Understanding Bankruptcy: A Comprehensive Guide

Bankruptcy is a legal process overseen by federal courts in the U.S. that protects individuals, couples, and businesses from financial ruin due to overwhelming debt. Upon successful completion of a Chapter 7 or Chapter 13 bankruptcy, many (but not all) consumer debts are discharged or eliminated. This guide will help you understand the differences between Chapter 7 and Chapter 13 bankruptcy, their eligibility rules, and how they impact your credit.

How Does Bankruptcy Work?

Bankruptcy provides a legal framework for individuals and businesses to manage or eliminate their debts. The process is designed to offer a fresh start by discharging certain debts while ensuring fair treatment of creditors. Debts that can be discharged through bankruptcy include unpaid credit card bills, medical bills, and unpaid rent and utility bills. However, some debts, such as unpaid alimony, child support payments, certain taxes, and federal student loans, cannot be discharged.

Chapter 7 Bankruptcy vs. Chapter 13 Bankruptcy

There are significant differences between Chapter 7 and Chapter 13 bankruptcy, primarily in how they handle debt repayment and asset protection.

Chapter 7 Bankruptcy

Chapter 7, also known as liquidation bankruptcy, is available to individuals and business entities whose financial means fall below a specified limit. In this process, assets valued beyond an exempt amount must be forfeited and sold, with the proceeds distributed among creditors. This type of bankruptcy allows debtors to quickly discharge most debts and get a fresh start, typically within three to five months.

Chapter 13 Bankruptcy

Chapter 13, or reorganization bankruptcy, is available to individuals (including sole proprietors) with regular income and total secured and unsecured debts less than $2,750,000. In this process, a bankruptcy trustee collects monthly payments from the debtor for three to five years to repay creditors. This type of bankruptcy allows debtors to keep their property and catch up on missed mortgage, car, and nondischargeable priority debt payments.

Eligibility Rules for Bankruptcy

Eligibility for bankruptcy depends significantly on your income. If your current monthly income falls below the median for your community, you are eligible for Chapter 7 bankruptcy. If your income exceeds that amount, a means test is required to determine eligibility. This test compares your household income and expenses to median values for your community. If the test finds financial means that exceed a legal threshold, you must either pursue Chapter 13 or show special circumstances to permit Chapter 7 to proceed.

For Chapter 13 bankruptcy, you must have regular income and your total secured and unsecured debts must be less than $2,750,000 on the date you file for bankruptcy.

Repayment of Debts in Chapter 7 and Chapter 13 Bankruptcy

Neither Chapter 7 nor Chapter 13 requires repayment of all outstanding debts. In Chapter 7, if you have assets of value in excess of the amount exempt by state and federal law, they are sold, and the proceeds are distributed to your creditors. If those funds are insufficient to cover all of your dischargeable debts, your obligation to pay any remaining portion of those debts is eliminated.

In Chapter 13, a repayment plan must be structured to enable full repayment of priority debts such as delinquent alimony and child support payments. It can also be used to bring you current on delinquent mortgage or car payments and allow you to keep nonexempt assets. If non-priority unsecured debts aren’t fully repaid by the end of your three- to five-year repayment term, any additional amounts you owe toward them will be discharged.

Impact of Bankruptcy on Credit

Bankruptcy is recorded on your credit reports and will adversely impact your credit scores and creditworthiness the entire time it is on your report. Chapter 7 bankruptcy remains on your credit report for up to 10 years, and Chapter 13 stays there for up to seven years, both dated from the month you file for bankruptcy. The negative credit score impact of bankruptcy eases as time passes, but some lenders refuse to extend loans or credit to anyone with a bankruptcy entry on their credit report.

Choosing Between Chapter 7 and Chapter 13 Bankruptcy

If you qualify to file for either Chapter 7 or Chapter 13 bankruptcy, choosing which procedure to follow depends on your circumstances. If you have steady income and are behind on mortgage and/or car payments but wish to keep your home or car, a Chapter 13 repayment plan is your only option for preventing foreclosure and/or repossession. Chapter 13 also has the benefit of expiring from your credit report more quickly than Chapter 7. However, failure to keep up with payments under a Chapter 13 plan can leave you with little option but eventually filing Chapter 7 anyway.

If you have relatively few assets, especially if the value of those falls below the amount exempted by applicable laws, Chapter 7 can eliminate dischargeable debt relatively quickly—typically within three to five months of your filing date—so you can start rebuilding your finances fast.

How to Apply for Bankruptcy

Before filing for either type of individual bankruptcy, you must obtain pre-bankruptcy credit counseling from a court-approved certified credit counselor. This counselor can help you sort out your options and provide guidance on the paperwork you must submit with your bankruptcy filing. All necessary forms are available to download free from the U.S. Bankruptcy Court website.

Filing for bankruptcy comes at a cost in the form of court fees. The fees for filing are $338 for Chapter 7 and $313 for Chapter 13. Additional administrative fees may apply if certain documents or addenda must be filed in connection with your case. If you file for Chapter 7, you can ask the court to permit you to pay your court fees in installments or, if your income is sufficiently low, you may ask the court to waive your fees altogether.

Finalization of both Chapter 7 and Chapter 13 cases requires completion of a debtor education class, available through court-authorized providers who may charge fees that typically do not exceed $50.

Whether you file for Chapter 7 or Chapter 13 bankruptcy, it’s typically a good idea to hire a lawyer to help with your bankruptcy. Even minor mistakes or missing a deadline by a day could get your petition thrown out. Attorney fees can differ by locality and also depend on the nature and complexity of your case. Legal fees must be paid upfront in Chapter 7 cases but may be rolled into the repayment plan with a Chapter 13 filing. Since funds are typically tight for bankruptcy applicants, local legal aid offices and online legal resources such as Upsolve may be helpful legal resources.

The Bottom Line

Chapter 7 and Chapter 13 bankruptcy differ in their approaches to repaying your creditors and their ability to protect assets you may want to keep. While both can provide relief from crippling debt, they also do significant harm to your credit and ability to borrow money. With patience and care, you can rebuild your credit after bankruptcy, and free credit monitoring from Experian can help you track your progress as your credit scores rebound.

If you are considering bankruptcy and need expert advice, O1ne Mortgage is here to help. Our experienced team can guide you through the process and help you make the best decision for your financial future. Call us today at 213-732-3074 for any mortgage service needs. We are committed to providing you with the best service and support during this challenging time.