In many cases, Chapter 7 bankruptcy is a better fit than Chapter 13 bankruptcy. For instance, Chapter 7 is quicker, many filers can keep all or most of their property, and filers don't pay creditors through a three- to five-year Chapter 13 repayment plan. But not everyone qualifies to file for Chapter 7 bankruptcy—and in some cases, Chapter 7 doesn’t provide the help the filer needs. Find out when Chapter 7 bankruptcy might be more advantageous than Chapter 13 bankruptcy.
Chapter 7 bankruptcy is an efficient way to get out of debt quickly, and most people would prefer to file this chapter, if possible. Here’s how it works:
Chapter 7 works very well for many people, especially those who:
You’ll take the means test to see if your income qualifies for this chapter. If your income is below the average income for a family of the same size in your state, you’ll automatically qualify.
If your income is higher than the median, you’ll have another opportunity to pass. However, if after subtracting allowed expenses, including payments for child support, tax debts, secured debts (such as a mortgage or car loan), you have income left over to make a significant payment to your creditors (called disposable income—more below), you won't qualify to file for Chapter 7 bankruptcy.
(For more information on this and other Chapter 7 eligibility requirements, see The Bankruptcy Means Test.)
Chapter 7 bankruptcy isn’t the best choice for everyone. Chapter 7 won’t help people whose debts won’t get wiped out (discharged), like certain income tax debt, student loans, and domestic support obligations. High-income filers find it hard to qualify. It’s also not a good fit for people who would lose substantial equity in a home or other property if they filed for Chapter 7 bankruptcy, or those facing foreclosure or repossession. For those individuals, Chapter 13 bankruptcy would likely be a better choice.
(Find out more by reading When Chapter 13 Bankruptcy Is Better Than Chapter 7 Bankruptcy.)
Most people prefer Chapter 7 bankruptcy because, unlike Chapter 13 bankruptcy, it doesn't require you to repay a portion of your debt to creditors. In Chapter 13 bankruptcy, you must pay all of your disposable income—the amount remaining after allowed monthly expenses—to your creditors for three to five years.
What Is Disposable Income?
Disposable income is the amount that remains after subtracting allowed bankruptcy expenses from your monthly gross income. Your disposable income will determine whether you qualify to discharge (wipe out) debt in Chapter 7 or Chapter 13 bankruptcy.
When you claim your deductions, you’ll be able to use the actual cost of some expenses. For others, such as the allowance for food, clothing, and housing, you’ll use the national and local standards.
Here’s a list of some of the deductions you’ll be allowed to take:
- food and clothing
- housing and utilities
- transportation costs
- involuntary payroll deductions
- life insurance
- court-ordered payments, such as family support
- certain education costs
- childcare expenses, and
- health care costs.
To determine your disposable income, you’ll complete one of two forms, depending on the chapter you intend to file (each chapter allows for similar deductions).
In a Chapter 7 case, you’ll complete the Chapter 7 Means Test Calculation form. You’ll deduct allowed expenses to find your disposable monthly income. Next, you’ll multiply that amount by 60 months. If the figure exceeds the maximum amount currently allowed (which will be listed on the form), you won’t qualify for a discharge. Additionally, you might not qualify if your disposable income is sufficient to pay 25% or more of your unsecured, nonpriority debt (such as credit card balances, medical bills, and personal loans).
In a Chapter 13 matter, you’ll fill out the Chapter 13 Calculation of Your Disposable Income form. The amount that remains after deducting expenses is your monthly disposable income. You’ll pay that number to your unsecured, nonpriority creditors each month over the course of your three- to five-year repayment plan.
Because each case is different, determining whether you qualify for bankruptcy can be challenging. When in doubt, contact a knowledgeable bankruptcy attorney.
Here are a few other things filers find challenging about Chapter 13 bankruptcy:
Despite these potential problems, Chapter 13 bankruptcy is a good option for people who have a regular income to pay into a repayment plan, and who would otherwise lose their house to foreclosure or who need time to pay back tax or support arrearages.
For more information about Chapter 13 bankruptcy, see An Overview of Chapter 13 Bankruptcy.