Chapter 7 vs. 13: Which is Right For You

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This section is designed to help you get a general idea what type of bankruptcy would be best for you. In the first part of this section, there is a general discussion on the two types of bankruptcy. The second part gives you factors to consider whether Chapter 7 or Chapter 13 is better based on  circumstances that may be occurring currently in your life.

General Discussion
Chapter 7 is commonly known as straight bankruptcy. Chapter 7 is designed to wipe out your debts as opposed to a Chapter 13 which is designed to restructure your debts and to pay your debts back to the extent your income and expenses allow you to do so. The following is a discussion of both types of bankruptcy actions.
 
Chapter 7
A Chapter 7 generally wipes out or discharges your obligation to pay back your unsecured debts. An unsecured debt is one that has no collateral guaranteeing the debt. Examples of unsecured debts would be general credit cards, medical bills, and signature bank loans. There are certain types or classes of debts that cannot be discharged in bankruptcy. Examples of such debts would be child support, taxes less than three years old, and government guaranteed student loans.
 
As to secured loans like a house or car loan, a Chapter 7 will allow you to  wipe out the obligation to repay the money but it does not wipe out the lien  under the security agreement which means the creditor still has the right to repossess the collateral. If you are wanting to keep the collateral, you will have to repay the loan. If you are current on a secured loan, Chapter 7 allows you to keep the collateral and to repay the loan. You can enter into what is called a reaffirmation agreement which is a contract approved by the Court in which you agree to be liable on the debt even though you have filed bankruptcy. On the other hand, if you want to surrender the collateral and wipe out the debt you can do that also. This is common, for example, where one is "upside down" on a loan like a car note and owes much more than the car is worth.
 
One question many people ask is whether or not they can keep all the property they have if they file Chapter 7. For most people, the answer to this question is yes. When you file Chapter 7, the law does not require you to give up "the shirt off your back". You are allowed to keep certain properties under what are called exemptions. The law allows you to keep or "exempt" several thousands of dollars worth of property. Most people fall well within these exemptions and their case is classified as a "no asset case." The property they own is within the exemptions and there is no court ordered sale of any property.
 
Chapter 13
As to Chapter 13, this type of bankruptcy is designed to restructure and reorganize your debts into one affordable monthly payment. The payment is affordable because it is calculated based off the amount of disposable income you have. Disposable income is the income you have left over after subtracting the amount of your total income from the amount of your reasonable living expenses.
 
Just like in a Chapter 7, you can choose to either keep the collateral on a secured loan or you can surrender it. If you choose to keep the collateral, the debt will have to be paid back one of two ways. If the debt is one that is so large it cannot be paid back in the life of the plan (like a mortgage), the loan will be paid back as what is called a continuing debt. This means the loan will be brought current and paid regularly during your plan and at the end of the Chapter 13 you will simply resume paying the loan at the regular monthly rate. The other way a secured debt is paid is that it is paid in full during the life of the plan. If you are buying an automobile, for example, you would typically pay back the debt on the automobile during your Chapter 13 plan which can last up to five years. You may or may not pay back the entire balance on the automobile depending on how long you have been buying the vehicle and other factors.
 
Whether or not your unsecured creditors are paid in full in a Chapter 13 depends on how much you are able to afford to pay. Bankruptcy law requires that you commit your disposable income for a minimum of 3 years. If there are not sufficient funds to pay the unsecured, they will receive only a percentage of what is owed them or possible  nothing at all. Again, it depends on what your income and expenses show you can afford to pay. You can go up to 5 years in a Chapter 13. As a general rule, the longer you go, the lower your monthly payment will tend to be. The amount you have to pay back to unsecured creditors and the length of your payment plan is also control to some decree to what is called a means test explained below. That means test is consistent with the general principle that you pay back your unsecured creditors based only on your ability to pay and your expenses.
 
Regardless of the Chapter you file, your relief begins immediately upon filing the bankruptcy. The day the bankruptcy is filed, the Court issues what is called an automatic stay which orders all of your creditors to stop all collection efforts whatsoever. They cannot call you, write you, sue you or garnish you. All collection is stopped.
 
Factors to consider based on circumstances:
 
Chapter 13
1. You have a house in foreclosure that you want to keep. You probably want to file a Chapter 13 because it is the only way to effectively keep your home. Chapter 13 allows us to propose a plan for you that pays all of the mortgage arrearage over a period of up to 5 years. You do not have to come up with any money in order to stay in home. The arrears are paid out through the plan.
 
2. You have an automobile that you are behind on the payments. Chapter 13 will allow you to catch the automobile payments up through the plan. If you cannot catch up the automobile on your own, it is probably wise to look at Chapter 13.
 
3. You have an automobile that has been repossessed you want to get back. Chapter 13 is what you will need to do to be able to get the automobile back. As long as you file Chapter 13 before your vehicle is resold by the creditor, the creditor is required by law to return the vehicle to you. Usually the vehicle is returned within a few days of filing.
 
4. You are buying a car that has a high payment. Chapter 13 can help you lower your automobile payment in many ways. First, a Chapter 13 plan can go up to 5 years. This allows you to be able to stretch the remaining balance over 5 more additional years. Also, as discussed in other section herein, a Chapter 13 can allow the loan to be paid back under more friendly terms which includes possibly lower interest rates or reducing the secured loan down to the current value of the vehicle.
 
5. You owe money on a car that you purchased more than 2 ½ years ago. You will want to look at possibility filing Chapter 13. If your vehicle is more than 2 ½ years old, you are allowed to pay it as a secured debt in the amount of the current value of the vehicle instead of having to pay the full remaining balance. Depending on your circumstances, this might save you a considerable amount of money.
 
6. You are buying a car that has high interest loan. In a Chapter 13, you are not required to pay the current interest rate on your auto loan. Bankruptcy allows you to pay the loan back at a low rate based on the rate of the federal prime which is very low currently. A lower interest rate can make a big difference in both the monthly amount and the total amount that has to be paid to payoff the note.
 
7. You owe money to the IRS or State. If you owe back income taxes, a Chapter 13 can help you take control and save you money in the process. First of all, if the taxes are more than 3 years old, you may be able to classified them as a general unsecured debt and only pay them to the extent your income and expenses show you can afford to do so. This means much or all of the debt may be discharged. If the taxes are less than 3 years old, they have to be paid but you are allowed to propose a plan which pays them without any further interest or penalties accruing. If you have tax debt, you probably already know that a large part of the debt consists of interest and penalties. Being able to have up to 5 years to pay the tax debt interest and penalty free can be a big savings.
 
8. You owe back child support. Child support cannot be discharged in any form of bankruptcy. But child support arrears can be reorganized and paid over a 5 year period. During the time you are in the Chapter 13, you are under the protection of the bankruptcy court and you cannot be held in contempt for failure to pay the support obligation.
 
9. You have a credit score that is not too bad despite having debt problems. While both Chapter 7 and Chapter 13 have some kind of negative impact on credit scores, a Chapter 13 is a reorganization bankruptcy and does tend to look better on your credit report than a Chapter 7. If your credit score is not bad and having as good a credit score as possible is important to you, you may want to consider filing a Chapter 13.
 
Chapter 7
1. You do not make an income above the medium for Arkansas or do not have a lot of disposable income. In order to qualify for Chapter 7, you have to pass what is called a “means test”. The purpose if this test is to make sure you don’t make too much income to be allowed to discharge out your debts.  If you are below the medium income for Arkansas, you do not have to do any means testing. If you are above the medium income level, you have to take the means test to make sure you do not have a lot of disposable income left over after your reasonable living expenses are deducted from your income.  For most people the means testing is not a problem and they are allowed to file Chapter 7. An experienced bankruptcy attorney will be able to run this test to determine your eligibility for Chapter 7.
 
2. You do not owe any secured debts. If you do not have much secured debt, a Chapter 7 may be best since there are no secured debts needing to be restructured. If you have only unsecured debt, Chapter 7 will allow you to completely discharge out most such debts with the exception of things like government guaranteed student loans, child support, and taxes less than 3 years old.
 
3. You owe secured debts but you are current on them and can afford their monthly payment. A Chapter 7 may be best. If you are comfortable that you can afford the payments on the secured debts you have, you can keep these secured debts (like a house or car loan) in a Chapter 7 by signing a reaffirmation agreement with the credit. The Chapter 7 will allow you to discharge out the other unsecured debts like credit cards or medical bills (subject to the exceptions stated above like child support or student loans).
 
4. You owe back income taxes that are more than 3 years old.  A Chapter 7 can help. Income taxes more than 3 years old can generally be discharged out If the taxes were not filed on time, they can still be generally discharged out if they have to have been filed for at least 2 years and have been assessed for more than 240 days.
 
5. You owe a lot of unsecured debt like credit cards or medical bills. A Chapter 7 is a good way to discharge out general secured debts like card cards and medical bills. 
 
Let Us Show You How We Can Help
The Harris Law Firm is experienced in helping Arkansans file both Chapter 7 and Chapter 13. We have over 25 years of legal experience.  Contact us at the Harris Law Firm. You can call us at 501-372-6985 or set an appointment online. We offer free consultation. There is never a fee unless you decide to file.