If you are researching consumer bankruptcy you have heard the terms Chapter 7 and Chapter 13. These are the two most commonly used chapters of bankruptcy used by single filers, married couples and small business owners who are struggling with debt. If you are trying to figure out if bankruptcy is the right choice for you, your family and your business, you want to first have a basic understanding of the differences between Chapter & and Chapter 13.
Chapter 7 is the most common chapter of bankruptcy. In Chapter 7 you can discharge credit card debt, medical debt, personal loans and other forms of unsecured debt as well as remove your liability on secured debts like mortgage and car loans.
In Chapter 7, your debts are discharged pretty quickly, usually 4-6 months after you file your case. It is often called “liquidation bankruptcy” because you are not on any payment plan. Rather, you get to keep all of your “exempt” property and any “non-exempt” property is liquidated by the bankruptcy trustee for the benefit of your creditors.
In reality, most people who file Chapter 7 bankruptcy keep everything they own. This is because the bankruptcy exemptions protect many assets. To see a list of Colorado’s bankruptcy exemptions, visit: https://winkandwink.com/chapter-7-personal-bankruptcy/.
Whether you qualify for Chapter 7 bankruptcy is determined by your gross household income. Each state has median income figures for every household size and if your income is lower than the median, you can file a Chapter 7. If not, Chapter 7 may not be available.
In chapter 7 bankruptcy, you can usually keep everything you own (including your house and your vehicles) but you cannot manipulate your secured debts. Chapter 13, however, gives you the ability to pay back certain debts over time and in some cases change the terms of secured debts like second mortgages and car loans.
Chapter 13 is also used by single filers, married couples and small business owners to discharge the same debts as in Chapter 7. Chapter 13 is used by people who have income too high for Chapter 7 and also by people looking to take advantage of some of the extra features of chapter 13.
In Chapter 13, there are some additional debts it can get rid of that Chapter 7 cannot such as property settlement awards following divorce, and there are some special features of Chapter 13 that can allow you to manipulate secured debts like mortgages and car loans.
Chapter 13 puts you into a monthly payment plan for three to five years. Your payment is determined by your income and expenses OR by the reason you are filing Chapter 13 in the first place—such as to make up missed mortgage payments or repay tax debt.
Most people who file Chapter 13 are in that chapter because their income is too high to file Chapter 7. In that case, the Chapter 13 payment is determined by a means test which allows you to take deductions from your gross monthly income to arrive at the amount you will be required to pay each month. Once you complete those payments, your debts are discharged—just like in Chapter 7. The means test can be very complicated and you will get the best results by using an experienced bankruptcy attorney who knows how the local courts and Chapter 13 trustees operate.
Chapter 13 can be a very good option for people who have income too high to file Chapter 7. In most cases, they will pay back only a fraction of their debts and they will be protected from debt collection the entire time they are in the repayment plan. Even people with very high incomes often choose Chapter 13 to repay all of their debts because of the ability to lock in your total debt amount when you file and repay the total over five years, without further interest accruing during the repayment period.
However, Chapter 13 is not only for people who have income too high for Chapter 7. There are some very good reasons to file a Chapter 13 even though you qualify for chapter 7.
Reasons to File Chapter 13 Even Though You Qualify for Chapter 7
- Lien Stripping— If you have a second mortgage, home equity line or even a third mortgage on your home (“junior liens”), those loans may be stripped off—meaning completely removed–in a Chapter 13 bankruptcy. In order to strip off a second mortgage or similar, the value of your house must be less than what you owe on the primary, or first, mortgage. You cannot strip off second (or third) mortgages in Chapter 7, this is only available in Chapter 13.
- Cure Mortgage Arrears—Chapter 13 bankruptcy allows you to take up to five years to repay overdue mortgage payments (called “Arrears”). This can be a way to save your home if your mortgage company refuses to accept partial payments, because they will be forced to take partial payments in your Chapter 13. You can also cure arrears on your HOA payment and even car loans.
- Back taxes and Back Child Support—Chapter 13 can also give you five years to repay back taxes and child support without the pressure of ongoing levies or garnishments.
- Non-Exempt Assets—Sometimes people who otherwise qualify for chapter 7 have non-exempt assets they wish to keep. Chapter 13 can give you up to five years to pay for such assets, instead of having to surrender them or pay for them over a short period of time in Chapter 7. For instance, if you have non-exempt equity in your home (Colorado’s homestead exemption allows you to keep up to $60,000 equity as an exempt asset) of $10,000. You can pay off the non-exempt portion over 60 payments and pay $166 per month to keep your home, rather than surrender it in Chapter 7.
- Cram Down or Refinance of Car Loan—If your car loan is more than two-and-a-half years old and your car is worth a good deal less than what you still owe, Chapter 13 gives you the ability to cram down the loan amount to the present value of your vehicle. Even in this is not an option, chapter 13 can allow you to refinance your auto loan(s) over a longer period of time to lower your payments.
Both Chapter 7 and Chapter 13 bankruptcy offer meaningful debt relief. The right chapter for you depends on your financial situation and what your goals are concerning any non-exempt property you own and your secured property (houses and cars). If you need debt relief, contact an experienced bankruptcy attorney and set up a free consultation.