Why should I file a Chapter 13 instead of a Chapter 7 bankruptcy?

You may like to file Chapter 13 instead of a Chapter 7 bankruptcy, if you're behind on your mortgage payments and you're trying to save your home. Chapter 7 does not give you the opportunity to catch up mortgage payments or otherwise save your house. A Chapter 13 would be the appropriate chapter to file for that. Also, some individuals just have too much income and don't qualify for a Chapter 7. In that case, you would need to file a Chapter 13 reorganization.


Additional Information

There are two ways that people generally file bankruptcy: Chapter 7 and Chapter 13. Both methods are court-directed ways to reset your debt. Which version of bankruptcy to file is a big question and will affect how your debts are considered by the court and what you will be required to pay back. To understand how bankruptcy affects debt, you need to understand debt.

Debts are born from contracts that you enter into with a lender where you receive money for your promise to pay it back with interest (the lender’s profit). Contracts contain terms which include how long you have to pay your debt back, and at what interest, and what happens if you do not pay it back.

In the simplest terms, a Chapter 7 bankruptcy discharges, or erases your debts, which means that the debts you owed before the bankruptcy are gone and you do not have to pay them. There are some types of debts that do not vanish and there are possible consequences. For instance, your home loan may be discharged in bankruptcy and you may not be personally liable, but the lender will still have the right to foreclose on your property to settle the mortgage.

The court will gather any assets from you not protected under bankruptcy exemptions and use those assets to repay the creditors, often at a rate of pennies on the dollar. At the end of Chapter 7, you do not personally owe any of the debts included in bankruptcy.

Chapter 13 bankruptcy does not make your debts vanish. Instead, the court restructures your debt. Restructuring means that the court changes the terms of your contract that created your debt in the first place. Often the court will discharge some of a debt, as in Chapter 7, to make it possible for you to pay back the majority of the debt you owe. These calculations made by the court are based upon the debts you owe, the assets you have, and the income you will likely receive.

On the surface, Chapter 7 seems like the better deal. If the goal is debt relief, then paying nothing on a debt is certainly better than paying something. But there are two main reasons where you would likely file a Chapter 13 instead of Chapter 7:

Means Test

To file a Chapter 7, you must pass a means test, which is the government’s way to check that you are not abusing the bankruptcy system. The means test applies your assets, income and debt, then calculates how much disposable income you have. If you have too much, you are ineligible for Chapter 7, so Chapter 13 is your only option.

Saving Your Property

When you are behind on your mortgage and you want to try and keep your home, this is a common reason to file Chapter 13. You can file a Chapter 7 bankruptcy and still lose your property to foreclosure if you are behind on your payments. In a Chapter 13, the court has the power to restructure your debt. Your payments might be reduced during the restructure period (usually five years) and the principal you owe on the loan may be modified.

There are many parts to a debt relief plan and bankruptcy is one tool in the kit. Talking with an attorney can clarify what will work in your situation. And knowing sooner is better than realizing too late that you made a wrong move that cannot be undone.