Chapter 7 vs. Chapter 13 Bankruptcy: Which One Is Right for You?

Financial struggles can be overwhelming, and if you’re facing mounting debt, bankruptcy might be a viable solution to get a fresh start. But with different types of bankruptcy available, how do you know which one is right for you? The two most common options for individuals are Chapter 7 and Chapter 13 bankruptcy—each serving a different purpose and carrying its own advantages and drawbacks.

In this blog, we’ll break down the key differences between Chapter 7 and Chapter 13 bankruptcy, helping you understand how each one works, who qualifies, and which option may best fit your financial situation.

Understanding Bankruptcy: A Brief Overview

Bankruptcy is a legal process that helps individuals and businesses eliminate or restructure debt under federal court supervision. While it may seem like a drastic step, bankruptcy exists to offer financial relief and prevent people from being trapped in insurmountable debt.

The two most common types of personal bankruptcy are:

• Chapter 7 Bankruptcy – Known as liquidation bankruptcy, this option allows you to discharge most unsecured debts by selling non-exempt assets.
• Chapter 13 Bankruptcy – Often called reorganization bankruptcy, this plan allows individuals to restructure their debts and pay them off over time.

Now, let’s take a closer look at each.

What Is Chapter 7 Bankruptcy?

Chapter 7 bankruptcy is designed for individuals who have significant debt and limited income. It allows for the discharge (elimination) of most unsecured debts, such as:

• Credit card debt
• Medical bills
• Personal loans
• Utility bills

How Chapter 7 Works

1. Filing the Petition: You file a petition in bankruptcy court, along with financial documents listing your debts, income, and assets.
2. Automatic Stay: Once filed, creditors must immediately stop collection efforts, including wage garnishments and lawsuits.
3. Asset Review and Exemptions: A court-appointed trustee reviews your assets to determine if any non-exempt property can be sold to repay creditors. However, many states have exemptions that allow you to keep essential property like your home, car, and personal belongings.
4. Debt Discharge: After about three to six months, most remaining unsecured debts are discharged, meaning you are no longer legally obligated to repay them.

Pros of Chapter 7 Bankruptcy

• Fast process (typically three to six months)
• Most unsecured debts are completely eliminated
• No repayment plan required
• Provides a fresh financial start

Cons of Chapter 7 Bankruptcy

• You may lose non-exempt assets
• It stays on your credit report for ten years
• Does not eliminate secured debts like mortgages or car loans
• Not everyone qualifies—income must be below a certain threshold

Who Qualifies for Chapter 7?

To be eligible, you must pass the means test, which evaluates your income, expenses, and ability to repay debts. If your income is too high, you may need to consider Chapter 13 instead.

What Is Chapter 13 Bankruptcy?

Chapter 13 bankruptcy is for individuals who have regular income but need help reorganizing their debts into a manageable repayment plan. Unlike Chapter 7, it does not involve liquidating assets. Instead, you work out a three- to five-year repayment plan to pay off debts over time.

How Chapter 13 Works

1. Filing the Petition: Just like Chapter 7, you submit your financial details to the bankruptcy court.
2. Creating a Repayment Plan: You work with the court to develop a payment plan that fits your budget.
3. Automatic Stay: Creditors must stop collection efforts, foreclosures, and wage garnishments.
4. Making Payments: You make monthly payments to a bankruptcy trustee, who distributes funds to creditors according to the plan.
5. Debt Discharge: After successfully completing the repayment plan, any remaining eligible debts are discharged.

Pros of Chapter 13 Bankruptcy

• You can keep your home and other valuable assets
• Stops foreclosures and repossessions
• Allows you to catch up on missed mortgage or car payments
• Unsecured debts (like credit cards) may be reduced

Cons of Chapter 13 Bankruptcy

• Takes three to five years to complete
• Requires consistent income to make payments
• Stays on your credit report for seven years
• Missed payments could lead to dismissal of the case

Who Qualifies for Chapter 13?

• You must have regular income
• Your debts must fall below a certain threshold (as of 2024, unsecured debts must be under $465,275 and secured debts under $1,395,875)
• You must complete credit counseling before filing

Key Differences Between Chapter 7 and Chapter 13 Bankruptcy

The main difference between Chapter 7 and Chapter 13 bankruptcy is how debts are handled. Chapter 7 is a liquidation bankruptcy, meaning most unsecured debts, like credit cards and medical bills, are wiped out. However, if you have non-exempt assets, they may be sold to pay creditors. This process typically takes about three to six months and is best for individuals with little to no income who need a fresh start.

On the other hand, Chapter 13 is a reorganization bankruptcy that allows individuals with regular income to create a three- to five-year repayment plan. This option helps those who want to keep their home, car, or other valuable assets while catching up on missed payments. Unlike Chapter 7, Chapter 13 does not require asset liquidation, but it does require consistent income to make monthly payments.

Another key difference is the impact on credit. A Chapter 7 bankruptcy remains on your credit report for ten years, while a Chapter 13 stays for seven years. While both negatively affect your credit score initially, Chapter 13 may be viewed more favorably by lenders since it demonstrates an effort to repay debts.

If you qualify for Chapter 7, it is often the faster and simpler option. However, if you have significant assets you want to protect or need time to catch up on secured debts like a mortgage, Chapter 13 may be the better choice. Understanding your financial situation and long-term goals can help determine which type of bankruptcy best fits your needs.

Which Bankruptcy Option Is Right for You?

Choosing between Chapter 7 and Chapter 13 depends on your financial situation, income, and long-term goals. Here’s a quick guide:

• If you have little to no income and cannot repay debts, Chapter 7 may be the best option.
• If you want to keep your home and have regular income, Chapter 13 is likely the better choice.
• If you have a lot of secured debt (mortgage, car loan, etc.), Chapter 13 may help prevent foreclosure or repossession.
• If you just need a fresh start and don’t have many assets to protect, Chapter 7 can help wipe the slate clean.

Contact Our Chapter 7 & Chapter 13 Bankruptcy Lawyers

Bankruptcy is often misunderstood, leading to myths and misconceptions that can deter individuals from seeking help. One common myth is that bankruptcy permanently ruins your financial future, when in fact, it can provide a fresh start and an opportunity to rebuild. Another misconception is that all debts are discharged in bankruptcy; however, certain obligations, like student loans and child support, typically remain. It's also important to recognize the emotional and psychological aspects of filing for bankruptcy, as it can be a stressful and overwhelming process. Understanding these realities can help you approach bankruptcy with a clear mind and realistic expectations.

As you consider your options, remember that The Law Firm of Marshall A. Entelisano is here to help. Located in Tuscaloosa, AL, our experienced team specializes in bankruptcy law and can guide you through the complexities of Chapter 7 and Chapter 13. Contact us today to schedule a consultation and take the first step toward financial freedom.

Call (659) 336-2597 or reach out online to speak with a reliable Chapter 13 bankruptcy lawyer in Tuscaloosa about how you can live life debt-free. Free consultations are available.