Many people file for bankruptcy when they’re unemployed. In fact, because income must be low enough to qualify for Chapter 7 bankruptcy, being unemployed can provide a small window of opportunity to quickly wipe out debt before finding a new job. By contrast, Chapter 13 filers need a steady income, so this chapter isn’t usually available during a period of unemployment.
If you aren’t familiar with the differences between the bankruptcy chapters, learning how to choose between Chapter 7 and 13 is an excellent place to start.
Low-income debtors can get a fresh start by wiping out dischargeable (qualifying) debt in Chapter 7 bankruptcy. Not everyone is entitled to a Chapter 7 debt discharge, however. Your earnings must be low enough to pass the Chapter 7 means test. So if you’re unemployed and presumably have little or no income, you’ll likely qualify for Chapter 7 bankruptcy more readily than if you had a well-paying job.
The means test compares your average monthly income for the six months before you file for bankruptcy against the median income for a similar household in your state. If your income is below the median, you automatically pass the means test and won’t need to complete the remainder of the form.
If you don’t pass the first portion of the means test, you’ll have another opportunity to pass it. If, after deducting expenses from your income, you don’t have enough remaining to make a meaningful payment to creditors through a Chapter 13 repayment plan, you’ll qualify for a Chapter 7 debt discharge.
Most unemployed debtors choose to file for Chapter 7 bankruptcy to wipe out qualifying debts, such as credit card balances. However, Chapter 13 bankruptcy has mechanisms not available in Chapter 7 to help debtors with regular income reorganize their debts.
For instance, if you are trying to save your home by catching up on missed mortgage payments, or wish to pay back nondischargeable priority debts like recent taxes or child support arrears, filing for Chapter 13 bankruptcy is typically the better choice. Chapter 13 filers can also eliminate underwater junior mortgages, cram down (reduce) car loans, and catch up on missed car payments. Find out when it’s better to file for Chapter 13.
Chapter 13 benefits significant wage earners who have disposable income to repay creditors. By contrast, most unemployed people—even those receiving unemployment benefits—are often barely able to meet necessary expenses. So, simply put, unemployed individuals usually don’t have enough income for Chapter 13 to be viable. Here’s how it works.
In Chapter 13 bankruptcy, you propose a three- to five-year repayment plan to pay back a portion of your debts. The Chapter 13 bankruptcy trustee responsible for overseeing the case collects the payments and forwards the funds to creditors.
Here’s the tricky part. While you might not need to pay anything toward nonpriority unsecured debts—such as credit card bills, medical debt, and personal loans—you could accomplish the same thing by filing for Chapter 7 and without paying into a creditor repayment plan.
People file for Chapter 13 to take advantage of the other benefits, such as catching up on a mortgage. However, in Chapter 13, debtors must pay certain debts in full—and it can get expensive fast.
Not only must a debtor repay all mortgage and car arrearages if they want to keep a house or car they’ve fallen behind on, but a debtor must also pay priority debts in full, too, such as support arrears and tax debt. In most cases, an unemployed debtor—whether receiving unemployment or not—wouldn’t have enough money to pay mortgage arrears, back car payments, and priority debts on top of their usual monthly living expenses.
That’s not to say it’s impossible to qualify for Chapter 13. A debtor might have other sources of income, such as Social Security or disability benefits, pension or retirement income, or a rental property. But, those debtors are rare, and the bottom line is that all filers must show the court that they can afford to keep up with the required Chapter 13 plan payments before the court will confirm (approve) of the plan. If the filer can’t meet that hurdle, the bankruptcy court will dismiss the case.