What is the Difference Between Chapter 7 and Chapter 13?
by Michael Sosna
Chapter 7 bankruptcy is usually best if you only have “unsecured debts” such as credit card debts and medical bills. It normally takes three to four months from the time you file until you are granted your discharge. A “discharge” is an order entered by the bankruptcy court wiping out your obligation to pay certain debts.
Chapter 13 bankruptcy is usually best if you are behind in your home or car payments. This chapter allows you to catch up payments on those debts without losing your property. You also receive a “discharge” in a Chapter 13. However, a Chapter 13 plan must last at least three years and no longer than five years. You receive the discharge upon completion of the plan.
In both types of bankruptcy, you must appear before a Trustee.
In both bankruptcies, you receive a discharge of your debts.
In both bankruptcies, you usually are able to discharge all of your unsecured debts, i.e., credit card debts, medical debts, personal loans, and other debts that are not secured by a lien against your property.
In both bankruptcies, you are allowed to keep property, under certain conditions, and most people keep their home, vehicles and other personal property after their discharge (i.e. after their bankruptcy is concluded).
But which debts you discharge, which debts you must continue to pay, and what property you keep can depend on the type of bankruptcy you file.
A Chapter 7 bankruptcy is a quick bankruptcy, usually taking only three to four months from the time you file until you receive your discharge. There are no payments to a Trustee in a Chapter 7 case.
A Chapter 7 bankruptcy is a liquidation bankruptcy, which means that the Trustee can sell non-exempt property and use the proceeds to pay unsecured creditors. However, most people who file a bankruptcy are able to exempt, or protect, all of the property they wish to keep, such as their home, vehicles and other personal property. This means that the Trustee is not allowed to claim it or sell it (see also “Will I lose my property if I file bankruptcy” to learn more about exemptions). If the value of an item of property (or equity if subject to a lien) exceeds the amount you are able to exempt, and you want to keep that property, you will need to file a Chapter 13 bankruptcy.
In order to file a Chapter 7 bankruptcy, your household income generally must be below the median income for a household of your size in North Carolina. There is a complicated formula—known as the “means test”—that determines whether the debtor’s household income is above the median. The means test compares the average monthly household income, minus certain allowed deductions, with the median income for a family of similar size. If your income is above that level, you typically are not allowed to file a Chapter 7 and must file a Chapter 13 bankruptcy.
If you have outstanding secured debts – a mortgage, a car payment, a furniture payment – and are current in your monthly payments, you can still get a Chapter 7 Discharge of your unsecured debts by agreeing to reaffirm those secured debts and to continue to make the normal monthly payment. If you are behind in those payments, you will likely want to file a Chapter 13 bankruptcy instead.
A Chapter 13 bankruptcy is a longer bankruptcy case: it must last at least three years and can last as long as five years. In a Chapter 13 bankruptcy, the debtor makes monthly payments to a Trustee, who uses that money to pay certain creditors according to a Chapter 13 Plan.
People generally use a Chapter 13 when they are behind in their mortgage payments and/or vehicle payments and are facing possible foreclosure or repossession. Once a bankruptcy case is filed, the creditor – the mortgage company, the car loan company, the furniture company – is prevented from taking any action to collect the debt. Any pending foreclosure case is stayed (stopped) from proceeding further, and creditors are prevented from repossessing vehicles or taking any other collection action.
In order to obtain this protection, debtors file a Chapter 13 Plan which proposes to pay – over 36 to 60 months – the amount necessary to bring those secured debts current. For a mortgage it means paying the arrears by monthly payments over that time, in addition to the normal mortgage payment, to the Chapter 13 Trustee. At the end of the case, the mortgage arrears will have been paid in full and the mortgage will be current.
For car loans or other secured debts – furniture loans, appliance loans, etc. – the Chapter 13 Plan either proposes to pay the arrears through the Plan, while continuing to make normal payments directly to the creditor or, more often, paying the entire balance due through the plan over 36 to 60 months. At the end of the case, these debts will either be current or paid in full.
Typically, unsecured debts are discharged in a Chapter 13 just as in a Chapter 7 and usually with only small, if any, payments made by the Trustee to those creditors. However, there are circumstances where an unsecured creditor receives a larger distribution from the Trustee over the life of the Plan.
One of those instances is where the household income is above the limit allowed by the Chapter 7 means test. If the means test determines that the monthly household income is above the median, then we must go a step further and calculate your “disposable monthly income.” Your disposable monthly income is the amount of your plan payment each month that must be paid to unsecured creditors.
Another instance is where you own property with “nonexempt equity” (i.e. the value or equity exceeds the amount that you can exempt under the law) that would otherwise be subject to liquidation by a Chapter 7 Trustee. You can still protect and keep the property in a Chapter 13 bankruptcy, so long as your Plan payment provides that your unsecured creditors will receive the amount they would have otherwise received if the Chapter 7 Trustee had liquidated (sold) the asset.
For example, let’s assume you have a car with a value of $5,000, but you only can exempt $3,500 of that value. In a Chapter 7 case, the Trustee could sell the car, give you back $3,500 – the value exempted – and use the remaining $1,500 to pay unsecured creditors. However, if instead you file a Chapter 13 and increase your Chapter 13 Plan to pay an additional $1,500 over the life of the Plan, say 60 months, then for a little more than $25 a month extra you are allowed to keep your vehicle and get your Discharge. This is because the unsecured creditors got paid what they would have received if the car had been “liquidated” in a Chapter 7 case.
This article is meant only as a general overview of Chapter 7 and Chapter 13. Every case is different. In addition, there are other types of bankruptcy cases (Chapter 11 and Chapter 12). In order to determine which type of bankruptcy is best for your particular situation, it is important to obtain the advice of an experienced bankruptcy attorney, like the attorneys at Sosna Law Offices, PLLC. We offer a free consultation so that you can discuss the particulars of your situation and receive expert advice on which bankruptcy will be best for you.