When is Chapter 7 bankruptcy the better option?
Let’s start with some scenarios where Chapter 7 is a better option, and then we’ll explain things a little bit more carefully.
Chapter 7 is probably the right move when you don’t have any non-exempt assets to liquidate, are current with your mortgage and car payments, don’t have very much money left at the end of the month to participate in a repayment plan, and have not received a bankruptcy discharge within the last eight years.
Let’s explain the above items a little bit further. Chapter 7 requires liquidation of your assets in order to pay off creditors as much as possible. Your primary residence is usually protected up to a specified amount in your particular state, but other items may have to be liquidated. So if you do have items that you would lose in bankruptcy, you need to decide whether you are willing to pay off some of your debts in order to keep these assets.
Another consideration is whether you have very much money left over at the end of the month. Chapter 7 is intended to get rid of your debts completely in exchange for liquidation of your assets (though most people don’t have many assets to speak of anyway). If you decided to go with Chapter 13 instead, you would have to establish a payment plan for the next few years, and this would require you to dedicate a portion of your income each month to pay off these debts.
Chapter 7 bankruptcy can eliminate most of your debts and protect your home from creditors, but it will not protect your home from the bank or mortgage company itself. If your primary concern is catching up on your mortgage payments and you do not want to lose your home, then Chapter 7 would not make sense for you.
Considering Chapter 13 bankruptcy
Chapter 13 establishes a repayment plan in which you will pay a small percentage of your original debts. You will pay this amount monthly for the next few years. Chapter 13 is an excellent way to catch up on your mortgage payments when you don’t want to give up your home in bankruptcy. It allows you to repay your creditors something in order to save face, and it is particularly helpful if you need help catching up with mortgage payments, child support, or income taxes.
You can also stop creditors from harassing a cosigner on your loan when you commit to a repayment plan.
The disadvantages of Chapter 13 bankruptcy
Remember that your repayment plan will last between 3 to 5 years. During this time, you’re going to have to keep a very tight budget in order to keep up with your monthly payments, and there are other requirements you have to consider as well. For example, you will likely have to surrender your income tax refunds in order to help pay off your debts, and if you happen to receive an unexpected windfall you would likely have to give this up as well. You are not allowed to take on any additional debts without permission from the bankruptcy trustee.
Unfortunately, the majority of Chapter 13 repayment plans end up failing. You can lose your job or simply have difficulty keeping up with the payments, even though the payment plan is supposed to be reasonable for your circumstances. If your plan fails, your bankruptcy protection is gone and the creditors can be on your back once again!
Some people believe that Chapter 13 is less damaging to your credit report, but this is probably not a good reason to choose this option. It still ends up on your credit report for a number of years, and creditors will also realize that, unlike people who file chapter 7, you have not even had your debts eliminated.
What about non-bankruptcy repayment plans?
Once again, under a Chapter 13 repayment plan you typically only pay a small fraction of your original debts. A typical non-bankruptcy payment plan would expect you to pay your debts completely.
Also, Chapter 13 helps you to catch up on alimony and child support obligations, which are usually not addressed by debt settlement plans or other non-bankruptcy solutions. A credit counselor, debt consolidation, or other payment plan outside of bankruptcy would not usually cover secured debts like your house or car.
In addition, Chapter 13 allows you to take advantage of the automatic stay provision, and this prohibits creditors from contacting you without the court’s permission, thereby giving you some immediate relief.