Should I file a Chapter 7 or a Chapter 13 bankruptcy?

For most consumers, your choices in filing for bankruptcy will come down to Chapter 7 or Chapter 13. (Chapters 9, 11, 12, and 15 are for municipalities, businesses and high-income debtors, family farmers, and foreign cases, respectively.) Which is the right one for you? It all depends on what you’re looking to accomplish and your current financial situation.

A Chapter 7 bankruptcy is sometimes referred to as a “liquidation” bankruptcy. Even though most people don’t lose anything, non-exempt assets may be sold by the trustee to pay creditors. (Don’t let that scare you. Seriously, very few people lose anything in a Chapter 7 bankruptcy. Your attorney should let you know before filing if any of your assets are at risk.)

In a Chapter 13 bankruptcy, you repay a portion of your debts through a 3-5 year plan. You send payments to a trustee and the trustee pays certain debts in full while other creditors receive a pro rata share of their claims.

The following are some of the main differences between Chapter 7 and Chapter 13:

Chapter 7
– Typically completed in 3-6 months.
– Legal fees usually in the range of $1500 – $2000.
– No payments to the bankruptcy trustee.

Chapter 13
– Plan typically completed in 3-5 years.
– Legal fees usually in the range of $3000 – $4000.
– Plan payments to the bankruptcy trustee for the life of the plan.

At the end of the case, the debtor will typically receive a discharge. There are a few debts that are dischargeable in a 13 that are not dischargeable in a 7, but the discharge is essentially the same in both.

So which makes more sense in your situation? For most of my clients, Chapter 7 is the better choice because of the lower cost and shorter time commitment. Most of my Chapter 13 clients file a 13 for one of three reasons:

1 – They aren’t eligible for a Chapter 7 discharge because they filed a previous bankruptcy less than eight years earlier.

2 – They make too much money and can’t rebut the means test’s presumption of abuse.

3 – They are trying to save a house or vehicle from foreclosure or repossession and want to cure any arrearage over 3-5 years while also making their regular mortgage/vehicle payments. Once you’ve defaulted on a loan, you can’t force a lender to reinstate in a Chapter 7, but can in a Chapter 13. For example, if you were $10,000 behind on your mortgage payments, a Chapter 13 would allow you to keep the house by repaying the $10,000 over 3-5 years. At the same time, you’d have to begin making the regular mortgage payments. While it may be expensive, it will allow you to keep your house without coming up with $10,000 immediately.

During initial consultations, I listen to my clients’ stories and try to figure out what would best serve their financial interests. Then I lay out all the options available to them (including the non-bankruptcy options) and explain why one would be better than another. When you speak with your bankruptcy attorney, be sure to learn if Chapter 7 or Chapter 13 makes the most sense in your particular circumstances.

 

Image credit: jeff_golden/flickr

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