What are Chapter 7 and Chapter 13 bankruptcy?
Chapter 7 and Chapter 13 are two different kinds of bankruptcy in the United States. They are part of bankruptcy law. Bankruptcy law helps people who owe more money than they can pay back. It gives them a fresh start.
How Chapter 7 and 13 are different
Chapter 7 and Chapter 13 work in different ways:
- In Chapter 7, the person who owes money (the debtor) has to sell most of what they own to pay back some of the debt. The rest of the debt goes away.
- In Chapter 13, the debtor gets to keep what they own. But they have to pay back some or all of their debts over 3 to 5 years. They make payments based on how much money they make.
How Chapter 7 works
Chapter 7 is also called “straight” or “liquidation” bankruptcy. Here is what happens in a Chapter 7 case:
Filing for Chapter 7
The debtor files bankruptcy forms called a “petition” with the bankruptcy court. They also file other forms that show:
- What they own (their assets)
- How much they make (their income)
- What they owe (their debts)
- Their monthly living expenses
The Automatic Stay
When the debtor files for bankruptcy, the “automatic stay” starts right away. The automatic stay means creditors cannot try to collect on debts. They cannot:
- Call the debtor
- Send bills to the debtor
- Sue the debtor
- Take the debtor’s property
The automatic stay gives the debtor a break from their creditors. It gives the debtor time to go through the bankruptcy process.
The Bankruptcy Trustee
After the debtor files, a bankruptcy trustee is put in charge of the case. The trustee’s job is to look out for the creditors who are owed money. The trustee reviews the debtor’s bankruptcy forms. The trustee makes sure the debtor is following the rules. In a Chapter 7 case, the trustee also sells the debtor’s nonexempt assets and uses the money to pay creditors.
The 341 Meeting
About a month after filing, the debtor must go to a “341 meeting” (also called a “meeting of creditors”). At the meeting, the trustee and any creditors can ask the debtor questions under oath about their bankruptcy forms and financial situation.
Property the Debtor Can Keep (Exempt Property)
Each state has a list of exempt property that the debtor can keep in Chapter 7. Exempt property often includes:
- Clothing
- Household furnishings
- An older car
- Tools needed for the debtor’s job
- Some retirement accounts
The trustee cannot sell exempt property to pay creditors.
Property the Trustee Sells (Nonexempt Property)
Property that is not on the state exemption list is “nonexempt.” The trustee can sell the debtor’s nonexempt property and use the money to pay creditors.
Many Chapter 7 cases are “no asset” cases. This means the debtor does not own any nonexempt property. The trustee does not sell anything. The debtor keeps everything they own. The creditors do not get paid.
The Discharge
At the end of a Chapter 7 case, the court enters an order called a “discharge.” The discharge wipes out (forgives) most of the debtor’s debts. Some debts (like most student loans) cannot be discharged. After the discharge, the debtor is no longer legally required to pay any discharged debts.
Most Chapter 7 cases take about 4 to 6 months from filing to discharge.
How Chapter 13 works
Chapter 13 is also called “reorganization” or “wage-earner” bankruptcy. It works very differently than Chapter 7. In Chapter 13, the debtor keeps their property. In exchange, they must pay back some or all of their debts over time.
The Chapter 13 Plan
To start a Chapter 13 case, the debtor files a packet of bankruptcy forms. This packet includes a proposed repayment plan. The plan shows:
- How much money the debtor will pay to the trustee each month
- How long the plan will last (3 to 5 years)
- Which debts the plan will pay and how much
The debtor starts making plan payments to the trustee 30 days after filing the case — even if the court has not yet approved (“confirmed”) the plan.
The Confirmation Hearing
After the debtor files the plan, the court holds a hearing to decide if the plan follows bankruptcy law. If it does, the court “confirms” (approves) the plan. If the court does not confirm the plan, the debtor may change it or file a new plan.
Making Plan Payments
While the plan is running, the debtor must:
- Make monthly plan payments to the trustee
- Stay current on any ongoing payments the debtor has to make directly to a creditor, like a mortgage or car payment
If the debtor finishes all plan payments, any remaining balance on dischargeable debts is eliminated at the end of the case.
If the debtor misses payments and the court dismisses (throws out) the bankruptcy, the debtor will still owe the unpaid balance. The automatic stay ends when the case is dismissed. Creditors can start trying to collect the debts again.
The Discharge
At the end of a successful Chapter 13 case, the court enters a discharge order. The discharge:
- Forgives any remaining balance on dischargeable debts the debtor did not have to pay back in full through the plan
- Does not cover some debts like student loans and most tax debts
The debtor is no longer legally required to pay discharged debts. After the discharge, creditors cannot try to collect discharged debts ever again. Most Chapter 13 cases take about 3 to 5 years from filing to discharge.
Which type of bankruptcy is better?
Chapter 7 might be better if:
- The debtor has mainly unsecured debts (like credit card bills and medical bills)
- The debtor does not own much nonexempt property
- The debtor cannot afford a Chapter 13 plan payment
- The debtor needs a fresh start fast
Chapter 13 might be better if:
- The debtor needs to catch up on house or car payments and cannot do so right away
- The debtor owes debts that cannot be discharged in Chapter 7
- The debtor has nonexempt property they want to keep
- The debtor can afford to make monthly plan payments
The right type of bankruptcy for any person depends on their unique situation. People struggling with debt should talk to a local bankruptcy lawyer. The lawyer can look at their situation and explain their options.
