When Chapter 7 Bankruptcy Is Better than Chapter 13 Bankruptcy

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.

Advantages of Chapter 7 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:

• It’s relatively quick. A typical Chapter 7 bankruptcy case takes three to six months to complete.
• No payment plan. Unlike Chapter 13 bankruptcy, a filer doesn’t pay into a three- to five-year repayment plan.
• Many, but not all debts get wiped out. The person filing emerges debt-free except for particular types of debts, such as student loans, recent taxes, and unpaid child support. (For more on these "nondischargeable" debts, see What Is the Difference Between Dischargeable and Nondischargeable Debts in Bankruptcy?)
• You can protect property. Although you can lose property in Chapter 7 bankruptcy, many filers can keep everything that they own. Bankruptcy lets you keep most necessities, and, if you don't have much in the way of luxury goods, the chances are that you'll be able to exempt (protect) all or most of your property.
• You can keep a house or car in some situations. You can also keep your house or car as long as you’re current on the payments, can continue making payments after the bankruptcy case, and can exempt the amount of equity you have in the property. (Find out what you can protect in Bankruptcy Exemptions by State.)

Who Should File for Chapter 7 Bankruptcy?

Chapter 7 works very well for many people, especially those who:

• own little property
• have credit card balances, medical bills, and personal loans (these debts get wiped out in bankruptcy), and
• whose family income doesn’t exceed the state median for the same family size.

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.)

When Chapter 13 Might Meet Your Needs

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.)

Drawbacks of Chapter 13 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
• taxes
• 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:

• You must complete the entire three- to five-year repayment plan before any qualifying debt balances get wiped out (unless the court lets you off the hook early for hardship reasons).
• If you owe nondischargeable past due taxes, or support arrearages, you’ll have to pay off the entire balance in your plan (many people don’t have sufficient income to do so).
• To keep a house or car, you’ll need to repay the arrearages over the course of your plan (while continuing to pay your regular monthly payment).
• Many people who file for Chapter 13 bankruptcy don't complete their plans, so filers run a very real risk that their debts won't be discharged.

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.