Both Chapter 7 and Chapter 13 bankruptcy are effective at discharging certain types of debt (credit cards, medical expenses) and ineffective at discharging others (student loans, alimony), and both provide relief to debtors in exchange for a lowered credit score. Chapter 7 and Chapter 13 bankruptcy differ when it comes to eligibility and debt discharge. Before you can decide which type of bankruptcy fits your situation, you’ll need to understand those differences.
Discharge of Debts
Chapter 7 bankruptcy is also referred to as liquidation bankruptcy because all unsecured debts can be completely wiped out in exchange for liquidating any non-exempt assets you own, in order to pay down some of your debts. When you file for Chapter 7 bankruptcy, you’re asking to have all applicable debts discharged immediately. The only payment toward these debts would be the amount your non-exempt assets are sold for.
In Chapter 13 bankruptcy, often called reorganization or wage-earner’s bankruptcy, you’d work with an appointed trustee to create a repayment plan to pay some or all of your debts over a three- to five-year period. Those who successfully complete Chapter 13 bankruptcy, however, do not have to surrender property to a trustee as they would under Chapter 7.
You must meet strict requirements to file for either type of bankruptcy. You may be eligible for both types, but many people are only eligible for one or the other. To qualify for Chapter 7 bankruptcy, you must first compare your salary to your state’s median income level. If yours is lower, you are eligible to file. If not, you’ll have to take the means test, which takes into consideration your entire financial situation, including debts, assets, property and expenses. If you pass the means test, you can go ahead and file under Chapter 7.
For Chapter 13 bankruptcy, you must have a regular income and be able to prove that it’s high enough and your debts are low enough to make a repayment plan feasible. The debt limits for Chapter 13 differ for secured versus unsecured debts, and they change every three years.
In both types of bankruptcy filings, you’ll receive a court-appointed trustee to manage your case. In Chapter 7, the trustee will handle collecting your non-exempt property and liquidating it to pay down some of your debts. What qualifies as exempt property varies by state, but the idea is to leave the debtor with necessities such as clothing, household goods and certain items such as wedding rings. Some states even consider home equity exempt. Many people do not own any property above and beyond the allowed amount, so they don’t end up losing any property. Additionally, most states protect your retirement accounts from creditors, so your pension plan, life insurance benefits and retirement accounts will most likely be safe in a bankruptcy proceeding.
The trustee’s job in Chapter 13 is to collect payment from you and distribute it to your creditors in accordance with the approved repayment plan. The rules of exempt and non-exempt property don’t apply the same way in Chapter 13, because no property is seized. Instead, you pay your debts over time using your income, and your repayment plan is based on the amount of non-exempt property you own or acquire within that period.
Your largest asset is most likely your home, and the fate of your home may be a big motivator in deciding which type of bankruptcy to file, should you qualify for both. If your state does not consider home equity to be exempt property, you may lose your home during a Chapter 7 filing. Bankruptcy can eliminate debts but not liens, so if a creditor has a lien on your property (such as your home) that creditor can repossess your property even if the debt is discharged.
Chapter 13 bankruptcy may be favorable to home owners because filing can actually stop a foreclosure from happening. You can also include mortgage payments in your repayment plan, so filing for bankruptcy may be the best way to keep your home if you qualify for Chapter 13.
The Effect on Your Credit
There’s no evidence that the two types of bankruptcy affect your credit score differently. The amount your score is lowered depends more on what your score was prior to bankruptcy than which type of bankruptcy you file for. However, the two types do affect your credit report differently. A Chapter 7 bankruptcy will remain on your credit report for 10 years after your debts are discharged, while a Chapter 13 bankruptcy will only appear on your report for seven years.
Knowing the difference between Chapter 7 and Chapter 13 bankruptcy is important if you’re considering bankruptcy. If you qualify for both types, you’ll want to weigh the pros and cons and determine which option is best. Before you can make an informed decision about which type to pick, or whether to file at all, you need to know the advantages, disadvantages and process of both Chapter 7 and Chapter 13 bankruptcy.