If you're in serious debt and can't keep up with repaying loans and credit card bills, Chapter 7 and Chapter 13 bankruptcy are the two most common programs you can use to reduce or eliminate your debt. (In case you're wondering, Chapter 11 is only for businesses.)
Chapter 7 bankruptcy is known as a liquidation bankruptcy. Most of your property is sold and used to pay off your debts. Chapter 7 bankruptcy is generally meant for people with limited incomes who do not have the ability to pay back all or some portion of their debts.
Chapter 13 bankruptcy is referred to as a reorganization bankruptcy. Your property is not sold when you file for Chapter 13 protection, and if you successfully complete a court-mandated repayment plan, you may be able to keep your property.
After completing the repayment plan in which you pay your creditors a portion of the outstanding debt over a fixed period of time, any remaining unsecured debts—such as credit cards and medical bills—may be "discharged." When debt is discharged, it means you're no longer required to pay back the debt.
Here is a quick reference guide to Chapter 7 and Chapter 13 Bankruptcy.
|Chapter 7||Chapter 13|
|Type of bankruptcy||Liquidation||Reorganization|
|Who can file?||Individuals and business entities||Individuals only (Including sole proprietors)|
|Eligibility restrictions||Disposable income must be low enough to pass the chapter 7 means test||Cannot have more than $394,7255 of unsecured debt or $1,184,200 of secured debt|
|How long does it take to receive a discharge?||Typically three to five months||Upon completion of all plan payments (Usually three to five years)|
|What happens to property in bankruptcy?||Trustee can sell all nonexempt property to pay creditors||Debtors keep all property but must pay unsecured creditors an amount equal to value of nonexempt assets|
|Allows removing unsecured junior liens from real property through lien stripping?||No||Yes (If requirements are satisfied)|
|Allows reducing the principal loan balance on secured debts through a loan cramdown?||No||Yes (If requirements are satisfied)|
|Benefits||Allows debtors to quickly discharge most debts and get a fresh start||Allows debtors to keep their property and catch up on missed mortgage, car, and nondischargeable priority debt payments|
|Drawbacks||Trustee can sell nonexempt property. Does not provide a way to catch up on missed payments to avoid foreclosure or repossession||Must make monthly payments to the trustee for three to five years. May have to pay back a portion of general unsecured debts|
Will I Lose My Property If I File Bankruptcy?
An important difference between Chapter 7 and Chapter 13 bankruptcy is what happens to your property and possessions.
Chapter 7 Bankruptcy
Most of your property will be sold and used to pay off your debts (for that reason, chapter 7 bankruptcy is often chosen by people who don't own a home). Some of your personal property is exempt from being sold, but there are limits on the value of exemptions.
There are federal exemption rules, as well as state exemption rules. Some states allow you to choose whether you want to use the federal exemptions or your state's guidelines. Other states may insist that you use the state exemption level. Married couples that file for bankruptcy together can typically double the value of exemptions.
Examples of property and value limits mandated by federal Chapter 7 rules include:
|Homestead*||Up to $23,675|
|Motor Vehicle||Up to $3,775|
|Personal Property*||Up to $12,625|
|Retirement Accounts*||Up to $1,283,025|
|Health Aids||The entire value is exempt.|
|Jewelry||Up to $1,600|
*See below for more information.
You can retain up to $23,675 of equity in homes, mobile homes, co-ops or burial plots. If you do not use all of this exemption, up to $11,850 can be used for other property.
If you have less than $23,675 ($47,350 for married couples) in equity in your home, your court-appointed bankruptcy trustee may decide to not sell the home, as there will be no proceeds to pay off your debts after applying your exemption. But that does not prevent your lender from foreclosing on the property.
If your equity exceeds the limit, the house may be sold. You will receive your exemption amount, and the rest of the proceeds will be used to pay off debts.
Personal property can include appliances, book, musical instruments and pets. You are allowed an exemption of $600 per item and a total exemption of $12,625.
Retirement accounts include all savings in a 401(k) or 403(b). The total exemption can be up to $1,283,025 in Individual Retirement Account (IRA) savings.
Chapter 13 Bankruptcy
None of your assets are sold when you file. With a Chapter 13 bankruptcy, you agree to a court-approved repayment plan of your debts. Depending on your income, your repayment period may be three years or five years.
If during the repayment period you catch up on back payments on secured assets (car, home) and are on time with current payments, you will be able to keep them after the repayment plan is finished.
Can I Get Rid of Credit Card Debt If I File Chapter 7 or Chapter 13 Bankruptcy?
Unsecured debts, including credit card debt and medical debt, can be "discharged" using either Chapter 7 or Chapter 13.
If you qualify for Chapter 7, your unsecured debts will be wiped out when the court approves your filing. This can take a few months.
With a Chapter 13 filing, you must continue to make payments on your unsecured debts during your repayment plan, as instructed in your court-approved plan. If you successfully complete your repayment plan, any remaining unsecured debts may be discharged.
What Are the Eligibility Rules for Chapter 7 and Chapter 13 Bankruptcy?
Chapter 7 Eligibility
Chapter 7 bankruptcy is typically for people with limited income who do not have the ability to pay back all or some portion of their debts.
If your household income is below the median level for your state, you are eligible for Chapter 7.
If your household income is above the median, you must pass a "means test" that assesses whether you have enough disposable income to be able to pay back some of your debts. Disposable income is income you have left over after covering essential living costs.
If you are deemed to have the means to repay at least some of your debts, you will be required to use Chapter 13 bankruptcy.
Chapter 13 Eligibility
To be eligible for a Chapter 13 bankruptcy repayment plan you must have:
- Regular income
- Total unsecured debts under $394,725. An unsecured debt is not backed by collateral, such as a car or home. Credit card and medical debt are unsecured debts.
- Total secured debt under $1,184,200. A secured debt is a loan where you have pledged an asset as collateral. Your home is the collateral for a mortgage. A car is a collateral for an auto loan.
Will I Need to Repay All My Debts With Chapter 7 and Chapter 13 Bankruptcy?
Certain debts can't be wiped out in Chapter 7 or Chapter 13. This includes mortgages, and car and student loans.
If you file for Chapter 13 protection, you may be able to have the balance of certain secured loans reduced. For example, in a Chapter 13 "cramdown," your court approved repayment plan may reduce the balance on your car loan to the depreciated value of the car. That can make repayment easier.
Unsecured debts, such as credit card balances and medical debt, can be "discharged" in both types of bankruptcy. In a Chapter 13 bankruptcy, your unsecured debts will only be discharged after you complete the repayment plan.
How Long Will a Chapter 7 or Chapter 13 Bankruptcy Stay on My Credit Reports and Impact My Credit Scores?
If you were already behind on debt payments before you filed for bankruptcy, your credit scores may not fall much more once you apply for bankruptcy protection. But typically:
- Chapter 7 remains on your credit reports for up to 10 years.
- Chapter 13 remains on your credit reports for up to 7 years.
For the 7 or 10 years that a bankruptcy is listed on your credit reports, there will bea negative impact on your credit scores. As time goes by, however, the impact of the bankruptcy on your scores will decline.
During this period you can also begin to rebuild your credit by making on-time bill payments and managing your debts smartly.
How Do I Apply for Chapter 7 or Chapter 13 Bankruptcy?
You should consider hiring a lawyer who specializes in consumer bankruptcy to help you decide your best bankruptcy option and assist you in petitioning for Chapter 7 or Chapter 13 bankruptcy protection.
You will need to complete a series of official bankruptcy documents. If you are applying for Chapter 13, you will also submit a proposal for repaying your debts. A court-appointed bankruptcy trustee will review your plan, and contact your creditors, before approving a final repayment plan.
Your petition for bankruptcy must be filed at a U.S. Bankruptcy Court. There are more than 90 U.S. Bankruptcy courts in the U.S. Find a local U.S. Bankruptcy Court here.
What Is the Cost of Applying for Chapter 7 or Chapter 13 Bankruptcy?
There is a filing and administrative fee when you file for Chapter 7 or Chapter 13. It costs $335 to file for a Chapter 7 bankruptcy and $310 for a Chapter 13. You can ask the court for permission to pay the fees in four monthly installments. You can also apply to have the fees waived.
If you hire a bankruptcy lawyer, you will also be responsible for paying the lawyer's fees. If you do hire a lawyer, the total cost will likely be somewhere between $1,500 and $4,000 depending on whether your file chapter 13 or 7 and the complexity of the case in general.
Editorial Disclaimer: Opinions expressed here are author's alone, not those of any bank, credit card issuer or other company, and have not been reviewed, approved or otherwise endorsed by any of these entities. All information, including rates and fees, are accurate as of the date of publication.
This article was originally published on March 28, 2018, and has been updated.