In this article, we explain when it makes sense to file a Chapter 13 bankruptcy rather than a Chapter 7 bankruptcy. We will answer the following questions: (1) “what is the difference between a Chapter 13 Bankruptcy and a Chapter 7 bankruptcy?” (2) “when does it make sense to file a Chapter 13 bankruptcy rather than a Chapter 7 bankruptcy?,” and (3) “what are the eligibility requirements for a Chapter 13 bankruptcy?”
What is the Difference Between a Chapter 13 Bankruptcy and a Chapter 7 Bankruptcy?
For some foundational information about the Chapter 7 bankruptcy process, you can check out our article, The Chapter 7 Bankruptcy Process Explained.
A Chapter 7 bankruptcy completely wipes out all of the debtor’s dischargeable debts while a Chapter 13 bankruptcy provides for the payment of some or all of the debtor’s debts over the course of 3 to 5 years. If, based on the debtor’s income, the debtor will not be able to pay off the full amount of the debts during the allotted time period in a Chapter 13 payment plan, the plan may provide for payment of a portion of the debts, with the remainder of the debt being discharged at the conclusion of the payment plan.
In both a Chapter 13 bankruptcy and a Chapter 7 bankruptcy, an “automatic stay” on collection of debts prevents creditors from taking any collection action while the case is ongoing. In the context of Chapter 13 bankruptcies, this means that creditors cannot take action against the debtor for the duration of the 3 to 5 year payment plan so long as the debtor continues to make payments according to the plan.
In a Chapter 7 bankruptcy, the debtor’s assets that are not exempt from bankruptcy liquidation are collected by the trustee and distributed to the debtor’s creditors in order to satisfy the debtor’s debts. In a Chapter 13 bankruptcy, the debtor is permitted to keep his or her assets and, instead, his or her income over the course of the plan is used to satisfy the debts.
When Does it Make Sense to File a Chapter 13 Bankruptcy Rather than a Chapter 7 Bankruptcy?
All things being equal, it is more advantageous to debtors to wipe out all of their dischargeable debts immediately through a Chapter 7 bankruptcy than to repay some or all of the debt over the course of 3 to 5 years through a Chapter 13 bankruptcy. However, there some scenarios where a Chapter 13 bankruptcy is the best option:
- Debtors may file a Chapter 13 bankruptcy when they are not eligible to file a Chapter 7 bankruptcy. A debtor is not eligible for a Chapter 7 bankruptcy if the debtor discharged his or her debts through a Chapter 7 case that was filed within the previous 8 years. The debtor may also be ineligible for Chapter 7 if his or her income is too high to qualify for Chapter 7 bankruptcy. This is determined through a calculation called the Chapter 7 “means test.” In both of these situations, the debtor may be eligible for a Chapter 13 bankruptcy even though he or she is not eligible for a Chapter 7 bankruptcy.
- A Chapter 13 bankruptcy may allow debtors to keep their homes or vehicles if they are behind on payments on their mortgages or car loans. In a Chapter 7 bankruptcy, many debtors can keep their homes and vehicles if they are current on payments by signing a “reaffirmation agreement” with the secured lender. (For details, check out this article: If I File for Chapter 7 Bankruptcy Can I Keep My House and Cars?) However, if the debtor is behind on loan payments, signing a reaffirmation agreement may not be an option in Chapter 7, meaning he or she would lose the home or vehicle in the bankruptcy. In a Chapter 13 bankruptcy, the amount overdue on the house or car loan (the “arrearage”) can be repaid through the Chapter 13 payment plan, allowing the debtor to discharge his or her other debts while keeping his or her home and vehicle. In these cases, while the arrearage is paid through the payment plan, regular monthly loan payments will continue to be paid directly to the lender.
- A Chapter 13 bankruptcy may allow debtors to keep property that would otherwise be collected to pay creditors in a Chapter 7 bankruptcy. In a Chapter 7 bankruptcy, a certain amount of equity in the debtor’s home and vehicles is exempt from collection by the trustee to pay creditors. There are certain other exemptions specific to property type. You can learn the specifics here. Any property that the debtor owns over and above these exemption amounts may be liquidated by the bankruptcy trustee in a Chapter 7 case to pay the debtor’s debts. This means that in a Chapter 7 bankruptcy even people who are current on their mortgage or car loan payments may lose their home or vehicles if they have paid off enough of their loans to have significant equity in the assets. Since Chapter 13 bankruptcies pay off debts via future income rather than the debtor’s existing assets, debtors may use Chapter 13 bankruptcies to discharge debts while keeping assets that would be at risk in a Chapter 7 bankruptcy.
- Chapter 13 Bankruptcies Protect the Debtor’s Cosigners and Guarantors of the debtor’s debt. When a debtor’s debt is discharged through a Chapter 7 bankruptcy, the creditors can still pursue any cosigners or guarantors of the loan. In a Chapter 13 bankruptcy, the “automatic stay” that prevents creditors from taking collection action against the debtor also applies to the debtor’s cosigners and guarantors for the duration of the payment plan. At the conclusion of the bankruptcy, creditors can pursue the cosigners and guarantors for any amount that remains unpaid.
Chapter 7 cases may be converted to Chapter 13 cases if the debtor’s situation changes or information is discovered that would make a Chapter 13 case more appropriate for the debtor’s situation.
What are the Eligibility Requirements for filing a Chapter 13 Bankruptcy?
In order to be eligible for a chapter 13 bankruptcy, the debtor’s unsecured debts must be less than $394,725 and his or her secured debts must be less than $1,184,200. A secured debt is a debt, like a mortgage or a car loan, for which the creditor can take back certain property (“collateral”) from the debtor if the debt is not paid. An unsecured debt is a debt for which there is no collateral.
If a previous bankruptcy case was dismissed based on the debtor’s willful failure to appear in court or to comply with the court’s orders, or if the case was voluntarily dismissed after a creditor requested relief from the automatic stay, a Chapter 13 case may not be filed within 180 days of the dismissal.