Attacking Your Debts with Chapter 7 vs. with Chapter 13

Posted by Kevin on November 19, 2012 under Bankruptcy Blog | Be the First to Comment

The type of debts that you have are a factor in deciding whether to file under Chapter 7 or Chapter 13.

The Overly-Simplistic But Still Helpful Rule of Thumb

Here’s a decent starting point: Chapter 7 handles your simple debts better than does Chapter 13, and Chapter 13 handles your more complicated debts better than does Chapter 7.

There are three kinds of debts:  “secured” for which there is collateral given, e.g., your house; “priority” debts which for most consumer creditors is child support, alimony or taxes; and “general unsecured” debts which include most credit cards, medical debts, personal loans with no collateral, utility bills, back rent, and many, many others.

Simple debts are generally general unsecured debts, and secured debts in cases where a) the debtor is current, their is no equity in the collateral and the debtor wants to keep the collateral or b) the debtor wants to give up or “surrender” the collateral.

Simple Debts- Better Off in Chapter 7

Chapter 7 treats “general unsecured” debts the best by usually simply discharging them (writing them off) forever in a procedure lasting barely three months.  You make no payments and you get to keep the property if it is exempt.

Chapter 13 instead usually requires you to pay a portion of these “general unsecured” debts. When you hear a Chapter 13 plan being referred to a “15% plan,” that means that the “general unsecured” debts are slated to be paid 15% of the amount owed.  Moreover, if your income goes up during the term of the plan, your payments can increase.  So, unless you feel morally compelled to make restitution to your creditors, Chapter 7 is the preferred economic method of disposing of “general unsecured” debts.

As for simple secured debts, in Chapter 7, if you surrender, you give up the property, the debt is discharged and you make no further payments.  If you surrender the collateral in a Chapter 13, however, you may be subject to paying a portion of any deficiency through your plan.  Clearly, in that case, Chapter 7 is the better alternative.

If you want to keep the property which is current with no equity, in a Chapter 7 the trustee “abandons” the property.  That means that it drops out of the bankruptcy and you keep it subject to the secured claim.  As long as you keep paying the secured creditor, you get to keep (and someday own outright) the collateral.  Moreover, the underlying debt  to the bank is discharged, so the bank can never come after you for a deficiency if you default down the line.

Now, you get pretty much the same deal in Chapter 13 ( you keep the collateral and continue with your payments), but you are subject to court supervision for up to 60 months. That can be  a hassle.    Hence, Chapter 7 is a better alternative because it is quicker and cleaner.

The next blog: how not-so-simple debts are handled in Chapter 7 and in Chapter 13.