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The basics of bankruptcy: Chapter 7 vs. Chapter 13

The legal system can feel daunting even when there is little at stake. When your finances become involved due to bankruptcy, everything can feel downright scary. It doesn’t need to. Bankruptcy is a way to ease the pressure and emotional burden of debts that have piled up, often for things out of your control.

If you’ve thought about bankruptcy you’ve likely come across the terms Chapter 7 and Chapter 13. Here’s a brief explanation of what those are, and what they do for the person filing bankruptcy.

Chapter 7: Liquidation

Chapter 7 bankruptcy is often summarized with the word liquidation. What liquidation means is, the person filing Chapter 7 bankruptcy sees some of their things – referred to as assets – sold off in order to pay back the debts they owe.

It’s important to know this does not require someone to sell absolutely everything they own. You can keep a number of things, including potentially a car, your home, retirement accounts, household goods (worth up to a certain amount), 75% of your wages and more.

You will have to part with many assets though. A trustee appointed by the bankruptcy court then gives the money earned from those sales to creditors (the people to whom you owe money). Afterward the court discharges certain debts – meaning you no longer have to pay them back. These dischargeable debts can generally include:

  • Credit card debt
  • Past-due utility bills
  • Some tax penalties
  • Personal loans
  • Medical bills
  • Business debts

There are some non-dischargeable debts, however. That usually includes student loans, any money owed for child support or alimony, court fines and penalties, and some tax debts. Those you will have to pay off in full.

Chapter 13: Reorganization

Chapter 13 is a different approach, and often referred to as reorganization. Rather than selling some assets to pay off portions of your debts, you instead have to follow a repayment plan. This repayment plan can last from three to five years, and has to be approved by the court. This repayment plan lays out not just how you will pay back creditors, but how much each will receive.

You can’t simply pick whatever amount you want. There are priority debts that you have to fully pay off over the course of your plan. In addition, any disposable income has to go to paying off debts. So once you account for your basic needs, any income above that should be going to creditors.

At the end of this repayment plan, if you stick to it, certain remaining debts will be discharged much in the same way as with Chapter 7 bankruptcy.

Other things to consider

Both Chapter 7 and Chapter 13 bankruptcy offer pros and cons you need to take into account. There are also some eligibility requirements.

For example, there is something called a “means test” if someone wants to file Chapter 7 bankruptcy. If you make too much, you may not be able to pursue that path. Or Chapter 13, for example, comes with some debt thresholds. If you owe too much in either secured or unsecured debt, you may not be eligible for Chapter 13 bankruptcy.

Keep in mind this is just a brief overview of what can be a complex topic. There are many additional factors and nuances in the law to consider. Because of this, there is no way to know which type of bankruptcy might be right for you without having an expert, such as an attorney, analyze your specific situation.

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