Definition
Chapter 7 Bankruptcy, often referred to as ‘liquidation bankruptcy,’ involves selling off a debtor’s non-exempt assets to pay off creditors. On the other hand, Chapter 13 Bankruptcy, or ‘reorganization bankruptcy,’ allows debtors to create a plan to repay all or part of their debts over three to five years, without liquidation of personal assets. Both types offer a fresh financial start but differ in duration, income requirements, and how they affect a person’s credit score.
Key Takeaways
- Chapter 7 bankruptcy is sometimes referred to as “liquidation bankruptcy”. In this type, non-exempt assets could be sold to pay off unsecured debt. On the other hand, Chapter 13 bankruptcy is often referred to as “wage earners’ bankruptcy”. It allows the debtor to retain their assets and provides a plan to repay all or a portion of their debts over three to five years.
- In terms of eligibility, not everyone can qualify for Chapter 7 bankruptcy. it is means-tested, and debtors must have a monthly income lower than the median income of their state to qualify. Conversely, Chapter 13 bankruptcy isn’t means-tested, but it does require that debtors have a regular income, as they’ll be required to make monthly payments towards their debts.
- The impact on credit is another area where Chapter 7 and Chapter 13 bankruptcy differ appreciably. Chapter 7 bankruptcy remains on the debtor’s credit report for ten years, while Chapter 13 bankruptcy remains on the report for seven years. This makes Chapter 13 a somewhat less severe mark on one’s credit history.
Importance
The distinction between Chapter 7 and Chapter 13 bankruptcy is highly significant in finance due to the different implications each has for individuals facing financial distress.
Chapter 7 bankruptcy, often referred to as “liquidation bankruptcy,” involves the discharge of unsecured debts such as credit cards and personal loans, but may also necessitate the sale of non-exempt property to repay creditors.
Chapter 13 bankruptcy, on the other hand, often referred to as “reorganization bankruptcy,” allows individuals to retain their property, and instead restructures their debt into more manageable repayments over a three to five year period.
This distinction is crucial because the preferable option largely depends on an individual’s circumstances, such as their level of income, the types of debt they have, and their long-term financial goals.
Explanation
Chapter 7 and Chapter 13 bankruptcy are two legal procedures outlined by federal law to help individuals and businesses struggling with excessive debt. The purpose of Chapter 7 bankruptcy, often called “liquidation bankruptcy,” is to discharge or eliminate most of an individual’s or business’s unsecured debt. This includes categories like credit card debt, medical bills, and personal loans.
Chapter 7 is typically an option for individuals with limited income who can’t pay back their debt. The process involves selling off the debtor’s non-exempt property to pay back creditors, which is why it’s also referred to as liquidation. It’s designed to give of a fresh start by wiping out debts.
On the other hand, Chapter 13 bankruptcy, also known as “reorganization bankruptcy,” is used by individuals who have consistent income but are unable to pay their debts in full. The purpose of Chapter 13 bankruptcy is to create a repayment plan that allows the debtor to pay back a portion, or sometimes all, of their debt over a period of three to five years. The repayment plans are based on the debtor’s income.
Chapter 13 protects important assets from being sold off, such as a home or a car, which might be liquidated in a Chapter 7 case. It’s generally used by those who are trying to avoid foreclosure or repossession, or who have substantial non-exempt property they want to keep.
Examples of Chapter 7 vs Chapter 13 Bankruptcy
Example 1 – Personal Bankruptcy: A person with a secure job but uncontrollable medical debts could file for Chapter 13 bankruptcy. Despite their high debt levels, their consistent income could allow for a repayment plan over a period of time, allowing them to keep their assets such as a house or car. On the other hand, a person with a low income and high credit card debts could file for Chapter 7 bankruptcy. This form of bankruptcy will discharge most of their unsecured debt and they would not have to set up a repayment plan. However, this action could result in the loss of their property if it’s not exempt.
Example 2 – Small Business Bankruptcy: A small retail business suffering from low sales and high overhead costs can file for Chapter 7 bankruptcy to completely shut down their operations. The business’s remaining assets will be sold off to pay creditors, and remaining unsecured debt will be forgiven. Alternatively, if that business sees a viable future if current debts are managed, they could file for Chapter 13 bankruptcy, creating a plan to repay debts over time while keeping their business in operation.
Example 3 – Celebrity Bankruptcy: Famous rapper 50 Cent filed for Chapter 11 bankruptcy (which is similar to Chapter 13 for individuals) in 2015 after a series of financial losses, despite a history of successful enterprises. His bankruptcy allowed him to consolidate his debts and plan a way to repay them, allowing him to preserve and restructure his wealth. On the contrary, actress Kim Basinger filed for Chapter 7 bankruptcy in 1993 after a failed investment into a town she planned to transform into a tourist destination. Her debts were discharged, but she had to liquidate assets to pay creditors.
FAQ: Chapter 7 vs Chapter 13 Bankruptcy
What are Chapter 7 and Chapter 13 bankruptcies?
Chapter 7 and Chapter 13 are types of bankruptcies that differ primarily in who they’re designed for and how they work. Chapter 7 bankruptcy is an option for consumers who have little or no income, whereas Chapter 13 bankruptcy is for consumers who have a regular income and can afford to make payments towards their debts.
How does Chapter 7 Bankruptcy work?
Under Chapter 7 bankruptcy, you may have to sell some of your property to pay off as much of your debt as possible. Once you’ve done this, most or all of your remaining debts will be wiped out, and you won’t have to make any more payments.
How does Chapter 13 Bankruptcy work?
Chapter 13 bankruptcy is a reorganization bankruptcy designed for debtors with regular income who can pay back a portion of their debts through a repayment plan. If you make enough money to cover your basic living expenses and have a certain amount left over each month, you’ll have to use that income to pay off some of your debt.
How long does each type of bankruptcy stay on my credit report?
Chapter 7 bankruptcy stays on your credit report for 10 years from the date of filing, while Chapter 13 bankruptcy stays on your credit report for 7 years from the date of discharge or 10 years if the bankruptcy is not completed and discharged.
Which type of bankruptcy is right for me?
The right kind of bankruptcy for you will depend on your financial situation, your income level, the amount of debt you owe, and your long-term financial goals. It’s recommended to consult with a bankruptcy lawyer or financial advisor to understand the best option for you.
Related Entrepreneurship Terms
- Debt Discharge
- Repayment Plan
- Means Test
- Non-Exempt Assets
- Debtor Education Course
Sources for More Information
- U.S. Courts: This official government page offers a wide range of information about the federal judiciary, including details on the bankruptcy process in the U.S.
- Nolo: This is one of the Internet’s leading legal websites that offers detailed insights into all sorts of legal topics, including the differences between Chapter 7 and Chapter 13 bankruptcies.
- Investopedia: An authoritative source for explanations of financial terms, Investopedia provides clear, in-depth discussions of an extensive list of financial topics, including Chapter 7 and Chapter 13 bankruptcy.
- Credit Karma: This site offers a wealth of information about personal finance and credit, including articles that explain the specifics of declaring bankruptcy under either Chapter 7 or Chapter 13.
