There are different types of bankruptcy available, with Chapter 7 and Chapter 13 being the most common. Below, we compare these two types of bankruptcy to help you decide which is most appropriate for your financial situation.
What is Chapter 7 Bankruptcy?
Chapter 7, also known as “complete liquidation,” is one of the most common types of bankruptcy for individuals and businesses. Under Chapter 7, a debtor can eliminate most of their debts by liquidating their non-exempt assets. This process is designed to provide debtors with a “fresh start” by discharging their financial obligations after selling certain assets.
What is Chapter 13 Bankruptcy?
Chapter 13, known as “reorganization,” is a type of bankruptcy that allows individuals with regular income to develop a plan to pay all or part of their debts over a period of three to five years. Unlike Chapter 7, which involves liquidating assets, Chapter 13 focuses on reorganizing the debtor’s finances and establishing an affordable payment plan.
Eligibility Requirements
Chapter 7
Not all debtors automatically qualify for this type of bankruptcy. The means test is the primary criterion used to determine eligibility for Chapter 7. Its purpose is to limit access to this type of bankruptcy to those who truly cannot pay their debts. The means test considers the debtor’s average monthly income during the six months prior to filing for bankruptcy and the composition of the family unit. This average monthly income is compared to the median income of a similarly-sized household in the municipality where the debtor resides. If the debtor’s average monthly income is equal to or less than the state median income, the debtor is eligible for Chapter 7.
Chapter 13
To file under this chapter, the following requirements must be met, among others:
- Regular Income
This income can come from various sources, including:- Wages or salaries from employment
- Self-employment or business income
- Pensions or social security benefits
- Alimony
- Rental property income
- Debt Limit
Chapter 13 imposes limits on the amount of debt a debtor can have to be eligible. If the total amount of the debtor’s debts exceeds these limits, they will not be eligible for Chapter 13 and must consider other bankruptcy options, such as Chapter 11.
Advantages and Disadvantages
Chapter 7
Advantages:
- Rapid Debt Elimination: The Chapter 7 process is generally completed in a few months, offering a quick and efficient resolution for debtors.
- Automatic Stay: The automatic stay provides immediate relief by halting collection actions by creditors.
- Fresh Start: The discharge of debts allows debtors to begin anew without the burden of most of their previous debts.
Disadvantages:
- Loss of Assets: Debtors may lose some of their non-exempt assets, as these will be sold to pay creditors.
- Not All Debts Are Eliminated: Some debts, such as student loans, alimony, and certain tax debts, are not discharged in Chapter 7.
Chapter 13
Advantages:
- Asset Protection: Unlike Chapter 7, the debtor can keep their assets, such as their home and vehicle, while paying their debts through the plan.
- Foreclosure Suspension: Chapter 13 can stop foreclosures and allow the debtor to catch up on overdue mortgage payments throughout the plan.
- Debt Reorganization: It allows for reorganizing debts into a manageable payment plan, based on the debtor’s income and expenses.
Disadvantages:
- Long-Term Commitment: The debtor must commit to a payment plan of three to five years, requiring disciplined and consistent financial management.
- Financial Restrictions: During the plan period, the debtor may face restrictions on their spending and must obtain court approval for certain significant financial transactions.
- Not All Debts Are Eliminated: Some debts, such as student loans, alimony, and certain tax debts, are not discharged in Chapter 13.
In Summary
- Chapter 7 is a quick and efficient resolution for debtors. However, meeting the eligibility requirements for Chapter 7 is essential to benefit from this type of bankruptcy; the means test is a crucial component.
- Chapter 13 is a viable option for those who wish to reorganize their debts and maintain their assets while working toward financial stability. It offers the opportunity to catch up on overdue payments and pay debts in a structured manner over time. However, it requires a long-term commitment and disciplined financial management.
- Consult with your bankruptcy attorney to help you understand whether Chapter 7 or Chapter 13 is the best option for your financial situation.
*** This information is a general summary of each bankruptcy chapter. Each case is evaluated individually and must meet its respective requirements.