Chapter 7 vs. Chapter 13 Bankruptcy: When to File One or the Other

What is Chapter 7 bankruptcy?

Chapter 7 bankruptcy, or liquidation bankruptcy, totally wipes out unsecured debts such as medical bills, credit cards, and personal loans. It may also require selling off property and assets, like a house, car, or expensive jewelry, to help pay off the debts, but most people who file Chapter 7 tend not to have these assets or there is already a lien against the property. It is a faster and cheaper route than Chapter 13, taking from four to six months to complete the process.

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Upon filing for Chapter 7 bankruptcy, the court puts a temporary stay on your debts, which prevents creditors from collecting payments, evicting you, turning off utilities, garnishing wages, etc. The court also takes possession of your property and appoints a trustee to your case. The trustee acts as a liaison between you and the court, reviewing your finances, selling the property that you can’t keep to use the profits to repay some of your debts, and arranging a meeting between you and your creditors.

Which debts are ineligible for Chapter 7?

Chapter 7 doesn’t wipe all of your debts, and the list of debts that bankruptcy doesn’t discharge, or eliminate, varies by state. In general, the following debts will still be your responsibility:

• Back taxes
• Court judgments or fees
• Alimony from a divorce
• Child support
• Student loans

Although Chapter 13 bankruptcy doesn’t include secured debts like a mortgage or auto loan in the repayment plan, it should offer the chance to regain control over those payments alongside the plan.

When to file Chapter 7

Filing Chapter 7 is most appropriate if the following applies to you:

• You don’t own a home
• You have limited income
• You own few assets (such as a car)
• Child support
• It would take you more than five years to pay off the debt with a concerted effort

How to qualify for Chapter 7 bankruptcy

To qualify for Chapter 7, your situation must follow certain parameters, including:

• Passing a means test: The means test is meant for people who mostly have consumer debts such as credit card and medical debt. Looking at the past six months, the test first analyzes your current monthly income against your state’s median income for your household size. It then evaluates all of your expenses to identify how much money you can put towards your debts; anything besides rent, groceries, clothing, and medical costs counts as disposable income to pay off the debt. Too high of disposable income will disqualify you from Chapter 7. If you don’t pass the means test, you may be able to qualify for Chapter 13, or take the test again in six months if you think your situation may later qualify.
• You have not filed for Chapter 7 in the past eight years
• You have not filed for Chapter 13 in the past six years
• You have not filed a bankruptcy petition in the previous 180 days that was dismissed because of failure to appear in court
• You have received credit counseling from an approved credit counseling agency within the previous 180 days

What is Chapter 13 bankruptcy?

Chapter 13 bankruptcy is also known as reorganization bankruptcy. Filing for this type of bankruptcy allows you to keep your property and assets like your home and car. Chapter 13 requires you to implement a repayment plan that takes three to five years. Usually, the plan will repay most of what you owe using all of your disposable income.

Under Chapter 13, the court suspends foreclosures and payments of any other debts during the process. The court also appoints a bankruptcy trustee to help consolidate the debts and pay them off. During the process, debtors don’t have direct contact with the creditors and instead act through the trustee. The trustee will host a meeting between you and the creditors like under Chapter 7, but this one confirms that everyone is aligned with the payment plan.

Which debts are ineligible for Chapter 13?

Like Chapter 7, Chapter 13 does not account for certain debts, including:

• Mortgage
• Auto loans
• Tax debts or back taxes
• Auto loans
• Child support
• Student loans

Although Chapter 13 bankruptcy doesn’t include secured debts like a mortgage or auto loan in the repayment plan, it should offer the chance to regain control over those payments alongside the plan.

When to file Chapter 13

Chapter 13 is also considered Wage Earner’s Bankruptcy as it suits people who can likely pay off their debt but have fallen very behind on their credit payments. If you don’t qualify for Chapter 7 bankruptcy and you can pay off your debts in three to five years with a plan, consider filing Chapter 13.

How to qualify for Chapter 13 bankruptcy

Qualifying for Chapter 13 entails particular parameters as well, such as:

• You have a regular income
• Secured debt is less than $1,257,850
• Unsecured debt is less than $419,275
• You can provide updated tax returns and tax payments
• You have not had a bankruptcy dismissed in the pay 180 days for a failure to appear in court
• You have not received a Chapter 13 discharge in the previous two years
• You have not received a Chapter 7, 11, or 12 discharge in the previous four years
• You have received credit counseling from an approved credit counseling agency within the previous 180 days

Benefits of Chapter 7 vs. Chapter 13

Filing for Chapter 7 is faster and cheaper than Chapter 13. It also stops any collections and any legal action that creditors may take to recover the debt.

Chapter 13 allows you to keep assets such as a mortgage or auto loan while you get caught up on the payments, and it includes protection for any cosigners on your debt. There is also a shorter waiting period before filing a second Chapter 13 bankruptcy than Chapter 7.

How often you can file for bankruptcy: Chapter 7 vs. Chapter 13

Ultimately, filing for bankruptcy once should get you back on track, but things happen—divorce, medical issues, and more. Once you declare bankruptcy, whether through Chapter 7 or Chapter 13, you must wait a while before filing again, if necessary.

• You can file for Chapter 7 every eight years.
• You can file for Chapter 13 every two years.

How to rebuild after bankruptcy

If you have to file for bankruptcy, consider it a time to organize your finances and to evaluate how to do things differently. Rather than a scar on your record for life, consider it a paper cut that will heal in time. In order to rebuild your finances after filing either Chapter 7 or Chapter 13, consider the following:

• Make a budget. Use a spreadsheet or a budget template in Microsoft Excel to track your expenses and your income, designate buckets for your recurring expenses, and identify ways to cut back on some of your spending. Once you make your budget, stick to it.
• Restore your credit. After filing for bankruptcy, your credit score will take a hit. Take action to improve your credit score by monitoring your credit report, continuing to make payments on time, keeping your balances low, and following your budget to avoid having to use a credit card.
• Apply for a secured credit card. While it’s important to reduce your credit card usage after bankruptcy, secured cards are a good way to help rebuild trust with creditors. With a secured card, you make a refundable security deposit and borrow against it. Choose a card that reports to all three credit bureaus so that your on-time payments and other good credit behavior reflect on your credit report. Be mindful of these cards’ high interest rates, though—they make it even more important to pay off the card each month and avoid racking up additional debt.

While bankruptcy comes with a host of challenges and complications, it is a viable option for many people who are struggling. Choose between Chapter 7 and Chapter 13 to improve your monetary situation and get back on the road to financial well-being.