankruptcy filing or not filing for bankruptcy.
Although a Chapter 7 bankruptcy is referred to as Fresh start bankruptcy, not all debt is discharged. For example, back child support, alimony, and other domestic support obligations are non-dischargeable debts. Likewise, some but not all income tax debt is classified as a non-dischargeable priority debt.
Mortgages, Car Loans, and Chapter 7 Bankruptcy
Both mortgages and car loans are classified as secured debt. Unlike unsecured debt described above, secured debt is a type of debt linked to collateral. For example, a mortgage creates a secured debt linked to real property, and a car loan is collateralized with a vehicle. Because these debts legally link to a property, they may not get discharged, especially if the collateral is not surrendered in a Chapter 7 Bankruptcy.
If a property is in foreclosure or a vehicle is about to be repossessed, then Chapter 7 bankruptcy may not be the ideal solution. The foreclosure or repossession should indeed stop with filing a chapter 7 bankruptcy case absent some extraordinary situations; however, the relief from foreclosure or repossession is temporary. The initiating creditor can generally foreclose or repossess after obtaining the bankruptcy court’s permission. Essentially, Chapter 7 temporarily stops foreclosures and repossessions. Such a temporary stay may be an option for someone trying to buy time to vacate the premises. It is generally not a long-term solution.
Customer Reviews
Our clients talk ?>/assets/images/Hooman Khoshnood law logo 4.png)
Chapter 13 Bankruptcy
Chapter 13 bankruptcy is generally called an individual’s reorganization bankruptcy, including a repayment plan to creditors. It is for people who have a regular income. The chapter 13 bankruptcy repayment plan does not necessarily pay all the filer’s debts in full. That is a common misconception of how a chapter 13 restructuring plan functions. Often, unsecured creditors don’t get all the money contractually owed to them. And the unpaid unsecured debt in a chapter 13 bankruptcy could get discharged. Therefore, it is possible to discharge debts in a chapter 13 bankruptcy and a chapter 7 bankruptcy. How much unsecured debt is discharged and how much is repaid by a chapter 13 bankruptcy is a complex question; there are many factors at play, such as the debtor’s monthly income, disposable income, un-exempt assets, types of debt, and the means test results, to name a few. To best understand how a chapter 13 repayment plan will work in a particular case, it is best to consult a bankruptcy attorney with experience.
It is, therefore, a misconception that all debt is discharged in a Chapter 7 bankruptcy, and all debt is repaid in a Chapter 13 bankruptcy. Both bankruptcies can discharge debt, and non-dischargeable debts remain regardless of the filed bankruptcy chapter.
Mortgages, Car Loans, and Chapter 13 Bankruptcy
This is where Chapter 13 Bankruptcy is generally useful. Missed Mortgage payments can be repaid through Chapter 13’s monthly payments. While the filer catches up on mortgage payments through Chapter 13’s monthly payments, the property is also protected from foreclosure. Once a Chapter 13 bankruptcy case is filed, pending foreclosures must stop by the operation of a section of the bankruptcy code called the automatic stay. It is not up to the mortgage company to agree to stop foreclosure. It is automatic, as the name automatic stay suggests. Of course, there are minor exceptions to this rule generally related to repeat bankruptcy filers. In summary, a filer can catch up on missed mortgage payments while protecting the property from foreclosure in a Chapter 13 bankruptcy.
Likewise, the automatic stay also stops repossessions. It is possible to structure a chapter 13 repayment plan to include the balance owed for a car loan. This way, vehicles owned by the filer could be paid off as part of their bankruptcy. It is also possible to reduce the interest rate of such loans depending on how high the interest rate is and the filer’s risk factors. In some cases, the balance owed on a vehicle can also be reduced.
Which one is worse for your credit score, Chapter 7 or 13?
I am often asked which bankruptcy is worse for a filer’s credit score, Chapter 7 or 13? I don’t think it should be a primary factor in your decision. You can start building credit by obtaining new credit after receiving your bankruptcy discharge. Credit scores can be rebuilt, but the real reason behind bankruptcy is to provide you with needed debt relief. In many cases, the benefits of erasing debt or repaying what you can’t erase through bankruptcy outweigh bankruptcy’s temporary impact on the credit score. Remember that your credit score is primarily good for incurring debt, and bankruptcy is designed to give you relief from debt. They have opposite functions. What do you need more, relief from debt or the ability to incur more debt?
Also, often but not always, creditors continue to report your payment history to credit reporting agencies even when you are in bankruptcy. Suppose you decide to keep your car in a chapter 7 bankruptcy and have a car loan. Often, the car creditor will continue to report to the credit agencies even when you are waiting to receive your chapter 7 bankruptcy discharge.
Likewise, suppose you are making mortgage payments while you are in a chapter 13 bankruptcy repayment plan. Your payment history’s timeliness may positively impact your credit score even while you are completing your chapter 13 payment plan. The exact algorithm that calculates credit score is not public information, but having a timely mortgage payment history is a positive data point.
What are the downsides and benefits of Chapter 7 bankruptcy?
Downsides of Chapter 7 Bankruptcy
The downside to filing a chapter 7 bankruptcy is that it does not protect the bankruptcy filer from liquidation; however, keep in mind that a properly executed chapter 7 bankruptcy considers the likelihood of liquidation by comparing nonexempt assets with the exempt ones before the case gets filed. If a prospective bankruptcy filer has unexempt (unprotected) assets, it may make sense to avoid filing for a chapter 7 bankruptcy and consider other bankruptcy chapters or nonbankruptcy options.
The other chapter 7 bankruptcy is that some people may frown on it, but they also don’t live your life and don’t fully understand the debt challenges that you may be facing. Priority Debt (generally, some types of income tax debt and domestic support) is unaffected and should consider a different solution to deal with priority debt.
Benefits of Chapter 7 Bankruptcy
It wipes out most unsecured debt. And that’s a significant benefit. Avoiding the stress of dealing with collection calls, demand letters, debt lawsuits, garnishments, and placement of liens and levies could be a life-changing benefit of Chapter 7 liquidation Bankruptcy.
What are the downsides and benefits of Chapter 13 bankruptcy?
Downsides of Chapter 13 Bankruptcy
Chapter 13 Bankruptcy typically lasts from three to five years.
Benefits of Chapter 13 Bankruptcy
Chapter 13 bankruptcy is a powerful solution to protect property and assets. It stops foreclosures, garnishments, and repossessions effectively. It is also a beneficial tool to eliminate or pay off tax debt. It is an effective debt management plan with the full force of the bankruptcy court, a federal institution behind it. With some exceptions, debt payments get eliminated or consolidated, making getting out of debt convenient. Attorney’s fees can also be included in the monthly plan payments making chapter 13 bankruptcy surprisingly affordable.
Eligibility requirements for Chapter 7 vs. Chapter 13 Bankruptcy
CFor an individual bankruptcy petition filing under either chapter, a credit counseling certificate has to be obtained from a credit counseling agency approved by the U.S. Trustee’s office within six months of the bankruptcy filing date. The credit counseling requirement can be waived in some limited circumstances, but it is most often required.
The household median income is also considered as part of the eligibility requirement. The budget, the means test, and the eligibility requirements for each bankruptcy chapter interplay in complicated ways. As a broad generalization, your household median income and expenses get compared with the IRS standards for the same household size in the same geographic area where you live to determine how much money is paid to the unsecured creditors in a chapter 13 bankruptcy. The means test is also used to determine whether a presumption of abuse arises in a chapter 7 case.
Chapter 13 bankruptcy has specific debt limits for the total amount of secured and unsecured debt. Chapter 7 bankruptcy has no debt limits.
Also, Chapter 7 bankruptcy is available to individuals and businesses, but chapter 13 bankruptcy is only available for individuals.
Hooman is a 18 year bankruptcy veteran from Georgia. He recently relocated to Texas to aid people on their path to financial recovery. During his time away from the office he finds peace in art, writing,
teaching, and traveling.
Read more about Hooman Khoshnood