Filing for Bankruptcy – Chapter 7 vs Chapter 13 Bankruptcy
April 29, 2009
Filing for bankruptcy can eliminate or reduce your debt but there are major consequences you should be aware of before you file for bankruptcy. Unmanageable debt is a huge problem in the U.S., bankruptcies totaled over 1.1 million last year; a 31% increase from the previous year. Here is a look at the two most common forms of personal bankruptcy, Chapter 7 vs Chapter 13, and what they mean for your finances.
Chapter 7 Bankruptcy
Chapter 7 bankruptcy is the most common type of bankruptcy for individual filers, the epitome of what people think of when they hear the term “bankruptcy”. Chapter 7 is basically a liquidation of all your assets that aren’t protected against creditors during bankruptcy proceedings.
In some states like Florida, the judge cannot force you to liquidate your principal residence if you are in good standing with your mortgage; however that is not the case in all states. With Chapter 7 your assets are liquidated to pay off your debts. Any remaining debt not covered by the sale of your assets is no longer your responsibility; your debt slate is “wiped clean”.
I don’t like that term, because there is nothing clean about bankruptcy. It is a long, painful process and it tarnishes your credit for many years to come. Also, keep in mind that federal student loans never go away since judges cannot dismiss federal student loan balances.
Chapter 7 bankruptcy is like starting over with your financial life, but the consequences for starting over are that you lose your possessions and you have a big asterisk on your credit report for the next 10 years.
Chapter 13 Bankruptcy
Chapter 13 bankruptcy is a reorganization of your debts supervised by a federal court; basically a way to renegotiate your debts and come up with a plan to repay them. Unlike Chapter 7, the debts are not dismissed by the court. Instead, your attorney and the judge work out a repayment plan to get you out of debt. In some cases the reorganization involves a reduction of the debt you’re required to pay but the debts are not completely eliminated.
Once your lawyer has negotiated the terms, you start paying monthly installment payments to a trustee appointed by the court and they distribute the funds to pay off creditors. In order to file for Chapter 13, you must show that you have income coming in on a regularly or fairly regular basis. How much you earn will determine the length of time over which they structure the repayment plan.
There are debt limits for Chapter 13 bankruptcy, if your debt is higher than a certain amount then the current laws won’t allow you to file for Chapter 13.
Chapter 7 vs Chapter 13
The advantage of chapter 7 is that you start over with no debt. Obviously a big disadvantage of chapter 7 is that creditors will take anything and everything they are allowed to get their hands on to pay off as much of your debt as possible before the courts wipe away the rest of it.
Of course, if you’re so deep in debt that you could never pay it all back you may be willing to sell everything you have to be free of it. A recent CNN Money article describes Chapter 7 as “often the best option for consumers saddled with insurmountable debt”.
Not having to sell all of your possessions is the upside to Chapter 13. One big advantage of chapter 13 for home owners that can work out a repayment plan with their bank is that you can keep your house. Another benefit is that a Chapter 13 stays on your credit report for a shorter time period than a Chapter 7; although they will both ruin your credit until they fall off your history.
Filing for Bankruptcy
If you are considering filing for bankruptcy, remember it is one of the biggest financial decisions you’ll ever make. The CNN Money article cautions against filing for bankruptcy without first doing your research.
“be wary of any potential conflicts of interest from credit counseling agencies or bankruptcy lawyers that could potentially profit from your position”
Not only should you consult with an attorney, it would be smart to talk it through with close friends and family. Another suggestion is to sit down and talk with people that have gone through a bankruptcy filing to hear their experience and what they learned from it.
Alternatives to Bankruptcy
As we’ve covered, bankruptcy is not an easy solution to getting out of debt. There are definitely other options you should look into before considering filing for bankruptcy.
Negotiating with Creditors – Your creditors would rather recieve a portion of the money you owe them than none of it so they may be willing to work with you. You can call the companies you owe money to, explain your situation, and try to work out a payment plan that will allow you to pay off the debt rather than simply defaulting on it.
Credit Counseling – The surge of debt problems in the U.S. has given rise to many credit counseling organizations that can work with you to help address your debt. A lot of them have education options where they’ll show you how to better manage your money and some of them will help you negotiate with your creditors.
Not all organizations claiming to be credit counselors have your best interest in mind, beware of fraudulent debt reduction companies. The US Trustee Program can help you find credible credit counseling services. The Trustee Program is:
“the component of the Department of Justice responsible for overseeing the administration of bankruptcy cases and private trustees under 28 U.S.C. § 586 and 11 U.S.C. § 101”
They have a portion of their website dedicated to credit counseling & debtor education information where you’ll find a list of approved credit counseling agencies.
Borrowing from Friends & Family – You can’t borrow your way out of debt but if you need some money to get through a tight spot one option is borrowing money from people you know. It’s certainly a tricky proposal that could ultimately ruin a relationship if not handled properly. However, if both parties are up front about what’s expected and responsible about meeting the agreed upon terms it could be a workable option. Here’s an article about borrowing money from family.
- Approved Credit Counseling Agencies
- Credit Counseling Frequently Asked Questions
- Approved Debtor Education Counselors
- Choosing a Credit Counselor
All posts by Ben Edwards