The Difference Between Chapter 7 and Chapter 13 Bankruptcy

What is the difference between Chapter 7 and Chapter 13 Bankruptcy? I think of it this way: There are two main reasons why a person would file a case with the Bankruptcy Court. One, to get a discharge of debts. Two, to get protection from your creditors. Chapter 7 focuses on the discharge, while Chapter 13 focuses on the protection.

Chapter 7 Bankruptcy: Focus on Discharge

Chapter 7 bankruptcy is usually a fast process. You file your case, a month later you go to a hearing, and (usually) two months after that, you receive a “Discharge Order” from the Court. That Order “discharges” some kinds of debts. Unsecured debts (credit cards, personal loans, medical bills, deficiencies on repossessed cars and post-foreclosure second mortgages) are all discharged. Your legal obligation to repay is gone, and the creditor’s right to try to collect is gone.

With secured debts (mortgages, car loans), you basically have the choice of either keeping the thing & keeping the debt or getting rid of the thing & getting rid of the debt. Other kinds of debts (recent income taxes, government fines and penalties, support arrears) are entitled to “priority.” They are not discharged; at the end of a Chapter 7 case, you still owe them. A fourth category is student loans. They should be general unsecured debt, but Congress has given them special treatment. At the end of a Chapter 7 case, you still owe them too.

Chapter 7 is “means tested.” The simplified explanation of that is, if you made too much money in the past six months, you have to go to Chapter 13 instead. Also, Chapter 7 is “liquidation bankruptcy.” If you have assets over the exemption limits, a Chapter 7 Trustee is empowered to liquidate those assets and distribute the proceeds to your creditors.

In a nutshell, Chapter 7 is best for people with modest incomes, assets below the exemption limits, and whose debts are mostly dischargeable.

Chapter 13 Bankruptcy: Focus on Protection

Chapter 13 bankruptcy lasts for 5 years, and that’s a good thing. The moment you file your case, something comes into effect called the “automatic stay.” Your creditors are stayed from trying to collect on any debt. You then present the Court with a Plan. That Plan says you’re going to pay a certain amount of money to a Trustee per month for sixty months. He or she then turns around and distributes that money to your creditors.

The Trustee takes a cut for administering the estate. He or she will pay your lawyer. Then there are certain debts that need to be paid in full, including car loans, taxes, and mortgage arrears. Everyone else (credit cards, medical bills, etc.) get what’s left over. Whether that amounts to 1% or 100% of what they’re owed largely depends on your income and your assets.

So why would anyone file Chapter 13 instead of Chapter 7, when it lasts for years and only gets you a partial discharge? One reason might be that you don’t pass the Chapter 7 Means Test. Another might be that you have assets over the exemption limits, and don’t want a Chapter 7 trustee liquidating them.

One of the traditional applications for Chapter 13 bankruptcy is to stop foreclosure. If you’re six months behind on your mortgage and are about to get foreclosed on, Chapter 7 doesn’t help you very much. You’d go through the process, and three months later, you’d still be behind on your mortgage. In Chapter 13, you use your five-year plan to get caught up on your mortgage arrears. And since you’re not making payments on your credit cards, you can afford to resume making the ongoing mortgage payments. Meanwhile, since you’re under the Court’s protection, the lender can’t move forward with the foreclosure.

There are many other things that can be accomplished in Chapter 13 cases. One that is increasingly common in my practice is that people are using Chapter 13 to get a five-year break from paying their student loans. Other things that can be accomplished include “stripping” second mortgages, “cramming down” car loans, and paying off tax debt before a lien can be imposed.

Your Situation Is Unique, So Talk to a Lawyer

So that, in broad strokes, is the difference between Chapter 7 and Chapter 13 Bankruptcy. Of course, there are caveats and exceptions and qualifications to all of the above. It is only intended to give you a general idea of the two types of cases. Your situation is unique, and you should sit down and talk with a bankruptcy lawyer to determine what type of case is best for you.

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