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Chapter 7 vs. Chapter 13 Bankruptcy: What’s The Difference?

Bankruptcy, although it carries a negative connotation, can actually be very beneficial for individuals, especially those who have trouble settling their debts. Depending on the type of bankruptcy case, a debtor can be enabled to eliminate all their debt obligations and start over financially.

While many people do know about bankruptcy and what can happen when they file for it, what many are unaware of is that there are several types of bankruptcy cases. Each of them also has its own different effects when it comes to debt and how it is eliminated. 

Two of the common bankruptcy cases filed are those under Chapter 7 and Chapter 13. Let’s take a look at how they differ so that you can make a better determination of what you should file and what each one means for your debt. However, should you decide to file for bankruptcy, it’s advisable to consult with an experienced attorney first so that you can make the best financial decisions. 

Chapter 7 Bankruptcy

The most common type of bankruptcy, Chapter 7, is also called liquidation bankruptcy. This is because of its process, which involves liquidating the assets of the person filing and using the money generated to pay off the creditors. If the debtor does not have any assets or only owns a few, the creditors do not get anything. 

Many people think that filing a Chapter 7 bankruptcy means that they lose everything they own. However, that’s not true. Statutes set forth certain exemptions that protect secured assets, such as a car or a home. The debtor gets the option of whether or not to continue paying for these secured debts or otherwise relinquish them. 

A Chapter 7 bankruptcy is considered the speedy type of bankruptcy case because a debtor gets immediate relief after his or her assets are sold. Most debts are also dischargeable under a Chapter 7 bankruptcy, making it more favorable for debtors. The only debts that cannot be discharged in a Chapter 7 bankruptcy include: 

  • 401k loans
  • Alimony and child support
  • Debts arising from fraud
  • Debts not included in bankruptcy forms
  • Government fines and penalties
  • Income tax debts
  • Payment for damages arising out of DUI convictions 
  • Restitution for criminal acts
  • Student loans

Because of its speedy nature and the high chances of getting most debts discharged, a Chapter 7 bankruptcy may be the most attractive option. However, it’s not for everyone. Before a person can qualify for a Chapter 7 bankruptcy, they need to pass a means test. If their income is low enough, they can proceed with a Chapter 7 bankruptcy. But if their income is sufficient and more than the threshold, it’s a better option to file under Chapter 13. 

Chapter 13 Bankruptcy 

Unlike in Chapter 7 bankruptcy where the debtor’s assets are liquidated to settle their debts, assets are more protected in a Chapter 13 bankruptcy. This is because, in this setup, the debtor is instead bound by a payment plan where they pay for their debts in arrears for a period of 3 to 5 years, depending on the debtor’s financial capacity. 

The process begins upon application for a Chapter 13 bankruptcy. The court will then total all of the debtor’s secured and unsecured debt obligations and order a suitable payment plan. In the same way that the Chapter 7 bankruptcy is not for everyone, so is the case in Chapter 13. This is only beneficial for debtors who have enough income to settle arrears of their debts. To determine if their income is enough, applicants need to take a means test. Should their income be above the State limit, Chapter 13 is for them. 

So, Which One Should You File?

Everyone’s financial situation differs. To determine which one you should file, you should first define your priorities. Although Chapter 7 may seem attractive at first glance because of the immediate relief, Chapter 13 may be more suitable for you if you have assets that you want to protect. Ultimately, it would depend on your income and how you perform in the means test. 

Before filing for bankruptcy, it’s important that you know what to expect when you do and which one is more suitable for your unique financial situation. You should also remember that filing for bankruptcy can affect your credit score and make it more difficult to qualify for future loans. It’s highly recommended that you speak to a bankruptcy lawyer before filing so that you can be guided to make the best financial decisions, navigate your bankruptcy case wisely, and move forward with your fresh financial start.

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Stephanie
Randall

Managing Partner

Colorado Springs