Bankruptcy can provide the ultimate debt relief for many people. But there is a big difference between Chapters 7 and 13 of the federal Bankruptcy Code. Both are applicable only to consumers (i.e. people, as opposed to businesses or other entities). However, both Chapters provide different forms of relief to different types of debtors. In general, Chapter 7 is total liquidation; and Chapter 13 creates a debt adjustment plan approved by the court.
All consumers should first consult with a local bankruptcy attorney prior to filing for bankruptcy. However, in planning for bankruptcy, consumers should consider the following factors in determining whether Chapter 7 or Chapter 13 is more appropriate for an individual debtor:
- The dischargeability of debts. There are eighteen types of debts that are not dischargeable under Chapter 7 bankruptcy. Some types of debts that are nondischargeable under chapter 7 may be dischargeable under Chapter 13. If a person has substantial debts that are dischargeable under Chapter13 but not under Chapter7, Chapter13 may be preferable. The eligibility of a person for a discharge may also be a factor to consider. A person who has received a bankruptcy discharge in the last 8 years is not eligible for a Chapter7 discharge, but may be eligible for a Chapter13 discharge.
- Retaining secured property. A person who is in default on an important secured obligation, such as a home mortgage or an automobile loan, is usually permitted to cure the default within a reasonable period under Chapter13 and retain the secured property. The curing of defaults in secured obligations is not usually feasible in a Chapter7 case. However, in a Chapter7 case the debtor is permitted to redeem or set aside liens against certain exempt personal property.
- Retaining nonexempt assets. In a Chapter7 case a debtor must turn all nonexempt property (or its cash equivalent) over to the trustee. In a Chapter13 case a debtor is usually permitted to retain his or her nonexempt property, provided that meaningful payments are made to unsecured creditors. Therefore, if a person has a large equity in his or her home or other important nonexempt assets, Chapter13 may be preferable. The best way to determine which property is exempt is to purchase a bankruptcy exemption manual.
- Income. In order to qualify under Chapter13, a debtor must have “regular income,” which is defined as income sufficiently stable and regular to enable a debtor to make payments under a Chapter13 plan. If a person is unemployed or otherwise devoid of regular income, a Chapter13 case may not be feasible. On the other hand, Chapter7 may not be feasible for someone with sufficient income with which to pay $117.08 a month or more to unsecured creditors over a three-to-five year period because the Chapter7 case of such a person is likely to be dismissed by the court as an abuse of Chapter7.
- Time and expense. Chapter 13 cases normally last from three to five years. Chapter 7 cases of typical consumer debtors last about six months, and a discharge is normally granted about four months after the case is filed. In Chapter13 cases, the attorney’s fees and administration expenses tend to be considerably more than in Chapter7 cases. If a person is not able or willing to make meaningful payments and otherwise comply with a chapter 13 plan during the entire duration of the plan and to bear the additional expenses involved, Chapter13 is probably not advisable for that person. Also, if anything is likely to occur during the duration of the case that would diminish or eliminate the person’s ability to make payments under a plan, a Chapter13 case may not be preferable.
This list highlights some of the differences between Chapter 7 and 13 bankruptcies. Again, everyone considering a bankruptcy should first consult with a local bankruptcy attorney. However, bankruptcy can be an important tool in financial planning, especially in today’s economic climate.