Under the current U.S. Bankruptcy codes, there are two main ways to file for bankruptcy: Chapter 7 and chapter 13 bankruptcy. While each form of bankruptcy provides the same essential function as a debt relief vehicle, each chapter's approach to accomplishing the goal is much different.
Common Use.
Chapter 7 bankruptcy is most commonly used in situations in which the filer has very few possessions outside of their basic living necessities, such as clothing and furniture. Additionally, the filer may be using all of their monthly income to cover basic living expenses, with very little left over. In some instances, there monthly income may not even cover their basic expenses.
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On the other hand, chapter 13 bankruptcy is used in situations in which the filer not only has significant equity in their home or other property, but the desire to maintain ownership of the property. Those most commonly filing this form of bankruptcy are not only covering their monthly basic living expenses, but they have income left over at the end of every month. However, they traditionally have large, unresolved debt that they are no longer able to effectively manage.
Based on these differences, chapter 7 bankruptcy is often referred to as "liquidation" while chapter 13 is usually designated as a "reorganization" of debt. Chapter 7 is an effective debt wipe for the filer while chapter 13 merely postpones or extends repayment expectations in order for the filer to more effectively manage their debt.
Advantages and Disadvantages.
The primary advantage of chapter 7 proceedings is that filer debt is effectively discharged over a short period of time. In most cases, proceedings will be fully completed within a six month period. The filer is protected from creditor contact during the course of the proceedings and also when the debt has been discharged.
Unfortunately for filers, chapter 7 is referred to as a "liquidation" process for a reason. Though some states offer specific protection for property and home equity, most of the time, chapter 7 proceedings result in full asset liquidation.
Chapter 13 offers filers a means of protecting their assets and spreading debt repayment over the course of several years. During the work with a bankruptcy trustee, the filer will create a schedule of repayment that best reflects their personal needs spread out over the course of 3-5 years. Repayment will be made in the form of a single, convenient, monthly payment, made directly to the bankruptcy trustee for disbursement.
The major disadvantage to filing chapter 13 bankruptcy is that filers will be on an extremely strict budget during the course of the repayment schedule. Bankruptcy courts closely examine all financial records and make a determination about repayment ability that factors in living expenses but makes no allowances for additional expenditures. In both instances, credit rating will be adversely affected for several years. Major future purchases will be extremely difficult, usually only available at relatively high interest rates.
Qualifying.
The qualifications for chapter 7 eligibility are fairly lax in comparison. In most cases, filers simply pass a simple means test and then complete a pre-filing session with a certified credit counselor at which point they will be eligible for chapter 7 bankruptcy protection.
Chapter 13 bankruptcy protection is significantly more difficult to qualify for. Chapter 13 filing requires a specific amount of monthly income relative to overall debt levels, and no more than $250,000 of unsecured debt, and no more than $750,000 of secured debt.
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