People often don’t realize that there is more than one choice when filing bankruptcy. There are actually six types of bankruptcies, but only four are available to individuals. The type of bankruptcy is usually designated by referring to the chapter of the Bankruptcy Code where that type is found. For example, Chapter 7 bankruptcies are found in Chapter 7 of the Bankruptcy Code; Chapter 13 in Chapter 13 of the Bankruptcy Code. The two most common types are Chapters 7 and 13.
Bankruptcy Goals. There are two overarching goals in any bankruptcy. The first is to give the debtor (the person filing bankruptcy) relief from her debts through a discharge, which is a court order that the debtor is no longer responsible for the debts covered by the bankruptcy. The second is to maximize the return of money to the debtor’s creditors. This is accomplished in different ways depending on which type of bankruptcy the debtor files. In either Chapter 7 or 13, there is a trustee appointed. The trustee is a person who oversees the debtor’s case to make sure the debtor qualifies for a discharge and to gain the biggest possible return to creditors.
Chapter 7. Chapter 7 is what most people think of when they think of bankruptcy. It gives relief from most debts (child support, alimony, other domestic support obligations; student loans; and most taxes are excluded). It’s relatively quick, about four months from start to finish. Usually, the debtor gets to keep all her property. But see here for what might be lost. The Chapter 7 trustee looks at everything the debtor owns, as disclosed in the bankruptcy petition, schedules and supporting documents filed by the debtor, and through questioning the debtor at a Meeting of Creditors. The trustee can make more detailed investigation if he sees fit. The trustee then liquidates (sells) any property that he feels has value above any secured debt owed by the debtor and any exemption to which the debtor is entitled. Most household property is subject to various exemptions, meaning the trustee cannot use the exempt portion. In many Chapter 7 cases the trustee finds no assets that he can sell, and the debtor gets to keep all her property, subject to any secured debt.
A bankruptcy does not eliminate liens or encumbrances on property, so if the debtor’s car is collateral for a loan, or the debtor has a mortgage on her house, she will have to pay that debt in order to keep the property. Alternatively, she can surrender the collateral, meaning she turns it back to the bank and walks away. Determining exemptions and what to do with secured debt is one of the biggest areas of concern in Chapter 7,
Chapter 13. In Chapter 13 the debtor makes payments to the Chapter 13 trustee for anywhere between three and five years (shorter if she can pay all creditors in full in less time). The trustee makes periodic payments to the creditors. People file Chapter 13 for one of two main reasons. First, they make too much money to qualify for Chapter 7 under the Means Test. This forces them into Chapter 13. Secondly, even though they might qualify for Chapter 7, maybe they have a house or a car they want to keep and would otherwise lose it in Chapter 7. There might be so much equity in the property that the Chapter 7 trustee would sell it, pay off the secured debt, give the debtor her exemption, and use the rest to pay creditors. Or maybe the debtor is behind in her payments and needs time to catch up. Chapter 13 allows a debtor to catch up past due payments without interest over the life of the plan. The debtor must make future payments as they come due, however.
Which is Better? Most people want Chapter 7. Who wants to make payments for up to five years? Chapter 7 is better if
Income is below the median income in your state for a family of your size.
There is a co-debtor who isn’t filing that needs to be protected
There isn’t substantial equity in a house, car or any assets that the trustee in Chapter 7 might sell.
The debtor doesn’t need time to catch up past due payments on cars, houses or other assets that might be foreclosed or repossessed.
Conversely, if any of the above situations apply, then Chapter 13 is probably the better option.
Sometimes people think they have to file Chapter 13 but upon looking at their situation, it turns out they can file Chapter 7. One example is they believe they have to file Chapter 13 to keep the car they owe $19,000 on and that is only worth $12,000. It’s true that if they file Chapter 7 they will either have to pay for the car or give it up, but once they look at the debt to value ratio, they realize that they are better off filing Chapter 7 and surrendering the car.
Choosing which chapter in bankruptcy is best can be complicated. There are lots of things to consider. Before making the decision, it’s best to talk with an experience bankruptcy attorney to understand your options and what each might mean. If you have bankruptcy questions, please contact us. You can also email firstname.lastname@example.org, or text or cal (801) 413-3708.