Chapter 7 or Chapter 13, which is better?

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bankruptcyMost individuals considering bankruptcy face two options – Chapter 7 or Chapter 13.  Sometimes you have the option of choosing which one to file, but in some situations you are eligible only to file a chapter 13 or only a chapter 7.  Let’s look at some of the factors to consider, keeping in mind that every case is different and this article is no substitute for the sound legal advise of your personal lawyer.

Filing either chapter may give you significant debt relief and, contrary to popular misconception, may actually improve your FICO credit score.

 

Chapter 7

Chapter 7, if you qualify, is generally cheaper and easier than chapter 13, and may be over in as little as 6 months, after which you can start rebuilding your credit.  

  1. Chapter 7 requires you to qualify by passing a “means test”.  Your annual income, caluclated in a special way, must be BELOW the threshold to qualify for Chapter 7.  There are some limited exceptions to this rule, but, in general, the higher your income (and the smaller the size of your family) the less likely you are to qualify for Chapter 7
  2. Chapter 7 is a “liquidation” bankruptcy.  There are 2 kinds of assets, exempt and non-exempt.  If you file chapter 7, you will have to turnover your non-exempt assets to the trustee, who will liquidate them at a sale and use the money to pay (1) the trustee and (2) the creditors.

In Arizona your house, car and furniture are generally exempt (up to certain limits).  But if you have non-exempt items you don’t want to lose, such as artwork, collections, boats, etc., the Chapter 7 may not be a good choice for you.

  1. Chapter 7 may be over quickly, but that is not guaranteed.  Trustee’s going after non-exempt property, preference actions, or actions by creditors may take 2 or 3 years after the case is filed.  This will significantly increase the cost of the Chapter 7 as well as the time before it is completed.
  2. Chapter 7 Trustees in Arizona are significantly more aggressive in the past due to the poor economy (a Trustee has got to eat too).  The chance of having “trouble” in your case is much greater now than in the past.

 

Chapter 13

  1. If you fail the means test, you will have to do a “long” Chapter 13, which will last for five years and require you to make 60 monthly payments to a Chapter 13 Trustee.  One advantage is that you don’t have to “liquidate” as long as you are paying for the non-exempt property you are keeping.
  2. A “short” Chapter 13, lasting as little as 36 months, may be a possibility if you pass the means test and can’t or don’t want to do a Chapter 7.

 

Upsides of Chapter 13

  1. Chapter 13 is the only realistic option if:
  2. You are facing a mortgage foreclosure and want to save your house.
  3. You are facing a vehicle repossession and want to keep your car/truck.
  4. You owe significant recent income taxes (or other tax debts) and penalties.
  5. You truly need to restructure your debts.  In this regard, Chapter 13 is a
  6. You own significant non-exempt assets
  7. As mentioned above, your household earnings put you well over the median for your family size.

 

Downsides of Chapter 13

  1. You will be in bankruptcy for a long time – 5 years in many cases.  This means that you will have a Chapter 13 Trustee who will have to approve any significant financial move, such as the purchase of a different vehicle.
  2. Chapter 13 Trustees put you on a strict budget with no emergency fund.  So if you have a family emergency, need an expensive repair or have a large medical expense, you will need to get permission while you are in Chapter 13.
  3. Chapter 13 is more expensive than Chapter 7, but there are creative ways to have your creditors help to pay your attorney fees.
  4. Many Chapter 13 cases don’t work.  They fail because people can’t or don’t make the required plan payments.  Our office has a much better track record on this than most, but we are selective on what cases we will file as Chapter 13 cases.
  5. You will be giving the Chapter 13 Trustee copies of your income tax returns for the whole time you are in Chapter 13 and you may also be giving the Trustee your tax refunds for the next 3 to 5 years.

This article is not intended to be legal advice, but to point out some of the pluses and minuses of Chapter 7 and Chapter 13.  If you have questions, we invite you to contact our office for a free consultation to see how we can best help you.