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How to Decide Which Chapter of Bankruptcy to File: Chapter 7 or Chapter 13?

Once you’ve decided that bankruptcy is the right solution for your financial situation, you will need to decide which type of bankruptcy is most beneficial. While there are many different “flavors” of bankruptcy available, the two chapters that apply to most consumers are Chapter 7 and Chapter 13.

Choosing the Right Type of Bankruptcy

In most cases, the type of bankruptcy filed will be contingent on two things: Your household income and your assets. Your income is important because it may preclude you from filing a simple Chapter 7 case, and your assets are important because if you have nonexempt property, you might have it sold by the Chapter 7 Trustee in a Chapter 7 case, but can protect it in Chapter 13.

What does a Chapter 7 Bankruptcy Do?

A Chapter 7 bankruptcy is the process of going through the federal courts is receive a court judgment that releases you from responsibility for repaying debts. You are permitted to keep “exempt” property, but “non-exempt property” will be sold to repay part of your debt.  Exempt property differs from state to state.

If you have assets that are not protected by exemptions then your assets will be sold by a court-appointed bankruptcy trustee, aka as the Chapter 7 Trustee. The proceeds go toward paying the trustee, covering administrative fees and, if funds allow, repaying your creditors as much as possible.

Currently, Chapter 7 is the most popular form of bankruptcy, making up the majority of bankruptcy case filings.

What does a Chapter 13 Bankruptcy Do?

A Chapter 13 Bankruptcy is a debt consolidation and repayment plan under the protection of the federal courts.  Depending on your income and assets, you may not have to repay all of your unsecured debt through the Chapter 13 Plan (which can last up to 5 years). Consumers who file for Chapter 13 usually have the ability to retain whatever assets they wish as long as a reasonable Chapter 13 Plan is proposed to the court.

Here are a few scenarios that illustrate which bankruptcy strategy would be best:

1. Debtors with low income and few assets – Chapter 7

If you have a substantial amount of debt such as credit cards, medical bills, collections, and personal loans but not very much in terms of assets then Chapter 7 may be your best choice if you can qualify income wise. It allows you to discharge your debt and start rebuilding your credit usually in about 4-5 months.

2. Small business owner– failing business or little equity in assets – Chapter 7

If you are small business owner and realize that you have a failing business but little assets then Chapter 7 will usually be the best chapter to file because it will allow you to wipe out your debt and move on to a new business opportunity. Most small business owners have to co-sign and/or guarantee their business debt so when the business fails they will need to file to stop collections against them personally.

3. Unemployed Homeowners – Significant Equity – Chapter 7 or 13

If you have a significant amount of equity in your property, then Chapter 7 may or may not be the best option. If your state’s real estate exemption protects your home then you don’t have to worry about a trustee selling your property but if the state homestead exemption doesn’t cover the equity, you may lose the home in a Chapter 7 bankruptcy when the trustee sells the home to pay your creditors. In a Chapter 13 bankruptcy however, if you can make your payments to the mortgage company and to the trustee each month you can retain your property.  You don’t necessarily have to have a W-2 job to be in a Chapter 13 case.  We have many clients who are self-employed, receive SSI, or receive family assistance to fund their repayment plans.

4. Employed Homeowners Facing Foreclosure – Chapter 13

For homeowners who have fallen behind on mortgage payments, Chapter 13 offers a way to catch up or “cure” past due mortgage payments while simultaneously eliminating some portion of dischargeable debt. This means they can save the home from foreclosure and get rid of a lot of credit card debt, medical debt, and possibly even second and third mortgages. Chapter 7 bankruptcy does not provide a way for homeowners to make up mortgage arrears or remove junior liens.  For move information on “Lien Stripping” please check out a current legal vlog: Lien Stripping in Bankruptcy.

5. Debtor that owes back child support/alimony and is facing jail or license suspension – Chapter 13

If you are facing a license suspension or jail time for failure to pay child support/alimony then you can file a Chapter 13 to restructure the arrears and give yourself 5 years to repay the balance. In Georgia, child support arrears are placed in the plan for repayment and all creditor collection actions as to the debt must stop.  Of course, debtors have to continue with their ongoing child support payments but this allows them some relief by allowing them to restructure the arrears.

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