Two Types of Bankruptcy - Chapter 7 and Chapter 13

In the past, someone declaring bankruptcy was allowed to choose whether he or she wanted to file Chapter 7 or Chapter 13. Unfortunately, the new bankruptcy laws take away that choice, for the most part. Now, most people with household incomes above their state's median are forced to file Chapter 13, and many low-income people are forced to file Chapter 7, even if they would prefer 13. People somewhere near the middle (slightly below average income) may have a choice, but regardless, it is important for everyone to know the differences between the two main types of bankruptcy.

The Basic Differences Between Types of Bankruptcy

You may have also heard of Chapters 11 and 12, but these deal with corporations and farmers, respectively, so they are not relevant for most of us. The basic difference between Chapter 7 and Chapter 13 is that Chapter 7 discharges your debts, while Chapter 13 establishes a plan for you to repay your debts over time. Since the passage of the new bankruptcy laws, citizens seeking to file either form of bankruptcy are required to meet with a credit counselor before filing, and enroll in budget management classes afterwards.

Chapter 7 Bankruptcy

By filing Chapter 7, you are essentially waving the white flag to your creditors and the court system - you have no feasible way of repaying your debts and you're just plain giving up. While many people have abused bankruptcy law over the years, it was originally created to protect honest people who got in over their heads. Rather than jailing debtors or consigning them to indentured servitude, Chapter 7 bankruptcy offers them a new lease on life - with a price. That price is an ugly stain on your credit report that remains for 10 years.

In addition, you may have to sell some of your property. In the past, this was more commonly the case, but since only below-average income earners are allowed to file Chapter 7 now, chances are that you won't have any "non-exempt" property that the court can force you to sell. For example, New Hampshire has a homestead exemption of $100,000. This means that if you have less than $100,000 in equity in your house, it is out of your creditors' reach. If you have considerably more than $100,000 (like $175,000 or $200,000) in equity, your bankruptcy trustee can force the sale of your home, pay off your mortgage, give you $100,000, and give the rest to your creditors.

For most practical purposes, your property will probably be exempt. Michigan, for example, allows you to keep up to $1,000 worth of appliances, utensils, books, furniture, and household goods, but do you think they're really going to force the sale of your Stephen King novels? It won't be worth your creditors' time.

Once your non-exempt property (if any) has been sold and the proceeds have been paid to your creditors, then your debts are discharged - they cease to exist. Your creditor can never bother you again, and for all intents and purposes, your debt never existed - except for that mark on your credit report, which will last a decade. That is the true price of filing Chapter 7.

Chapter 13 Bankruptcy

The good news about Chapter 13 is that you don't have to sell any of your property. Have a $1 million house? You can keep it? Two-thousand dollars worth of appliances, utensils, books, furniture, and household goods - even Michigan will let you keep them. So what's the catch? Well, it's a big one: Literally every cent that you earn, beyond your basic living expenses, must be paid to your creditors. And assuming you're over your state's median income level, which you probably are if you file Chapter 13, you don't even get to decide what your "living expenses" are - the IRS does.

More good news: After establishing a plan to pay your creditors, pro-rata, for three or five years, most of your debts are discharged at the completion of your plan - assuming you stick to it. Unfortunately, only 40% of Chapter 13 filers have been able to remain faithful to their payment plans, and that was when filing Chapter 13 was entirely voluntary - now that number is sure to drop.

Non-Dischargeable Debts

Bankruptcy is not a "Get Out of Jail Free Card" - especially not when your creditor is the government. Student loans, recent back taxes, child support and alimony, court-imposed fines, debts owed to a spouse as result of a divorce, loans owed to a pension plan, and debts owed to the plaintiff in a personal injury or death suit that resulted from drunk driving are all non-dischargeable, however, the monthly payments on most of these debts can be lowered with a Chapter 13 payment plan - you will just owe your actual balance once the plan has been fulfilled.

So is bankruptcy the right option for you? It rarely is, especially with the new bankruptcy laws. Most of the time, you're better off trying to work out a plan with your creditors, using the assistance of a lawyer if that makes you feel better. Oftentimes lawyers can threaten your creditors with bankruptcy in order for them to reduce your debt. Use the resources here at acedebtconsolidation.com to learn as much as you can about bad credit, debt consolidation, and bankruptcy so that you will be as well-informed as possible as you confront your debts and make the life-altering decision whether or not to file bankruptcy. Good luck!