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Bankruptcy

Bankruptcy: Chapter 7 vs. Chapter 13



When you’re facing bankruptcy, it can seem like the end of the world, but it doesn’t have to be. In fact, bankruptcy can give you a way out of a bad financial situation. And you’re certainly not alone.

According to Debt.org, in 2020, there were 544,463 bankruptcy filings: 70% Chapter 7 and 28% Chapter 13. Chapter 7 and Chapter 13 are two sections of the U.S. Bankruptcy Code outlining different ways of settling your debts. In this article, we compare them to help you decide which one might be right for you. But first, you should carefully consider whether bankruptcy is a good route for you at all.

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Key Takeaways

Chapter 7

  • Is the most common way to declare bankruptcy
  • Liquidates your assets to pay off debt—but most people get to keep their property
  • Requires a means test
  • Discharges all remaining eligible debt after liquidation
  • Leaves you with a clean slate

Chapter 13

  • Involves no liquidation of assets
  • Reorganizes debt into a monthly payment
  • Comes with terms of 3–5 years
  • Discharges your remaining eligible debts at the end of the term
  • Has a high failure rate

Is Bankruptcy The Right Choice for Me?

Bankruptcy may be a necessary step if your debts have become so overwhelming that you’ll never catch up, given your current circumstances. But filing for bankruptcy should be a last resort after you’ve explored all your options. The damage to your credit can be substantial, making it hard or even impossible to get a car loan or mortgage—maybe even a job.

There are alternatives to bankruptcy you should consider first.

Debt Settlement

If you go into bankruptcy, your creditors risk not getting any payment toward your debt. They know this, so they may be willing to negotiate a reduced debt settlement. To them, some payment is better than none.

Depending on your settlement agreement, you may be able to reduce what you owe by up to 50%. Repayment plans commonly give you 2–3 years to pay off the remaining debt. Your creditors will also stop any collection efforts, including harassing calls from collection agencies.

You can approach creditors yourself for a settlement or go through a debt settlement company. Working with a company may make the negotiations easier, but you’ll pay a percentage fee for each creditor it reaches an agreement with. Always do your research on a company before agreeing to their terms.

Before you can negotiate a settlement, you must already be defaulting on your debt. This means stopping payment on all the loans you want to try to settle. Of course, this isn’t going to be good for your credit score. Furthermore, a debt settlement remains on your credit report for seven years, and the unpaid balance is considered income, so you have to report it on your tax return.

Debt Consolidation

Another alternative to bankruptcy is to consolidate your debt into a single, more manageable payment. We suggest going through a reputable, non-profit credit counseling service to create a plan for consolidation and repayment.

A debt consolidation service works with your creditors to reduce interest rates, waive fees, and determine a monthly payment amount you can afford. You make this payment to the credit counseling service, which distributes it among your creditors. You don’t have to deal directly with creditors, and they stop their collection efforts—including calls.

Debt consolidation doesn’t affect your credit score as long as you make your payments on time, but you will have to close the credit cards you’re consolidating.

Debt settlement and debt consolidation aren’t applicable to all forms of debt. And it’s completely up to your creditors if they want to work with you this way; they’re within their rights to demand full payment. In this case, bankruptcy may be your only remaining option.

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How Do Bankruptcy 7 and 13 Work, and Am I Eligible?

When you file for any type of bankruptcy, a judge and court trustee look at all your assets and liabilities. They’ll determine whether you’re eligible and what type of bankruptcy is appropriate.

If you’re eligible, the court will decide whether to discharge (forgive) your debts or restructure them.

Be aware, if you’ve already filed for Chapter 7 and had your debt discharged at some point during the previous eight years, or six years for Chapter 13, you’re not eligible to file again. You’re also ineligible if you had a Chapter 7 or Chapter 13 bankruptcy dismissed in the last 180 days because you violated a court order or your claim was determined to be fraudulent.

The Department of Justice requires you to complete a credit counseling course within 180 days of a bankruptcy filing. You’ll need to choose a U.S. Trustee-approved agency and be ready to submit the certificate of completion from the course.

After filing, you’re required to complete a financial management course with an approved debtor education program before your debts can be discharged.

The differences between Chapter 7 and Chapter 13 bankruptcy relate to your total amount and type of debt, as well as requirements regarding your income. Let’s take a look.

What is Chapter 7 Bankruptcy?

The goal of Chapter 7 Bankruptcy is to get rid of any unsecured debt (credit cards, personal loans, medical bills) you may have, while Chapter 13 focuses on restructuring your debts so you still make some amount of payment toward them.
Chapter 7 Bankruptcy

Chapter 7 is the most common type of bankruptcy, aiming to completely discharge eligible debts. (Ineligible debts include tax debt, alimony or child support, and student loan debt.)

With Chapter 7, your assets are liquidated (sold), and the proceeds go toward your debt. You may be wondering, “Will I lose my house if I file Chapter 7?” According to Upsolve, a non-profit that helps low-income families file for bankruptcy at no charge, more than 95% of people filing for Chapter 7 bankruptcy keep their primary residence, car, and most of their household property.

Filing Chapter 7 also requires a means test—a measure of your income compared to the median income in your state—to determine whether you qualify.

If you do, the court will issue an automatic stay immediately after you file. This bans creditors from taking any collection actions against you. No more harassing calls or threatening letters. Collection actions are also banned after all your debts have been wiped out.

Chapter 7 helps you keep more of your future earnings. Creditors are not allowed to take any of your wages for your debt after you file. Money or property that you receive after filing usually doesn’t go into your liquidated assets (with some exceptions).

There are no debt limits with Chapter 7, and once you file, things happen quickly. Most debts can be discharged within three months.

Bankruptcy with Chapter 7 will stay on your credit report for ten years, which can affect your credit score negatively. Don’t forget, though, that having outstanding unpaid debts will hurt it, too.

Chapter 7 doesn’t protect anyone else who co-signed for credit or loans with you. They aren’t subject to the automatic stay, so creditors may still contact them.

Finally, bankruptcy is a matter of public record, so anyone who goes looking for that information about you will be able to find it.

What is Chapter 13 Bankruptcy?

If Chapter 7 is the most common form of bankruptcy and has a high success rate, why would you file Chapter 13 instead?

The most common reason is that you don’t qualify to file for Chapter 7.

Chapter 13 is an option if you have both unsecured and secured debt. Remember that secured debt isn’t eligible for discharge under Chapter 7.

Chapter 13 reorganizes your debts into a more manageable monthly repayment plan. For 3–5 years, as long as you make your repayments, any remaining debt is discharged (with some exceptions) at the end of the term.

Chapter 13 is geared toward those who do have income and can repay some of their debts, even if they don’t completely clear them. You get the same automatic stay to protect you from creditors, and you don’t have to liquidate any of your assets. Unlike Chapter 7, any co-signers are also protected under the automatic stay.

Any foreclosure or repossession of property is halted. Chapter 13 allows you to catch up on back payments for your mortgage, car, or other priority debts. You still need to make your regular mortgage or car payment, though—the reorganization is for your outstanding debt only.

The reorganization and repayment plan takes all of your debt and categorizes it as either priority, secured, or unsecured. Your plan will put money toward your priority debts first—those need to be paid in full over the life of your repayment plan. Priority debts include back taxes, court fees, and child support or alimony.

Secured debts are paid next. This could mean missed mortgage payments or car payments.

Unsecured debts, such as credit cards, are paid last. It’s possible that your unsecured debt won’t be paid in full by the end of your repayment period, and any remaining balance will be discharged.

Filing for Chapter 13 bankruptcy does have some disadvantages.

Only individuals, not businesses, can file for Chapter 13—and there is a debt limit. You can’t have unsecured debts greater than $394,725 or secured debts over $1,184,200.

Also, it’s common for people to be unable to complete repayment. According to Upsolve, Chapter 13 bankruptcy has a 67% failure rate.

When you’re approved for a Chapter 13 repayment plan, the expectation is that you put all your disposable income—as calculated at the time of filing—toward your debts. Things can change a lot in five years, and you may find yourself unable to continue making those payments.

Failing to complete repayment can leave you in a worse place than where you started—back to being responsible for the entirety of your debt without any of the protections you had under bankruptcy. The filing is still on your credit report, and you may now owe court and attorney fees.

The high failure rate also means you could still lose your house or car—something you were trying to avoid when you filed for Chapter 13 in the first place.
What Happens to Your Credit in Chapter 7 vs. Chapter 13 Bankruptcy?

Filing for bankruptcy can be a way to climb out from under a mountain of debt and give yourself a fresh start, but it’s not something to do lightly.

Even though your credit score will take a hit under both Chapter 7 and Chapter 13, there are ways to repair credit after bankruptcy.

How Do I Repair My Credit After Bankruptcy

You’ll have taken a mandatory financial management course as part of your agreement—now’s the time to put that knowledge to work. Building a realistic budget, one that allows for emergencies and some fun stuff, will give you a plan to follow.

Make sure to keep up with any remaining debts you have. Missed payments are toxic to your credit score.

If possible, take out a small loan or a new credit card. Showing that you’re reliable when paying your bills and completing a loan repayment goes a long way toward building credit.

Make sure your payments are being reported to credit bureaus. You can even request that non-credit payments such as utility bills be reported. Any positive activity (making payments on time) will help raise your credit score.

Check your credit reports regularly. Errors in your credit report will hurt you through no fault of your own. It’s not uncommon to find inaccurate information, so double-check yourself. If you find something there that you don’t recognize at all; for example, if someone has stolen your identity and filed bankruptcy in your name fraudulently, a credit repair professional can support you in eliminating this negative item from your report.

Lastly, keep your balances low. Your credit score is partially determined by your debt to credit ratio. Using a smaller percentage of your overall available credit is a positive to potential lenders.

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FAQ

Which is better, Chapter 7 or Chapter 13?

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This depends on your individual circumstances. Generally, Chapter 7 is considered quicker and more cost-effective, but not everyone is eligible for this route to settling debts.

Which is worse on credit, Chapter 7 or 13?

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Both Chapter 7 and Chapter 13 will negatively affect your credit score and stay for a period of several years on your credit report. However, with patience, careful financial management, and perhaps even the help of a credit repair expert, it's possible to rebuild your credit.

What is the difference between Chapter 7 and Chapter 13 bankruptcy?

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Chapter 7 bankruptcy wipes out any unsecured debts (e.g., credit cards, personal loans, and medical bills) you may have, once a court approves your application. Chapter 13 creates a restructured debt repayment plan to help you pay off at least some of your debts over time.

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