Bankruptcy Chapter 7 vs. Chapter 13
Bankruptcy is a legal process, often seen as a last resort for people or businesses, that reduces or eliminates the obligation to pay back certain debts and offers a fresh start. But it can get confusing because different chapters of the bankruptcy code may be applied, depending on whether the debtor is an individual or business and other factors. So you shouldn't feel bad if you don't know the difference between Chapter 7 and Chapter 13 bankruptcy, two options that apply to consumers.
There are actually six types of bankruptcy: Chapter 7, Chapter 9, Chapter 11, Chapter 12, Chapter 13 and Chapter 15. But odds are, if you're reading this, you're going to file for a Chapter 7 bankruptcy or a Chapter 13 bankruptcy.
[Read: What Debt to Pay Off First?]
What Is the Difference Between Chapter 7 and 13?
"The two most common types of consumer bankruptcy are Chapter 7 and Chapter 13. While a Chapter 7 is commonly referred to as a liquidation, in actuality most, if not all, assets are protected," says Matthew Zimmelman, a bankruptcy attorney in Valley Stream, New York.
"A Chapter 13 works differently in that you are creating a three- to five-year reorganization plan to pay your debt," Zimmelman says. "Mortgage arrears, taxes and domestic support obligations are paid in full in the plan while credit cards, personal loans and medical bills can be paid pro rata -- at a percentage -- depending on household disposable income."
Most individuals tend to file for Chapter 7; most businesses opt for Chapter 13. But not always. Some business owners opt for Chapter 7, and some homeowners end up filing a Chapter 13 bankruptcy.
Below, we'll break down the differences a bit more:
Eligibility requirements. Generally, with Chapter 7, your income must fall below the median income level of your state, or you may have to take a means test to determine whether you can repay your debts. In other words, if you're fairly wealthy, the courts won't likely approve your bankruptcy. If you truly are tapped out, you will probably be granted a Chapter 7 bankruptcy.
Meanwhile, anyone is eligible for Chapter 13, as long as your unsecured debts are less than $394,725 and secure debts are less than $1,184,200. (Those numbers are for 2021; they change along with the consumer price index.)
Discharge rate. This is a term that's used to describe the completion or success rate of a bankruptcy. In 2020, there were 378,953 Chapter 7 filings and 156,377 Chapter 13 filings in the U.S. Those numbers were considerably less than in previous years, which goes against the grain of what you may have expected during the COVID-19 pandemic. That said, businesses filing Chapter 11 were considerably higher than in previous years.
Property. With a Chapter 7 bankruptcy, you may have to sell certain property you own. With a Chapter 13, you won't. But before you panic, most states have bankruptcy exemptions that allow individuals to keep their home and car in a Chapter 7 bankruptcy. That said, it should help your case if you don't miss your mortgage payments; if you are wildly behind, you may instead end up in a Chapter 13 bankruptcy. Obviously, if you're really in a jam, it's best to consult a bankruptcy attorney.
Pros of a Chapter 7 or Chapter 13 bankruptcy. You can get a fresh start on many of your debts. You generally won't have all of your debts forgiven, though. Student loans and taxes are hard to wipe off your ledger in a bankruptcy, for instance. If you owe child support, bankruptcy won't change that. But many debts, like credit card debts and hospital bills, will be discharged for good.
Cons of a Chapter 7 or Chapter 13 bankruptcy. Expect your credit score to be throttled. That said, you never know. Chances are, if you're headed for a bankruptcy, your score may already be banged up. Anecdotally, some lenders have loaned money to individuals after a bankruptcy. Why? Because the lender knows you no longer owe a ton of money and can probably make regular payments once again.
[Read: 10 Debt Relief and Payoff Options.]
Chapter 7 Bankruptcy
How it works. Going through the bankruptcy process isn't difficult, according to Dai Rosenblum, an attorney and a counselor of law in Butler, Pennsylvania.
"It is truly simple to file a Chapter 7 fresh-start bankruptcy," Rosenblum says. "You find a competent bankruptcy lawyer, you pay their fee, you fill out a questionnaire, you review your paperwork for completeness and accuracy, you have a five-minute creditors meeting, you wait approximately two months to get a piece of paper in the mail that discharges all of your debts. That's it. All of my clients say the same thing: 'I can't believe how easy this was. I wish I had done this a long time ago.'"
How do I find out if I qualify for Chapter 7 bankruptcy? As noted, you'll likely take a means test determining that you truly do need to declare bankruptcy, and the rules for who is eligible are different in every state. Consulting a bankruptcy attorney is the best way to go.
Can I lose property in Chapter 7 bankruptcy? Yes. Again, everyone's situation is different. But many people are able to keep their property in a Chapter 7 bankruptcy, especially if it's their primary home. It often depends on the state you live in.
Chapter 13 Bankruptcy
How it works. According to Rosenblum, "Chapter 7 is always preferred over Chapter 13. You file a Chapter 13 because you have to, not because you want to."
You and an attorney -- and the courts or circumstances -- will decide what you file.
But generally, Rosenblum says, you'll file Chapter 13 if you're behind on your mortgage, or if you are over the median income in your state and don't qualify for a Chapter 7. He says you may also end up filing for Chapter 13 if you have too much equity in an asset, such as a house or a business, and you want to pay your creditors yourself over time rather than risk losing your asset to a Chapter 7 trustee to liquidate.
You might also file Chapter 13 if you owe a lot of back taxes, Rosenblum adds.
How much of my debt will I have to repay if I file for Chapter 13 bankruptcy? That's impossible to say. It depends on the debt you owe, and the courts have to approve your repayment plan. So, no, a bankruptcy court isn't likely going to approve you paying $10 on a $10,000 loan.
That said, you are going to feel some sense of relief when you file. "A Chapter 13 is not as good as a Chapter 7, but Chapter 13s are wonderful," Rosenblum says.
He adds that you are guaranteed a zero percent interest rate on any unsecured debt that you're paying off.
How long will my repayment plan last if I file for Chapter 13 bankruptcy? Three to five years, depending on how much debt there is and how fast you want to pay it off.
Can I keep my home with a Chapter 13 bankruptcy under foreclosure? Yes, that's definitely possible. That's because when you file for a Chapter 13, you get what's called an automatic stay.
"The automatic stay stops all creditor activity dead in its tracks," Rosenblum says, adding that it even stops the IRS.
He adds: "If a creditor has recently seized an asset, such as a vehicle or a bank account, they have to give it back. There are exceptions. In law, there are always exceptions and often exceptions to the exceptions. But that's the gist of it."
So if you receive a foreclosure notice, a Chapter 13 will basically freeze time from a financial standpoint, and it could allow you to work out a plan to pay your mortgage lender so you can catch up on back payments.
Can I use my retirement to fund a Chapter 13 repayment plan? You may want to, but is that really a good idea? It doesn't seem like it, since you'd be creating a future problem in which you someday have less money for your retirement. In any case, you will have to get permission from the bankruptcy court.
Can a Chapter 13 bankruptcy help me pay back the IRS? You can use a Chapter 13 bankruptcy to help you pay back the IRS, though if that's your only creditor, you may want to discuss a repayment plan without declaring bankruptcy. You may also want to attempt an offer in compromise, which can allow a taxpayer to settle their tax debt for less than the full amount that they owe.
[Read: What Happens if You Don't Pay Your Taxes?]
Which Should I Use: Chapter 7 or Chapter 13 Bankruptcy?
There's no way to know without talking to an attorney first. What's right for some people may be wrong for you.
That said, most people go with Chapter 7, according to Carlo Sabatini, a bankruptcy attorney and managing partner at Sabatini Freeman LLC, in Dunmore, Pennsylvania.
Generally speaking, Sabatini says, "Chapter 7 is less expensive than Chapter 13 and much faster. A Chapter 7 is usually over within about four months. A Chapter 13 takes at least three years. But for some consumers, Chapter 13 offers some relief that is not available in Chapter 7."
For instance, he says some homeowners use Chapter 13 to recover a vehicle that has been recently repossessed or to completely cancel certain second mortgages.
Bottom line: If you have a choice in the matter, you take whichever route -- Chapter 7 or Chapter 13 -- is right for you. And with any luck, the bankruptcy will allow you to write a new, better chapter in your financial life.