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Chapter 7 vs. Chapter 13 Bankruptcy – Which Should You File?

By Kira Botkin

bankruptcy eraserIf you’ve decided to declare bankruptcy, it’s important to understand the different types. Both Chapter 7 bankruptcy and Chapter 13 bankruptcy offer unique benefits.

Which one will make sense for you depends on your personal situation including, but not limited to, the amount of debt you have, your income, and the value of your assets.

Which Do You Qualify For?

Anyone can submit a bankruptcy¬†petition (i.e. your “application”) for either Chapter 7 or Chapter 13 bankruptcy. However, the court does not have to accept your petition if the trustee determines that you should be filing for the other type of bankruptcy, or if you do not qualify to declare bankruptcy at all.

It is fairly common for people who submit a petition for Chapter 7 to be required to file for Chapter 13 instead. This usually happens if you fail the means test, or if you have a sufficient amount of income to pay off at least some of your debt. In this case, the court requires that you file for Chapter 13 and at least attempt to repay your debts.

But if you don’t have much in the way of income or assets, it is much easier (and more advantageous) to file Chapter 7 since the majority of your debt will be wiped out. With that said, people who have significant assets to protect will want to file for Chapter 13 to avoid being forced to sell those assets.

Annually, approximately twice as many people file Chapter 7 as Chapter 13. Below, we’ll discuss in detail the most common reasons why people choose one type of bankruptcy over the other.

empty pockets man

When to Use Chapter 7 Bankruptcy

1. If you have very little income or assets.
Declaring Chapter 7 bankruptcy allows the court to take some of your valuable possessions, property, or savings (known collectively as assets) and sell them to pay your creditors. That said, most people who qualify to file for Chapter 7 don’t really have much in the way of assets, and thereby have little if anything to pay their creditors with. As a result, their debts are forgiven without any attempt at repayment.

Moreover, because their income is so low, there is not enough money to feasibly construct a debt payment plan, which means they cannot be pushed into a Chapter 13 bankruptcy. Statistics show that the majority of people who declare Chapter 7 bankruptcy don’t have any significant income and 85% have no assets that can be sold by the court.

2. If your debts are too high to pay down.
If you have an extremely large amount of debt (perhaps due to high medical bills), you may have already exhausted your resources trying to pay it down and probably do not have enough income to construct a Chapter 13 payment plan. In this case, Chapter 7 may be the only way for you to get out from under an enormous amount of debt and move on with your life.

When to Use Chapter 13 Bankruptcy

1. If you have assets you want to protect.
In Chapter 13 bankruptcy, the court won’t sell any of your assets because you’ll use current income to pay off your debts. So if you own a home that you would like to keep or if you have other items you don’t want sold, Chapter 13 is probably a better choice. However, you do need a good income that is reasonably stable in order to construct a debt payment plan. The money left over after deducting your living expenses and secured debt payments is then used to pay off your other creditors.

But one requirement for Chapter 13 is that your payment plan pays off at least as much debt as if your assets had been sold. For example, if you have a valuable collection of art, you probably won’t be able to declare Chapter 13 bankruptcy and keep it. This is because under Chapter 7, your collection would be sold and your creditors repaid.

2. If you have a regular income and have been making debt payments.
Chapter 13 bankruptcy allows you to construct a payment plan where your debts are paid down in line with what you can afford according to your income. Plus, you won’t have to worry about interest rates going up or being hit with extra penalties or fees. At the end of the payment plan, you will have paid as much as you can over a three or five-year payment period, and the remainder of your debts will be forgiven – ideally without you having to sacrifice any assets.

Final Word

Declaring bankruptcy is a very big step and it’s important to make sure you choose the right type of bankruptcy as it will greatly affect the next several years of your life. Before declaring bankruptcy, you’re required to undergo credit counseling, which can provide a useful forum to get your questions answered and to receive guidance.

Also, there are certain debts, such as alimony, child support, and student loans, that can’t be forgiven regardless of what type of bankruptcy you file. In addition to using the information above to help you decide which type of bankruptcy is right for you, read more at the U.S. Courts bankruptcy website and consult an attorney if you have more detailed or state-specific questions.

(photo credit: Shutterstock)

Kira Botkin
Kira is a longtime blogger and serial entrepreneur who enjoys gardening, garage sales, and finding stray animals. She lives in Columbus, Ohio, where football is a distinct season, and by day runs a research study for people with multiple sclerosis. She hopes that the MoneyCrashers team can help you achieve your goals and live a great life.

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  • Shane

    As a bankruptcy attorney, this information is not accurate. And the worst part is, you don’t recommend that the person reading this article consult an attorney, but rather only consult the article for guidance. This is not good.

    • Kira

      I would be happy to correct the article if you can provide specific instances of information that is incorrect. Also, every page states at the bottom that you should consult a professional if you need professional advice.

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