Two Types of Personal Bankruptcy: Chapter 7 and Chapter 13

Today, in our second edition of Bankruptcy Facts in Five, we are going to discuss the two types of consumer bankruptcy. Because we are lawyers, we always have to call everything by non-descriptive legalese names. So we have Chapter 7 bankruptcy and Chapter 13 bankruptcy, referring to the particular chapter within the federal bankruptcy code where each law is written.
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Let’s start with Chapter 7, since about 60% of all individual bankruptcy filings are Chapter 7 liquidations. The main difference is that Chapter 7 is “liquidation” bankruptcy, which means that if you have possessions worth more than that provided by either state or federal law, then the Trustee will sell those items and give the proceeds to your creditors. After that, all your debts are discharged, and you do not need to make any additional payments.

Each state has a different list and values of property that is exempt from the clutches of the Trustee in a Chapter 7 filing. For example, in Arizona, the exemption list includes up to $5,000 in equity in a motor vehicle and $1,000 in jewelry. Also, usually your retirement plans are exempt. However, if you have property that is worth more than your exemptions, either you will have to “redeem” the property by paying the Trustee the difference, or allow the Trustee to sell your property for the benefit of your creditors.

One important new rule regarding Chapter 7 bankruptcy is the “means test”. In short, the means test is a formulaic approach to assessing your income versus your expenses when determining whether you are even eligible to file for Chapter 7. If your income is below the median income in your area for a similarly-sized household, you automatically qualify under the means test. If, however, you have a bigger income, then the means test assesses your allowed expenses in determining if you are eligible under Chapter 7. Essentially, the test is designed to prevent higher income debtors from applying for discharge of all their debts under Chapter 7.

A Chapter 13, on the other hand, is a “repayment plan” bankruptcy, where for the most part, you keep your possessions, but your monthly debt payments are reduced to the amount you can afford. Depending on your situation, the repayment plan will last from three to five years, at which point your remaining debts will be discharged. Note that if there if you life situation changes, either because of a medical situation or loss of a job, you can always apply to alter the terms of your original Chapter 13 repayment plan.

There are certain debts that are generally not dischargeable in bankruptcy. These include many tax debts and most student loans. In the cases where these debts are predominant, a Chapter 13 may be the better choice.

This Chapter is generally appropriate when you have property that is too valuable to simply “give-up” to the Trustee, and is very useful for people who own their own business. Because of the limitation on the exemptions allowed under Chapter 7, for these people, it is often, but not always, necessary to file Chapter 13 to avoid losing the business as well. So, besides having a stable income with disposable income, you also can have no more $1,010,650 in secured debt (like mortgages and car loans) and $336,900 in unsecured debt.

There are some other advantages to a Chapter 13 filing. This includes the fact that the filing remains on your credit report for a shorter period of time, and also the amount of time that you need to wait until filing for a future bankruptcy is reduced. Also, many people feel better about repaying as much of a debt as possible.

The decision about which type of bankruptcy to file depends on your own personal situation. You need to consult with a bankruptcy attorney as early as possible to determine your best course of action. In many cases, the choice will be obvious, but in many instances there will be a choice which only you can make.

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