What's The Difference Between Chapter 7 and Chapter 13 Bankruptcy?

What's The Difference Between Chapter 7 and Chapter 13 Bankruptcy?

Prakash Pandey

by Prakash Pandey
Contributing Writer

November 3, 2020
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What's The Difference Between Chapter 7 and Chapter 13 Bankruptcy?

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If you're carrying an overwhelming amount of debt and need help paying it down, there are solutions you can turn to. These typically include debt consolidation, systematic debt repayment plans, and qualified forgiveness schemes.

But, if you are burdened with a truly excessive amount of debt, filing for bankruptcy may be a necessary step to regain control of your life.

If you find yourself in this situation, you're not alone – according to the American Bankruptcy Institute, the total number of non-business bankruptcies in 2019 stood at 752,160.

Chapter 7 Bankruptcy vs. Chapter 13 Bankruptcy

The two most common types of bankruptcy proceedings are Chapter 7 and Chapter 13. It's essential to understand the basics of these bankruptcy filings, their impact on your credit score, and how they differ from one another before choosing the best type for your situation.

Chapter 7 Bankruptcy

Chapter 7 Bankruptcy filing, also known as "liquidation filing," provides the legal option to eliminate unsecured debt, including credit card debts, personal loans, and even some secured debts. Under this type of filing, creditors have the right to sell your non-exempt property or assets to recover their outstanding debts. Examples of property that may be sold include secondary vehicles and homes, investment and bank accounts, valuable collections such as artwork, stamps, or coins. Exempt assets are "off-limits", including furniture, clothing, and retirement accounts.

Chapter 7 bankruptcy is an appropriate legal option for those who do not have the financial capability to repay their debts.

In order to qualify, you must satisfy the disposable income requirements. Once you begin the process, an automatic stay will apply to all your collection accounts. The Chapter 7 bankruptcy entire process can take anywhere between three and five months to complete.

Benefits of Chapter 7 Bankruptcy

  • No more debt repayments: Chapter 7 Bankruptcy will release you from most types of debt, enabling you to dedicate your income to other expenses.
  • Relief from debt collectors: When you file for Chapter 7 bankruptcy, you receive relief from debt collectors, wage garnishment, and creditors can no longer file or pursue any lawsuits to collect debts.
  • Shorter completion period: Chapter 7 bankruptcy proceedings take anywhere between three to four months in competition, which is much shorter than a Chapter 13 filing.

Drawbacks of Chapter 7 Bankruptcy

  • Loss of property: When filing for Chapter 7 bankruptcy, your creditors will have the option to sell your assets (property or other assets) or access cash for debt repayment. If you're trying to protect your assets, Chapter 7 isn't the ideal choice for you.
  • Significant hit to credit score: Chapter 7 bankruptcy stays on your credit report for up to 10 years, leaving a negative impact on your financial life. You may end up paying higher premiums and interest rates. Any future loan terms will be less favorable.

Chapter 13 Bankruptcy

Another legal option to get relief is Chapter 13 bankruptcy, also known as Reorganization Bankruptcy. A key difference between Chapter 13 and Chapter 7 bankruptcy is that the filer is required to make monthly payments to the creditors.

The court will evaluate your situation and construct a repayment plan in alignment with your disposable income for a term of three to five years. Plus, you'll be able to keep most of your assets after the successful completion of the repayment term.

Chapter 13 bankruptcy allows filers to wipe out most types of unsecured debt. However, mortgages, student loans, income taxes, or automobile loans are not dischargeable under Chapter 13 bankruptcy.

It can take anywhere between three to five years to complete Chapter 13 bankruptcy (depending on your repayment plan).

Chapter 13 is suitable for borrowers with a regular income trying to protect their assets from liquidation.

In order to qualify for Chapter 13, your debts should be below these limits.

  • Secured debts: $1,184,200
  • Unsecured debts: $394,725

Benefits of Chapter 13 Bankruptcy

  • Stop debt collections or foreclosure: Once you file for Chapter 13 bankruptcy, any ongoing foreclosure proceedings will stop. Chapter 13 also discharge certain types of secured and unsecured debts, thereby providing relief from debt collectors.
  • Flexible repayment terms: Under Chapter 13 filing, the court will analyze your disposable income and provide a repayment term. You may witness partial discharge of some of your debts.

Drawbacks of Chapter 13 Bankruptcy

  • Longer completion period: Chapter 13 bankruptcy often involves a three to five-year completion period. As a result, it may only partially relieve the financial stress you are experiencing.
  • Your disposable income goes entirely towards debt repayment. The court requires you to allocate all of your disposable income towards debt repayment. Your other financial goals are put on hold.

Chapter 7 vs. Chapter 13 Bankruptcy

So, which bankruptcy filing makes more sense for you? Below are the key differences between Chapter 7 and Chapter 13 bankruptcy proceedings.

Chapter 7 Chapter 13
Eligibility Disposable income should be below the state’s median income or pass the means test. Maximum unsecured debt: $394,725. Maximum secured debt: $1,184,200
Who can file? Individuals and business Individuals and sole proprietors
Handling of assets, property Non-exempt property is sold to pay debts. The filer can keep the property or assets as long as unsecured creditors are paid an amount equivalent to the value of non-exempt assets.
Time to completion 3 to 5 months 3 to 5 years
Treatment of junior lien on a property Not removed Removed if conditions are met.
Treatment of loan principal on a secured loan Not reduced Reduced if conditions are met.

Impact of Chapter 7 Bankruptcy and Chapter 13 Bankruptcy on Your Credit Score

Bankruptcy proceedings will undoubtedly harm your credit score. Here is how a bankruptcy may affect your credit profile.

  • Chapter 7 bankruptcy may stay on your credit report for up to 10 years.
  • You’re likely to lose your credit cards or any specific benefits you received because of an eligible credit score.

When applying for bankruptcy, understand that you will have limited access to many financial instruments, especially those that involve credit, for a couple of years. However, as the years go by, the impact of bankruptcies will fade away.

Bankruptcy proceedings are never simple. They should always be considered as the last resort.

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