Is It Better To File A Chapter 7 or 13 Bankruptcy?

When first exploring bankruptcy, it's common to wonder whether it is better to file for Chapter 7 or Chapter 13 bankruptcy. The short answer is that it will depend on your financial circumstances and what you'd like to accomplish with bankruptcy.

Many people prefer to file for Chapter 7 because it's quick, with most people receiving a debt "discharge" eliminating qualifying debts in about four months. Also, filers can usually keep all or most of their property, and don't pay into a three- to five-year Chapter 13 repayment plan.

But not everyone qualifies to file for Chapter 7 bankruptcy, and in some cases, Chapter 7 doesn't provide the help needed. In this article, you'll learn when Chapter 7 bankruptcy might be more advantageous than Chapter 13 bankruptcy and when Chapter 13 might be the better choice.

Advantages of Chapter 7 Bankruptcy

Chapter 7 bankruptcy is an efficient way to get out of debt quickly, and most people would prefer to file this chapter, if possible. Here's how it works:

• It's relatively quick. A typical Chapter 7 bankruptcy case takes four to six months to complete.
• No payment plan. Unlike Chapter 13 bankruptcy, a filer doesn't pay into a three- to five-year repayment plan.
• Many debts get wiped out. A filer emerges debt-free except for "nondischargeable" debts like student loans, recent taxes, and unpaid child support.
• You can protect property. Although you can lose property in Chapter 7 bankruptcy, many filers can keep everything they own using bankruptcy exemptions. Bankruptcy lets you protect most necessities, and if you don't have much in the way of luxury goods, you'll likely be able to "exempt" or protect all or most of your property.
• You can keep a house or car in some situations. You can keep your home or car as long as you're current on the payments, can continue making payments after the bankruptcy case, and can exempt the amount of equity you have in the property.

Find out what happens to cars in Chapter 7 bankruptcy.

Who Should File for Chapter 7 Bankruptcy?

Chapter 7 works very well for many people, especially those who own little property, have predominately credit card balances, medical bills, personal loans, and other debts that get wiped out in bankruptcy. To qualify for Chapter 7, you'll need to meet requirements that include having an income low enough to pass two financial tests.

Chapter 7 Means Test Qualification

You'll take the means test to see if your income qualifies for Chapter 7 bankruptcy. You'll automatically be eligible if your gross income for the six months before filing is below the average for a family of the same size in your state. If your income exceeds the median, you'll deduct expenses on the second portion of the means test, giving you another opportunity to pass.

Example. Helen is a single woman whose gross yearly income is $75,000, according to the means test calculation. Her state's median income for a single person is $65,000, so Helen won't pass the first part of the Chapter 7 means test. Helen will deduct actual and allowed expenses in the second portion of the means test and pass if the calculation demonstrates that she doesn't have extra funds to pay creditors.

Chapter 7 Current Income Test

The means test evaluates past income. However, the Chapter 7 trustee responsible for managing the case will also evaluate your current income and actual budget. If your current budget would allow you to make reasonable monthly payments to creditors, you won't qualify for Chapter 7 bankruptcy.

Example. Jesse received a promotion and salary increase the month before filing for bankruptcy, but his monthly expenses remained unchanged. As a result, Schedules I and J of his bankruptcy paperwork showed he had an extra $200 monthly to pay creditors. Even though he passed the means test, the Chapter 7 trustee recommended that the bankruptcy judge convert Jesse's Chapter 7 case to Chapter 13. The bankruptcy judge granted the request.

Other Chapter 7 Requirements

You must live in your state for a particular period before filing and before using that state's exemption laws to protect property in Chapter 7. Also, people who have filed for bankruptcy before must wait several years before qualifying for another debt discharge.

Find out more about multiple bankruptcy filings and who can't qualify for Chapter 7 bankruptcy.

Who Should File for Chapter 13 Instead of Chapter 7 Bankruptcy?

Chapter 7 bankruptcy isn't the best choice for everyone. Chapter 7 won't help people whose debts don't qualify to be "discharged" or wiped out, such as recently incurred income tax debt, student loans, and domestic support obligations.

High-income filers find it hard to qualify, and Chapter 7 isn't a good fit for people who would lose a home or other property if they filed for Chapter 7 bankruptcy. Also, Chapter 7 doesn't help those facing foreclosure or repossession keep a house or car.

For those people, Chapter 13 bankruptcy would likely be a better choice.

Advantages Offered in Chapter 13 but Not Chapter 7

Before exploring options afforded by Chapter 13, check whether you meet these criteria:

• You're an individual or a sole proprietor. Partnerships, LLCs, and corporations can't file for Chapter 13.
• You meet debt requirements. In Chapter 13, your debt can't exceed certain limits. If it does, you'll use Chapter 11 bankruptcy. You can view the current Chapter 13 debt limits here.

If these factors don't preclude you from filing, you might be able to take advantage of these exclusive Chapter 13 benefits.

You Can Catch Up on a Mortgage or Car Loan

If you fall behind on a house or car payment, you risk losing it if you file for Chapter 7. Why? Because these debts are "secured," you must give the property back to the lender if you don't pay as agreed, and Chapter 7 doesn't have a mechanism to help you bring the loan current.

However, in Chapter 13 bankruptcy, you can make up the missed payments over time and keep the home, car, or other property securing the debt. Learn more about making up mortgage arrears and car loan arrears in Chapter 13 bankruptcy.

You Can Force a Creditor Into a Payment Plan

Some debts are "nondischargeable" and don't qualify for a discharge in bankruptcy, such as newer income tax balances and domestic support arrearages. The past-due amounts for these types of debt can be hefty.

If you filed for Chapter 7, your creditor could immediately collect the entire balance owed when the bankruptcy case closed by garnishing your wages, levying your bank account, or even seizing property.

Instead, you can use the Chapter 13 plan to pay these debts off over three to five years without the threat of harsh collection actions hanging over your head. Learn more about debts in Chapter 13 bankruptcy.

You Can Protect a Codebtor on a Personal Debt

If someone with good credit helped you buy a car or get an apartment by signing your auto loan or apartment lease contract as a responsible party, that person is a codebtor on that debt. They've guaranteed your loan and are responsible for paying it if you don't.

Chapter 7 will discharge your obligation to pay only, not your codebtor's responsibility. If you were to file for Chapter 7 bankruptcy, your codebtor would still be on the hook, and the creditor would likely pursue the codebtor for payment.

By contrast, if you file for Chapter 13 bankruptcy, the creditor will leave your codebtor alone if you keep up with your bankruptcy plan payments and pay the debt in full. Learn more about what happens to codebtors in bankruptcy.

You Can Keep Property You'd Lose in Chapter 7

When you file for Chapter 7 bankruptcy, you can keep property protected or "exempt" from creditors under state or federal law. The bankruptcy trustee appointed to your case will sell any "nonexempt" property not covered by a bankruptcy exemption and use the proceeds to pay creditors.

In Chapter 13 bankruptcy, you don't have to give up any property. However, there's a catch. You must pay its value through the repayment plan. So, if you have nonexempt property you can't bear to part with and can afford to pay to keep it, Chapter 13 bankruptcy might be the better choice.

You Can Pay Less on Cars and Other Property Over Time

Sometimes, you can use a Chapter 13 "cramdown" to reduce the amount you owe on income-producing real estate, cars, and other financed property that the lender could take back if you don't pay. A cramdown reduces the amount you owe to the collateral's actual value, so it works great when you owe more than the property is worth.

But here are the catches. A cramdown doesn't apply to the home you live in, and you must pay the entire reduced balance through the repayment plan. If you'd like to cram down the mortgage on your vacation home in the Poconos, expect a hefty monthly plan payment.

You Can Strip Off a Junior Home Mortgage

Chapter 13 offers a powerful benefit if your residential home is worth less than you owe. Chapter 13's "lien stripping" mechanism lets you remove a "wholly unsecured lien" from your home. A wholly unsecured lien would be a junior loan that wouldn't receive a penny if you were to sell your house.

For instance, suppose you owe $500,000 on your first mortgage and $70,000 on a second junior mortgage, but your house is worth only $460,000. If you sold the house, the sales proceeds wouldn't fully pay the first mortgage, so there'd be nothing to pay toward the second. The second would qualify as a wholly unsecured junior mortgage, and you could eliminate the lien and essentially the loan using Chapter 13's lien stripping procedure.

Drawbacks of Chapter 13 Bankruptcy

Here are a few things filers are surprised to learn about Chapter 13 bankruptcy and often find a bit challenging:

• You must complete the three- to five-year repayment plan before the bankruptcy court erases any qualifying debt balances unless the court lets you off the hook early for hardship reasons.
• If you owe nondischargeable past due taxes or support arrearages, you'll pay the entire balance in your plan, something many people don't have sufficient income to do.
• To keep a house or car, you'll need to repay the arrearages in your plan while continuing to pay your regular monthly payment.
• Some people who file for Chapter 13 bankruptcy don't complete their plans, so filers risk debts not being discharged.

Despite these potential problems, Chapter 13 bankruptcy is a good option for people with regular income who would otherwise lose their house to foreclosure or need time to pay back tax or support arrearages.

How to Qualify for Chapter 13

Some debtors make too much to qualify for Chapter 7 bankruptcy, and Chapter 13 is the only bankruptcy option available. If you don't know if you qualify, take the Chapter 7 bankruptcy means test.

However, making too much for Chapter 7 doesn't automatically qualify someone for Chapter 13. You'll need to take additional steps to determine whether you have sufficient income to repay everything required in a Chapter 13 repayment plan.

Paying Disposable Income in Chapter 13 Bankruptcy

Most people prefer Chapter 7 bankruptcy because, unlike Chapter 13 bankruptcy, it doesn't require you to repay a portion of your debt to creditors. In Chapter 13 bankruptcy, you must pay your creditors all of your disposable income—the amount remaining after allowed monthly expenses—for three to five years.

Disposable income is the amount that remains after subtracting allowed bankruptcy expenses from your monthly gross income. When you claim your deductions, you can use the actual cost of some expenses and the national and local standards for others, such as the allowance for food, clothing, and housing.

Here's a list of some of the deductions you'll be allowed to take:

• food and clothing
• housing and utilities
• transportation costs
• taxes
• involuntary payroll deductions
• life insurance
• court-ordered payments, such as family support
• certain education costs
• childcare expenses, and
• health care costs.

In a Chapter 13 matter, you'll fill out the Chapter 13 Calculation of Your Disposable Income form. The amount remaining after deducting expenses is your monthly disposable income. You'll pay your disposable income to the lowest priority creditors in your three- to five-year repayment plan.

Meeting the Best Interest of Creditors Test

You'll have one additional hurdle to meet. The amount you pay unsecured creditors must meet or exceed the value of your nonexempt property. Otherwise, you won't qualify. This is known as the "best interest of creditors" or "best efforts" Chapter 13 test.

It's not unusual to find you don't earn enough to propose a Chapter 13 plan the bankruptcy court will approve or "confirm." A local bankruptcy attorney can review your finances and explain your options.

Need More Bankruptcy Help?

Did you know Nolo has made the law accessible for over fifty years? It's true, and we want to ensure you find what you need. Below, you'll find more articles explaining how bankruptcy works. And don't forget that our bankruptcy homepage is the best place to start if you have other questions!

We wholeheartedly encourage research and learning, but online articles can't address all bankruptcy issues or the facts of your case. The best way to protect your assets in bankruptcy is by hiring a local bankruptcy lawyer.