Some basic differences between Chapter 7 and Chapter 13 bankruptcies

What are the differences between a Chapter 7 and a Chpater 13 bankruptcies?

When it comes to bankruptcy, the many differences between a Chapter 7 bankruptcy and a Chapter 13 bankruptcy can be a source of common confusion.  This guide is intended to point out many of the basic differences.

The most basic difference between a Chapter 7 and 13 bankruptcy is the way they operate.

Although a Chapter 7 and a Chapter 13 both typically wipe away debts, the way these bankruptcies operate is distinctly different.

A Chapter 7 bankruptcy is often referred to as a “liquidation bankruptcy.”  This common description is a little bit misleading since certain assets of the debtor are protected by what are called exemptions.  In Mississippi, exemptions are set out in protective laws that specify certain types and values of property that our state legislature has decided we get to keep through a bankruptcy.  Exempt property is generally of the type that is needed to live and provide for one’s self and family.

What the debtor owns will then be examined by an individual called the Chapter 7 trustee.  The Chapter 7 trustee is a court appointed individual who collects and examines the debtor’s non-exempt property to decide whether there is anything to be collected and sold to pay creditors.  In a large number of bankruptcy cases the consumer’s assets will all be exempt and will not be subject to sale by the bankruptcy trustee.  The trustee sells property collected and then splits the proceeds between the creditors who are owed money by that individual.

When compared to other court proceedings, a Chapter 7 usually moves quickly, often lasting only a few months from start to finish.

A Chapter 13 bankruptcy is sometimes referred to as a “wage earner’s plan” or a “reorganization.” A chapter 13 bankruptcy provides an opportunity to reorganize and wipe out debt without having to liquidate or sell any of your assets. Chapter 13 can also wipe out more types of debt than a Chapter 7.  In a Chapter 13 an income based plan for the payments to creditors is submitted to the court for approval.  Depending on your income, the plan will last either 3 years or 5 years.  When the plan is completed, the bankruptcy court discharges, or wipes out, the eligible debts that remain.  As discussed more fully below, Chapter 13 plans are useful for stopping foreclosure and auto repossession.  Chapter 13 also provides useful tools for dealing with certain difficult debts.

Keep assets vs. give them up

In a Chapter 7 bankruptcy you may have to give up assets that don’t fall within the exemptions provided by Mississippi law.  Most of the time your property will be protected by the exemptions, but if you have valuable property that is not protected by the exemptions, the Trustee will collect those assets and sell them.  The money from the sale will then be paid out to your creditors.

In a Chapter 13 bankruptcy, you keep all of your assets.  Your debt payments are restructured.  You make the plan payments for 3 or 5 years, at the end of which time, the eligible debt that remains is discharged by the Court.  With unsecured debts like credit cards and medical bills you make a reduced payment on the debts which are then wiped out by the court at the end of the plan.

In other words Chapter 7 lets you keep the assets that the law deems exempt.  In Chapter 13 you keep all your assets if you want.

Another difference between Chapter 7 and Chapter 13 is the ability to dismiss the case

Once you file a Chapter 7 it can only be dismissed after a hearing and for a good reason.  A chapter 13 voluntarily filed can be also be voluntarily dismissed, even over the objections of creditors.

Stopping creditors

One of the big benefits of filing a bankruptcy is the automatic stay.  This is an order of the court that automatically stops the collection efforts of creditors.  The automatic stay puts a halt to everything from harassing phone calls to foreclosure on a house.  It also stops lawsuits, repossessions, garnishments and utility shut offs.  This stay is designed to give you some breathing room and allow for an orderly process of sorting out debts and assets.

In a Chapter 7, the automatic stay is only in place for a short period of time while the case is pending, usually 3 to 4 months.  If your home was being foreclosed on the stay in a Chapter will stop the proceeding, but only for a few months.  After that the foreclosure process will start again.  In Chapter 13, however, the stay is in place until the chapter 13 plan is approved by the court.  After that time, all actions between you and your creditors are subject to the plan.  As long as you make your payments, the majority of your creditors must leave you alone until the 3 or 5 year plan period is over.

Mortgages and Automobiles

If you are behind on your mortgage or car payment and don’t have a way to immediately catch them up, a Chapter 7 bankruptcy typically will not help keep the home or the car.  A chapter 7 can stop a foreclosure or repossession for a few months while the bankruptcy is pending.  If you are not able to catch up past due amounts by that time the bank may go forward with the foreclosure or repossession.  The stay may not even last that long.  If a bank is worried about its collateral, it can ask the court for permission to move forward with the foreclosure or repossession even though the bankruptcy is pending.

On the other hand, Chapter 13, allows you to catch up past due payments on mortgages and car loans over the course of the plan, 3 or 5 years.  You can, therefore, get caught back up through the plan, and make your regular payments to keep the house and or car.  As long as you comply with the terms of the plan your house and car will be protected from creditors over the 3 or 5 year period the bankruptcy is pending.

Debts that are discharged in 13 but not in 7

Bankruptcy can legally and permanently get rid of debts that you owe.  Not all debts are wiped out though.  Chapter 13 wipes out more types of debts than a chapter 7.   Rather than try to list the different types of debts here, I have included some of the more common ones.

Second and greater mortgages

On a primary residence that has a first and second mortgage and the amount owed on the first mortgage is more than the value of the property, Chapter 13 can be used to remove, or “strip,” second and third mortgages from your home.  The United States Supreme Court has recently confirmed that this is not an option available in a chapter 7 bankruptcy.

Debts incurred for the purpose of paying non-dischargeable Federal, State or Local taxes

If you took out a loan (including paying by credit card) to pay taxes that are otherwise not dischargeable in bankruptcy, the money you borrowed to pay the taxes will not be wiped out or discharged in a Chapter 7 bankruptcy.  In Chapter 13, however, you can get rid of this kind of debt.

Undersecured liens

In certain situations a chapter 13 allows what is commonly called “lien stripping” with respect to secured assets.  Lien stripping is where you strip off debt from an asset such as a car or house.  Chapter 13 also allows you “strip” the interest rate down to a lower rate decided by the court.  In situations where lien stripping is allowed, you keep paying the debt for the asset, but the total amount you have to pay is now lower.  Chapter 7 does not allow you to strip down debts secured by assets.  In chapter 7 you are stuck with the amount of the debt and the interest rate you initially agreed to.

Criminal restitution

While not often applicable, Chapter 13 allows the discharge of restitution orders imposed as a condition or probation.  Chapter 7 does not.

Debts for willful and malicious injury

Damages for willful and malicious injury to another or their property are not dischargeable in a Chapter 7.  In Chapter 13 debts for malicious injury to property of another are dischargeable.  Also debts for malicious injury to another are dischargeable in Chapter 13 if the bankruptcy is filed before an award for the damages is adjudicated or finalized by the court.  In other words you will need to file for bankruptcy before the lawsuit is over for this to apply to malicious injury to a person.

Chapter 13 provides a way to deal with unmanageable debts over time even though they are not dischargable in bankruptcy

 Debts such as student loans are typically not discharged in bankruptcy.  Once the automatic stay is lifted in a Chapter 7, your student loan holders can go back to their collection actions against you, including wage garnishments.  Chapter 13, however, provides a way to stop garnishments and other collection actions on these loans.  You can also use the Chapter 13 to decrease the amount of the payments you make on the loans during the 3 to 5 year period of time the bankruptcy is pending.   Unfortunately interest still accumulates on student loans during the period of the plan and will be waiting on you afterwards. Putting student loans in a Chapter 13 plan, however, potentially offers a way to deal with this difficult debt until you are in a better position to pay it off.

Chapter 13 can offer protection to co-signers on loans that chapter 7 cannot

 If you have a family member or friend who co-signed on a consumer debt you owe and you want to protect that person from collection actions.  In chapter 7, co-signers are not protected and creditors can immediately go after them for the full amount of the debt they co-signed on.  In most instances, a co-debtor or co-signer of a consumer loan is protected through the duration of a chapter 13 plan while you make payments on that debt through the plan.

Alimony and Child support Nonsupport debts from a divorce

Alimony and child support cannot be discharged in any bankruptcy.  This doesn’t include all debts resulting from a divorce, though.  There are some debts from divorce that can be discharged in a Chapter 13 but not a Chapter 7.  These are called non-support debts.  They are debts, other than domestic support obligations (alimony and child support) you owe to your former spouse from a divorce or separation agreement. Non-support debts are more commonly known as property settlement debts.  These debts can be wiped out by a Chapter 13, but not in a 7.

Chapter 13 can also be used to get caught up on past due alimony and child support payments through the Chapter 13 plan.

Income limitations

If most of your debts are consumer debts as opposed to business debts there are income limitations for filing a Chapter 7 bankruptcy.  If you don’t meet certain exclusions, and your current monthly income is above the median income for the state, some calculations are required to determine whether you are eligible for a Chapter 7.  Chapter 13 is generally available regardless of income.  If you have over a certain amount of debt, however, you may not be eligible for a Chapter 13.

How long will bankruptcy stay on your credit report?

According to credit bureau, Equifax, a Chapter 7 bankruptcy stays on your credit report for 10 years from the date of filing.   A Chapter 13 stays on a credit report for 7 years from the date filed.  Since a Chapter 13 lasts either 3 or 5 years depending on your income, the bankruptcy will only be on your report for 2 to 4 years after the bankruptcy is complete.  For most, the bankruptcy will not make their credit report any worse, but will instead begin to make it better.

Cost and payment

A chapter 13 takes longer and is more involved than a Chapter 7.  Attorney fees are, therefore, higher for a 13 than a 7.  In Chapter 13, however, fees may be paid as part of the plan.  In chapter 7 all fees must be paid before filing.

If you are considering bankruptcy protection and have questions about how the different types of bankruptcy may apply to your specific situation, please feel free to contact us.  To schedule an initial free and confidential consultation to discuss your particular situation call 601-853-9966.