Bankruptcy is a legal process that individuals may consider when they find themselves in overwhelming financial distress. The most common types of bankruptcy for individuals are Chapter 7 and Chapter 13.
While both aim to provide relief from debt, they differ in several key ways.
Chapter 7 bankruptcy
Chapter 7 bankruptcy is a “liquidation” bankruptcy that involves selling a debtor’s non-exempt assets to pay off his or her debts. Non-exempt assets may include valuable properties or assets that are not necessary for the debtor’s basic living expenses. Chapter 7 has a relatively quick resolution. Debtors can often receive a discharge of eligible debts within a few months, allowing them to start fresh without the burden of unsecured debts.
To qualify for Chapter 7, debtors must pass a means test, which assesses their income and expenses. Debtors with insufficient income to repay their debts may be eligible for Chapter 7.
Chapter 13 bankruptcy
Chapter 13 bankruptcy is a “reorganization” bankruptcy and does not involve liquidating assets. Instead, debtors create a repayment plan, which can last three to five years, to pay off their debts. The plan considers the debtor’s disposable income after necessary living expenses. Chapter 13 allows debtors to retain their assets, including those that might be non-exempt in Chapter 7. This makes it a preferable choice for individuals with valuable properties they wish to keep.
Chapter 13 has income and debt limitations. Debtors must have a regular source of income to fund the repayment plan, and their total unsecured and secured debts must not exceed certain limits.
Per the Motley Fool, the majority, or about 70% of consumers who file for personal bankruptcy do so through a Chapter 7 filing. While both options offer potential solutions for debt relief, the choice between chapters depends on a debtor’s financial situation, goals and the desire to either liquidate assets or repay debts over time.