Understanding the Difference Between Chapter 7 vs Chapter 13 Bankruptcy

If your debts have gotten away from you and you are considering filing a bankruptcy petition, you need to understand all your options to make the best choice, given your specific financial situation. Understanding the difference between Chapter 7 vs Chapter 13 bankruptcy proceedings is essential because they operate differently and could mean different things for your financial future.

What is the Difference Between Chapter 7 vs Chapter 13 Bankruptcy?

Both Chapter 7 and Chapter 13 of the United States Bankruptcy Code are designed to help individuals and married couples escape burdensome debt. However, they do this differently and they have different requirements. Whether your best option is under Chapter 7 or Chapter 13 depends on your income, assets, and future financial goals.

Chapter 7 Liquidation

A Chapter 7 bankruptcy is the better choice for many individuals and couples looking for a quick resolution of their unsecured debts. In a Chapter 7 bankruptcy, the bankruptcy trustee liquidates – or sells – property that has equity to satisfy a portion of your outstanding unsecured debts in exchange for forgiveness of anything not paid at the end of the process.

This may sound extreme, but certain property can be retained and certain property can be exempted from liquidation. For example, a trustee is unlikely to sell a primary residence that does not have any equity – i.e., the mortgage balance is close to or higher than the value of the residence – value of home equity ($15,000 for each spouse under Illinois exemptions)

• ERISA-qualified retirement plans (such as pensions and 401(k) accounts)
• A vehicle (up to a certain value)
• Personal property (up to a certain value)
• Equipment or tools used for a profession
• Cash value of insurance policies
• A “wildcard” exemption to cover a certain value of other property

The advantage to a Chapter 7 bankruptcy is that it is comparatively quick and inexpensive, and it doesn’t require you to make lengthy payment commitments to creditors or the court. Instead, it treats your financial situation as a snapshot of assets and debts that exist at the time the petition is filed. At the end of the process, any qualifying unsecured debt is discharged entirely, allowing the debtor to avoid thousands of dollars in debt repayment. It is important to understand that some debts do not automatically qualify for discharge, the most prominent being student loan debt and tax debt.

However, not everyone can file a Chapter 7 bankruptcy. To qualify, you must pass the Chapter 7 Means Test. Anyone who makes too much money will be forced to file under Chapter 13 instead. You should consult an attorney to discuss whether you qualify for Chapter 7 relief under the means test. As a rule of thumb, a single person (no dependents) living in Cook County and earning more than $50,000 to $60,000 a year may not qualify for Chapter 7.

Chapter 13 Debt Reorganization

If a Chapter 7 bankruptcy is a snapshot, a Chapter 13 bankruptcy is a movie trilogy. A petition for bankruptcy under Chapter 13 seeks permission for the reorganization of debts. It is filed along with a repayment plan to show how you plan to use your income to satisfy your financial obligations, or at least part of them. As in Chapter 7, at the end of the process, any unpaid dischargeable debts are forgiven. However, that process is far longer – often involving three to five years of regular monthly payments to the bankruptcy trustee.

Why would anyone choose Chapter 13? Unlike a Chapter 7 bankruptcy, a Chapter 13 bankruptcy does not require the liquidation of assets. A Chapter 13 bankruptcy can protect your substantial equity in your home, second vehicle, vacation properties, collectibles, and other assets not covered by the Chapter 7 bankruptcy exemptions.

Chapter 13 also allows you to end collections efforts on everything you owe while prioritizing nondischargeable debts. This way, you can pay down your mortgage or student loan balances without risking collections efforts from credit cards or medical debts. Debtors under a Chapter 13 repayment plan can put more of their projected disposable income (PDI) toward debts that will live on after the bankruptcy, allowing a larger percentage of the eligible debts to be discharged, up to certain caps set by federal law.

Again, not everyone qualifies for a Chapter 13 bankruptcy. In order to file a repayment plan preserving your assets you must have sufficient reliable income to make payments toward your debts. If your income is variable or unreliable, or if you owe unsecured debt of more than $465,275 and secured debt of more than $1,395,875, you will not qualify for Chapter 13. Individuals whose debts are greater than the Chapter 13 debt cap may be limited to a Chapter 11 bankruptcy or a Chapter 7 bankruptcy.

Chapter 7 vs Chapter 13 at a Glance

Chapter 7 vs Chapter 13: Which is Best?

There is no quick answer to whether a Chapter 7 or Chapter 13 bankruptcy is best. It will depend on what you own, what you owe, and what your plans are over the next several years. For example, a debtor in a Chapter 13 bankruptcy is generally not allowed to take on new debts during the repayment period without the Court’s permission. If you know that you are planning to move, will need to replace your vehicle, or expect to take on student loan debt (even as a cosigner for your children) in the next 3-5 years, a Chapter 7 bankruptcy may be the best option. However, if what you owe is mostly secured debt (such as mortgages or student loans) or you have substantial non-exempt property, a Chapter 13 bankruptcy may be better suited for you. There are also non-bankruptcy options to be considered.

This is why the bankruptcy attorneys at FactorLaw offer an initial consultation (usually at no charge), with one of our attorneys in Northbrook, Downtown Chicago, or by phone. At this initial consultation, our attorneys will discuss your situation and review your financial circumstances to see if you qualify for a Chapter 7 bankruptcy, or would benefit more from a Chapter 13 repayment plan. We want to help you take full advantage of the federal and state laws offering bankruptcy protection to Illinois residents. Contact us today to schedule an appointment.