The U.S. Bankruptcy Code provides six ways to wipe out debt. Of these, Chapter 7 and Chapter 13 are the two that consumers use the most often. According to Debt.org, about 70 percent of all consumer bankruptcies are Chapter 7, and the other 30 percent are Chapter 13. Although both accomplish essentially the same thing, each is significantly different from the other. Understanding their differences is an important part of researching your options.
Liquidation vs. Reorganization
The main difference between Chapter 7 and Chapter 13 is that Chapter 7 cancels most or all of your unsecured debts within three to six months, and Chapter 13 cancels only those debts you can’t repay within a three- to five-year period.
Chapter 7 bankruptcy is a liquidation plan. In exchange for eliminating debt, the trustee has the option to repay creditors a portion of what you owe by seizing and selling assets and property not protected by state law.
Chapter 13 is a wage earner’s reorganization plan. It requires that you follow the terms of a court-approved repayment plan in which you cure secure debt deficiencies and repay as much unsecured debt as possible within the repayment period.
Each type has its own eligibility restrictions. To qualify for Chapter 7, you must first pass the Chapter 7 means test. The test is designed to prevent bankruptcy abuse and force people who have enough financial resources to repay debts via a Chapter 13 reorganization plan. It compares your household income to the median household income for your state. The more your income exceeds the median for your state, the greater the chance is that you won’t qualify.
Chapter 13 eligibility requirements focus not on your income, but on the amount of secured and unsecured debt. To qualify, you can’t have more than $1,010,650 in secured debt and $336,900 in unsecured debt as of publication.
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A Chapter 7 bankruptcy remains in your credit history for 10 years, while a Chapter 13 bankruptcy notation is usually deleted after seven years. Although both affect your credit score, according to the American Bar Association, creditors may view a Chapter 13 repayment plan more favorably than a Chapter 7 bankruptcy.
Unlike a Chapter 7, which is over and done within three to six months, a Chapter 13 takes up to five years to complete. During this time, you must get the court’s permission to incur any new debt and need to turn over most of your disposable income, including tax refunds, to the trustee handling your case.
A Chapter 7 bankruptcy usually requires that you appear in court only for the meeting of creditors. With a Chapter 13, you must attend the meeting of creditors and the repayment plan confirmation hearing and may need to appear in court if you miss any payments or to get permission to take on a new loan.
Advantages and Disadvantages
Filing a Chapter 7 bankruptcy petition puts your home, vehicle and valuable assets at risk. Although it wipes out debt quickly, the mark on your credit history can be difficult to overcome.
A Chapter 13 bankruptcy won’t affect your possessions as long as you keep your payments current. However, completing a Chapter 13 repayment plan successfully requires a significant long-term commitment. If you default on the plan, the trustee has the option to dismiss your case, which leaves your creditors free to resume collection activities. According to Debt.org, more people fail than succeed.