FAQ #12: What is the difference between a Chapter 7 and a Chapter 13 Bankruptcy?

Chapter 7 Bankruptcy, sometimes referred to as "liquidation" or “straight bankruptcy”, is designed for people who do not have the ability to pay their existing debts. To prove that you cannot pay your debts, you are subject to a "means test" designed to determine whether the case should be permitted to proceed under Chapter 7. The means test generally looks at the debtor’s gross income from all sources over the past six months, and if it is over the median income for your state, then you cannot file Chapter 7 bankruptcy because the formula has determined you have enough excess income to pay your debts over time. There are some exceptions to the “means test” so you should consult with an attorney to be sure.

At the end of a Chapter 7 Bankruptcy (usually about 6 months) you receive a discharge of your debts and you no longer owe those debts (except for some debts like student loans which cannot be discharged).

Chapter 13 Bankruptcy involves the repayment of all or part of your debts with your excess monthly income. Chapter 13 is designed for individuals with regular income who can pay at least some of their debts in installments over a period of time.

Under Chapter 13, you must file with the Bankruptcy Court a plan to repay your creditors all or part of the money that you owe them, using your future earnings. The period allowed by the court to repay your debts may be three (3) to five (5) years, depending on your income and other factors. The court must approve your plan before it can take effect.

Provided that you have complied with the plan and made all payments required under the plan, at the end of a Chapter 13 repayment plan (3-5 years) you will receive a discharge of the unpaid portion of your debts (except for some debts like student loans which cannot be discharged).

Because a Chapter 13 requires some payments of your debt, it is not usually a person’s first choice. However there are some good reasons to file Chapter 13:

A Chapter 13 is often filed:

1. To stop foreclosure and cure mortgage arrears, allowing someone to keep a house they might lose in a Chapter 7 case;

2. If the debtor is over the means test limit for a Chapter 7 case, but still wants a fresh start debt after 3-5 years;

3. To pay tax debt over time;

4. To protect property from creditors and avoid a Chapter 7 liquidation of assets;

5. To sell property to maximize price, rather than let it go to Chapter 7 auction; and

6. To avoid dischargability problems with creditors that might occur in a Chapter 7 (although the 2005 changes to the Bankruptcy Code have reduced Chapter 13 filing's ability to avoid dischargability problems).