Once you’ve made the difficult decision to file for bankruptcy, the next step is figuring out which type most suits you—Chapter 7 or Chapter 13. In many cases, factors such as your income, assets and debts will determine which filing you can pursue. But in other instances, your financial goals—like wanting to remain in your family home—will ultimately decide your bankruptcy path.
Here are the two types of bankruptcy filings available to individuals and when you should choose each.
What is Chapter 7?
Chapter 7—also called liquidation bankruptcy—eliminates your general unsecured liabilities such as credit card debts, personal loans and medical bills. After you file, a trustee administers your case—reviewing your documents and overseeing the sale of nonexempt property to pay back your lenders. Typically, this type of bankruptcy is discharged between three and five months, and it stays on your credit report for 10 years.
When to Choose Chapter 7
This type of bankruptcy is designed for lower-income consumers with little to no assets and who want a fresh start. To qualify, you must show that you make too little money—less than the median income for your state—or have insufficient disposable income to pay your debts. To determine the latter, you must pass a means test that subtracts your necessary expenses from your income.
Let’s say you pass that means test. Does that mean Chapter 7 is the best option for you? If your burden comes from debts that can be discharged, such as medical bills or credit cards, then, yes, Chapter 7 is a good solution for you. Those debts will be wiped away and you get a clean slate.
It’s also a smart choice if you don’t have many assets--since those may need to be forfeited if they’re sufficiently valuable. Do you drive an old car? Do you rent rather than own? If you answered yes, then Chapter 7 may work for you. Some of your possessions—like your car, house, and household items—are exempted from being sold up to certain amount, depending on federal and state law. So, if your car’s value is below the exemption amount, it’s yours to have after a Chapter 7 bankruptcy. Last, if you don’t think you can pay off your debts in the next three to five years—maybe because you don’t expect a meaningful change to your income in that time—opt for a Chapter 7 bankruptcy.
What is Chapter 13?
Say you don’t pass the means test and have too much money to qualify for a Chapter 7. Then there’s Chapter 13. Also known as reorganization bankruptcy, it’s designed to help you pay back some or all of your debts through a repayment plan that lasts between three and five years. The bankruptcy is discharged after you complete the repayment plan, and it stays on your credit report for seven years from filing date.
What you must repay depends on your income, expenses and the type of debt you have. But you can’t have more than $394,725 of unsecured debt or $1,184,200 of secured debt. These limits change every three years and are current as of April 2016.
When to Choose Chapter 13
For most people, a Chapter 13 bankruptcy is chosen for them if they fail the means test. But that might not be only reason to consider reorganization over liquidation. If most of your onerous debts are ones that can’t be cancelled under a Chapter 7 bankruptcy, then Chapter 13 may be the only option left. Debts that can’t be discharged include:
- Alimony and child support
- Some student loans
- Some taxes
- Debts after bankruptcy is filed or some incurred in the previous six months
- Debts from personal injury while drunk driving or from willful and malicious injuries to person or property
If you want to keep your house or car—and their values exceed the exemption allowed in Chapter 7 bankruptcies—then choose Chapter 13 to avoid losing them to foreclosure or repossession. Chapter 13 also provides a way to get back on track if you’re behind on the payments on your mortgage or car loan. (Not so for Chapter 7; you would likely lose your home or car if you’re delinquent on payments.) Chapter 13 also allows you to keep non-exempt property—such as a fancy car, expensive art or heirloom jewelry—that you would otherwise have to sell in a Chapter 7.