Which Type of Bankruptcy Should You File? Chapter 7 vs. 13

If you're thinking about bankruptcy, you'll need to consider which type is right for you. Here are the highlights.

Once you've decided that bankruptcy is the right solution for your financial situation, you will need to decide which type of bankruptcy is best.

If you are an individual or a small business owner, then your most obvious choices are Chapter 7 "liquidation" bankruptcy or Chapter 13 "wage earners" or "reorganization" bankruptcy.

We'll go over the pros and cons of each, the eligibility rules, and give you some information to help decide which would be best for you given your financial situation.

There are a select few other types of bankruptcies that are available under certain circumstances, and we will touch on those as well.

Chapter 7 vs. Chapter 13

To get started, here's a look at the highlights of both Chapter 7 and Chapter 13 bankruptcy:

Chapter 7 Bankruptcy

Chapter 13 Bankruptcy

Basics: A Chapter 7 bankruptcy will discharge most types of unsecured debt. The trustee will sell any significant nonexempt property in order to repay your creditors. Basics: In Chapter 13 bankruptcy, you repay your creditors (some in full, some in part) through a Chapter 13 repayment plan.
Time Frame: A typical Chapter 7 bankruptcy case takes three to four months to complete. Time Frame: The Chapter 13 payment plan lasts three or five years (depending on your income). At the end, many of your unsecured debts will be discharged.
Property: Many Chapter 7 debtors keep all or most of their property. Petitioners with significant equity or assets that are not exempt by law could lose them to satisfy some debts. Property: No property is liquidated under a Chapter 13 bankruptcy.
Your Income: Some high income earners won't be eligible for Chapter 7. Your Income: Chapter 13 requires a regular income for the monthly payment.
Homeowners/Foreclosures: Chapter 7 can temporarily stop foreclosure, but unless you can get current on your mortgage, the foreclosure will eventually continue. Homeowners/Foreclosures: Chapter 13 can stop a foreclosure and you can make up  past due mortgage payments through your repayment plan.
Eligibility: Chapter 7 is available to those whose income is less than the median of their state, or those who can pass the means test. Eligibility: Chapter 13 has no income requirement, but unsecured debt must be below $383,175 and secured debt below $1,149,525.
Filing Complexity: Filing for Chapter 7 involves preparing a large set of forms and navigating some tricky legal issues, but simple cases can be done pro se - that is, without hiring an attorney.

See: How to File for Chapter 7 Bankruptcy
Filing Complexity: Chapter 13 bankruptcy involves submitting a repayment plan to the court, and will almost always require hiring an attorney to complete successfully.

See: How to File for Chapter 13 Bankruptcy

Chapter 11 and Chapter 12

Chapter 11 and Chapter 12 are similar to the Chapter 13 repayment bankruptcy, but designed for specific debtors.

Chapter 11 bankruptcy is another form of reorganization bankruptcy that is most often used by large businesses and corporations. Individuals can use Chapter 11 too, but it rarely makes sense for them to do so.

Chapter 12 bankruptcy is designed for farmers and fisherman. Chapter 12 repayment plans can be more flexible those in Chapter 13. In addition, Chapter 12 has higher debt limits and more options for lien stripping and cramdowns on unsecured portions of secured loans. 

Choosing the Right Type of Bankruptcy

In many cases, the type of bankruptcy filed will be contingent on two things: Your income and your assets. Your income is important because it may preclude you from filing a simple Chapter 7 case, and your assets are important because if you have nonexempt property, you might lose it in Chapter 7, but can protect it in Chapter 13. 

Here are a few scenarios that explore which bankruptcy strategy would be best:

1. Unemployed Debtors with Few Assets – Chapter 7

Loss of income combined with a large amount of debt is the number one reason people file for bankruptcy. Compounding factors like divorce, medical emergencies, or the death of a family member are also common. Assume that in this scenario the debtor has no income other than unemployment benefits, does not own a home, and has one car with a loan against it.

In cases like this, a Chapter 7 bankruptcy is the fastest, easiest,  and most effective means of getting rid of debt. As a matter of fact, this is the most common bankruptcy case, often called a "no asset" bankruptcy

2. Unemployed Homeowners – Upside-Down Mortgage – Chapter 7

Homeowners who are experiencing a loss of income also have options under bankruptcy law. For those homeowners whose property value has fallen below the value of the loan against it, Chapter 7 is probably still the best option. Since the value of the home is less than the value of the lien against it, the homeowner has no equity in the bankruptcy estate, so the house is protected from liquidation. A Chapter 7 bankruptcy can quickly relieve them of their obligations to repay unsecured debts, making monthly bills much more manageable.

3. Unemployed Homeowners – Significant Equity – Chapter 7 or 13

If a homeowner has a significant amount of equity in property, then Chapter 7 may or may not be the best option. If the homeowner's state exempts a generous amount of home equity, then the home may be safe. But if the state homestead exemption doesn't cover the equity, the homeowner may lose the home in a Chapter 7 bankruptcy. The homeowner can keep the home in Chapter 13 bankruptcy if he or she keeps current on the mortgage. Keep in mind though, there must be enough income available from the petitioning household to fund a repayment plan.

4. Employed Homeowners Facing Mortgage Delinquency or Foreclosure – Chapter 13

For homeowners who have fallen behind on mortgage payments, Chapter 13 offers a way to catch up or "cure" past due mortgage payments while simultaneously eliminating some portion of dischargeable debt. This means they can save the home from foreclosure and get rid of a lot of credit card debt, medical debt, and possibly even second and third mortgages or HELOCs. Chapter 7 bankruptcy does not provide a way for homeowners to make up mortgage arrears.

5. Wealthy Petitioners with a Large Amount of Debt - Chapter 11

Very wealthy debtors often need to file under Chapter 11 due to the debt and income limits of Chapter 7 and Chapter 13 bankruptcies.

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