How to Decide Between Chapter 7 vs Chapter 13 Bankruptcy
Updated: Jun 5, 2020
If you are facing increasing debts or debts you cannot pay, bankruptcy comes to mind as a solution. Many people have concerns about whether to file bankruptcy, but after concluding that bankruptcy is the best option the more important decision becomes whether to file Chapter 7 or Chapter 13. If a business is involved, Chapter 13 is not an option. For individuals, the decision between filing Chapter 7 vs Chapter 13 may determine how much debt is eliminated, the types of debt eliminated, what assets the debtor may keep, and whether creditors will receive future income of the debtor. Anyone considering bankruptcy must carefully analyze their assets, income, and debts to make the best bankruptcy decision.
Keeping Assets in Bankruptcy
The first big distinction is what types of assets may be kept and what assets are lost to creditors. Chapter 7 may result in the loss of assets to pay creditors. In Chapter 7 cases where the types of assets or values of assets are too high, the bankruptcy trustee may sell the property and use the sale proceeds to pay creditor claims.
Chapter 13 is totally different from Chapter 7 in this regard. In Chapter 13, the debtor keeps all of his or her property as part of the bankruptcy. If a homeowner is behind on mortgage payments, rather than potentially losing the house to the trustee, the homeowner has an opportunity to keep the house and pay any arrearages or unpaid mortgage payments over the life of the Chapter 13 repayment plan along with the regular mortgage payments as they come due. A debtor may also keep a car and other property that may be secured by a mortgage or security interest.
One important concept for Chapter 7 filers is exempt property. The bankruptcy code exempts certain qualifying property from the bankruptcy trustee’s reach. The bankruptcy code also allows a state to allow state specific exemptions as an alternative to the federal bankruptcy exemptions. Michigan provides exemptions to allow a debtor to keep certain property or the equity of certain property before the trustee may take the property. This allows many Chapter 7 filings to be “no asset” cases where the debtor is able to discharge some or all of their debts and keep all of their assets.
Assets that are potentially exempt include:
A primary residence
A primary vehicle
Medical or health aids
These important asset classes are treated differently under the federal and state exemptions, and a debtor may only choose one set of the exemptions with those specific exemption amounts. There is no cherry-picking the best exemptions. See my other exemption post here for more specific information on what types of exemptions and the available amounts for a Michigan bankruptcy filing.
If you do have all exempt property, then Chapter 7 is the best way to go because you will not lose any property and you can discharge priority unsecured debts and other unsecured debts that may be discharged. If you have non-exempt property that the trustee will sell to pay creditor claims, then you may choose to file Chapter 13 if you want to keep the property. For some debtors, protecting equity in a home may be a good financial decision because if a Chapter 13 bankruptcy is completed, the equity is no longer at risk of being used for creditors. If the equity value is too high, it may not matter because creditors in a Chapter 13 are entitled to the value they would receive in a Chapter 7, so repaying them may be required in either Chapter 7 or Chapter 13.
Income or Wage Earner Requirement of Chapter 13 vs No Income Requirement in Chapter 7
Filing Chapter 7 bankruptcy requires an evaluation of a “means” test which looks at how much income a debtor’s household earns. If the debtor’s household income is too high, a debtor will have to justify why the income cannot be used to pay down debts. If a debtor fails the means test, a Chapter 13 filing may be the only option to reorganize debts and avoid creditors seizing property and garnishing wages.
Qualifying for Chapter 13, on the other hand, requires a debtor to have a regular source of income. Chapter 13 requires a regular source of income to provide a source of funding to successfully complete the Chapter 13 repayment plan that covers three to five years. A debtor who does not have a regular source of income cannot qualify for Chapter 13 bankruptcy.
There may be an overlap where a Chapter 7 debtor may have a regular source of income, but it qualifies for Chapter 7 under the means test, so that debtor may get a fresh start and discharge priority debts that must be repaid in a Chapter 13 bankruptcy. There may also be cases where a Chapter 13 debtor loses the regular source of income during the Chapter 13 repayment period and so cannot successfully complete the plan. In those cases, the debtor may seek to convert the Chapter 13 case to a Chapter 7.
Timeline to Complete Chapter 7 vs Chapter 13 Bankruptcy
A debtor is often looking for a fresh start as quickly as possible. Chapter 7 vs Chapter 13 are very different when it comes to time and steps to complete the bankruptcy and get the fresh start.
For a Chapter 7, the time to complete may be 60 to 90 days from the date of filing, depending on the contents of the petition and whether there is any litigation involved. For “simple” cases, this timeline can be expected and the only in-person involvement of the debtor will be attending the Section 341 creditor meeting where the bankruptcy trustee typically interviews the debtor regarding sources of assets and income available to pay creditors and verify the contents of the bankruptcy petition.
Filing Chapter 13 requires a repayment plan that may be completed over a 3 or 5 year period, but not longer. The plan period is used to repay certain secured creditors for payment arrearages and pay other priority creditors. Importantly, debts are not discharged until the plan is completed and may Chapter 13 plans fail for this reason. Anyone considering Chapter 13 to save a house should carefully analyze their ability to stick to a plan and make sure a plan is reasonable. Being financially constrained for 3 to 5 years can be difficult depending on the terms of the plan.
Chapter 7 vs Chapter 13 Dischargeable Debt Differences
Bankruptcy law provides certain creditors with a repayment preference or priority. Priority creditors get paid before other unsecured creditors. The bankruptcy code provides a specific ordering of creditors and in a Chapter 7 case, these creditors are paid in order to the extent of available non-exempt assets. Some debts are not dischargeable if unpaid during the bankruptcy, and so will survive bankruptcy and subject a debtor to collection efforts after the bankruptcy case is closed. What’s worse is that a debtor may not file another bankruptcy to prevent collection activity, and so may have wages garnished or assets seized. This is not the outcome debtors want.
Chapter 13 allows the debtor to include these non-dischargeable debts in the repayment plan, allowing for an organized repayment that avoids unpredictable creditor collection activities after bankruptcy. Under the Chapter 13 rules, repaying creditors in Chapter 13 in an orderly fashion may provide benefits that essentially squeeze out non-priority creditors from collecting anything based on the liquidation value creditors would receive. For some debtors, paying these creditors under bankruptcy protection makes sense.
Debts to consider include domestic support obligations including child support and spousal support (aka alimony), certain unpaid taxes, student loans, etc. The differences in Chapter 7 vs Chapter 13 make the analysis important, and while not everyone will have non-dischargeable debts, many do and are looking to resolve these debts as part of the bankruptcy process to achieve a fresh start.
Contact Michigan Bankruptcy Attorney Andrew Steiger to Help Analyze Your Chapter 7 vs Chapter 13 Bankruptcy Decision
If you are considering bankruptcy, you will need to carefully consider your specific facts taking into account your income, types of debts and assets, and your desired timeline to a fresh start. Each case is different and should be thoroughly reviewed before making a final decision to file bankruptcy. Contact Michigan bankruptcy attorney Andrew Steiger for a free bankruptcy consultation to review your options and help you decide if Chapter 7 vs Chapter 13 is best for you and will help you achieve your goals. Call today at (248) 259-6367 for a free consultation or email him at email@example.com to schedule an appointment. If you are facing financial difficulties and struggling to pay your debts, call Andrew Steiger today to see if you can reduce your debts and take control of your finances again.