Area of Law:
Bankruptcy is a legal process to eliminate or repay some or all of your debts. The majority of people who decide to declare bankruptcy choose to file under either Chapter 7 or Chapter 13, though there are other types as well. There are pros and cons to declaring bankruptcy, as well as pros and cons to each type of bankruptcy. If you are in financial trouble and trying to decide if bankruptcy is the right move for you, the first step is to learn about bankruptcy. This includes the differences between a Chapter 7 and a Chapter 13 bankruptcy, how these types of bankruptcy work, and what filing bankruptcy can and cannot do for you.
Pros and Cons to Declaring Bankruptcy
The main benefit to filing bankruptcy is that you can clear (“discharge”) some or all of your debts, such as credit card obligations and other unsecured debts, like medical bills. (“Unsecured” means that the creditor doesn’t have a lien on any of your property and therefore cannot repossess items if you don’t make payments.) Declaring bankruptcy can typically eliminate this type of debt. Filing bankruptcy has another significant upside in that it will stop your creditors from harassing you to collect owed payments. Once you declare bankruptcy, an “automatic stay” goes into place. The stay prohibits most collection activities, such as phone calls from creditors and legal actions, although there are some exceptions and creditors can ask the bankruptcy court to remove (lift) the stay. However, filing bankruptcy won’t help you will all of your debts. For example, you won’t be able to eliminate child support obligations or student loan debt (in most cases, unless you can prove that repaying the student loans will cause you an undue hardship). And, if the creditor can convince the bankruptcy judge that a particular dischargeable debt should survive the bankruptcy, you will still remain responsible for it even afterwards. For example, if you incurred a debt through fraud by lying on a credit application, it most likely won’t be discharged in a bankruptcy. Furthermore, filing bankruptcy won’t stop a secured creditor from repossessing certain items or real estate. Getting a bankruptcy discharge will wipe out your debts, but it won’t eliminate liens. This means that the creditor can still repossess an item that has lien (for example, a car) or foreclose on any real property that is subject to a lien (such as your home) if you don’t make the payments. Another downside to filing bankruptcy is that your credit score will take a big dip. In fact, bankruptcy is just about the worst thing that can happen to your credit, even worse than a foreclosure.
Overview of Chapter 7 and Chapter 13 Bankruptcies
A Chapter 7 bankruptcy is called a liquidation bankruptcy. This is because a trustee administers the case by reviewing your bankruptcy petition, along with supporting documentation, and selling (liquidating) any nonexempt property to repay your creditors. However, if there aren’t any nonexempt assets to sell, the creditors won’t get anything. (Most debtors get to keep all or most of their belongings.) This type of bankruptcy eliminates the majority of unsecured debts. In order to be eligible for a Chapter 7 bankruptcy, you must have little or no disposable income. Those who earn too much income must use a Chapter 13 bankruptcy. Chapter 13 bankruptcies are called reorganization bankruptcies. This type of bankruptcy is for those debtors who earn a steady income and can afford to repay at least a part of their debts through a repayment plan. The total amount you’ll have to pay back depends on your income, expenses, and what type of debts you have. Upon completion of the plan, certain debts are discharged. While those who make too much money to be eligible for a Chapter 7 bankruptcy are limited to this type of bankruptcy, there are some debtors who chose to file a Chapter 13 bankruptcy instead of filing under Chapter 7. Which type of bankruptcy is best for you mainly depends on how much you earn, your assets, your debts, and, ultimately, what you hope to accomplish by filing bankruptcy.
Pros and Cons to Chapter 7 Bankruptcy
A Chapter 7 bankruptcy is typically faster than a Chapter 13 bankruptcy, taking only three to six months to complete. In addition, you won’t have to repay part or all of certain debts, as you would though a Chapter 13 bankruptcy plan. While you might have to give up some of your belongings in a Chapter 7 bankruptcy, most people who file this type of bankruptcy don’t. In most cases, you’ll only have to give an item up if you’ve put it up as collateral for a loan and you’re behind in the payments. On the downside, not everyone qualifies for a Chapter 7 bankruptcy.
Pros and Cons to Chapter 13 Bankruptcy
There are quite a few potential upsides to a Chapter 13 bankruptcy. For example:
- If you are delinquent on your mortgage payments or car payments, you can make up the missed payments over time, which you cannot do in a Chapter 7 bankruptcy.
- If you want to pay your debts, but your creditors are harassing you, then filing a Chapter 13 bankruptcy will provide a formal plan and protection from harassment.
- If you have certain obligations that wouldn’t be discharged through a Chapter 7 bankruptcy and you want to repay them over time, then a Chapter 13 bankruptcy might be right for you.
- You can keep certain nonexempt property that would be sold if you filed for Chapter 7 bankruptcy.
On the downside, Chapter 13 bankruptcy plans take three to five years, which means your income is tied up for this period of time. And, if you fail to complete the plan, your debts won’t be discharged.