If you decide to file for bankruptcy, you will have some major decisions to make. The first–and most important–is determining whether to file for Chapter 7 or Chapter 13 Bankruptcy. This determination can mean the difference between losing your home and keeping it, so do not take it lightly.
In this article, we will examine some of the major differences between Chapter 7 and Chapter 13 bankruptcy.
Chapter 7 vs. Chapter 13: What’s the Difference?
Filing bankruptcy can help discard debt or give you more time to pay it off. People who file for bankruptcy are typically insolvent, which simply means they can’t pay their bills–often because their debts have outpaced their income.
Chapter 7 and Chapter 13 bankruptcy proceedings share a common goal: to alleviate your financial burdens so you can have a “fresh start.” However, they have different methods of achieving this. A Chapter 7 bankruptcy erases your debt, while a Chapter 13 bankruptcy restructures it. (We’ll explore this in greater detail below.)
Chapter 7, also known as liquidation bankruptcy, is geared towards individuals without the financial means to pay back their debts. Chapter 13, on the other hand, is often more optimal for individuals with a steady income and substantial assets in their name.
Does It Matter Whether I Choose Chapter 7 or Chapter 13?
Well, you don’t necessarily get to “choose” which chapter of bankruptcy you file. Your income, assets and debt determines which one you are eligible to pursue. Let’s take a look:
Qualifying for Chapter 13
In certain instances people who fall below a certain income threshold may not be an ideal candidate to file for Chapter 13 bankruptcy. The court places Chapter 13 filers on a repayment plan. What may have to be paid back is determined by looking at assets, income and the type of debt that someone has. Paying back your debt will not be feasible if you do not have enough income to make the monthly payments that may be required based upon those factors.
Additionally, you are only eligible to file for Chapter 13 if your combined total secured and unsecured debts are less than $2.75 million at the time you file for bankruptcy relief. 11 U.S.C. § 109(e)
Qualifying for Chapter 7
For Chapter 7 bankruptcy, you must pass, in legal terms, what’s called a Means Test – basically, an income test. The federal government has the means test in place to make sure debtors don’t abuse bankruptcy if they have the means to pay back their debt.
You qualify for Chapter 7 bankruptcy if your family’s gross yearly income is lower than Colorado’s median income for your household size.
For bankruptcy cases filed on or after April 1, 2023, the median family income in Colorado is:
- $75,710 for one earner
- $93,175 for a two-person household
- $104,785 for a three-person household
- $122,707 for a four-person household
Add $9,900 for each individual in your household in excess of four. Source: U.S. Census Bureau
How to Determine Your Income for Chapter 7
You will base your income on what you earned each month in the six months leading up to your bankruptcy petition. This does not include the month you filed for bankruptcy. For example, if you filed for Chapter 7 bankruptcy in December, you will calculate your current monthly income based on your earnings from June 1 to Nov. 30.
The first step is to add up all the countable gross income during the last six months. Gross income is what you make before taxes and other deductions are taken out. So this is not your “take home” pay.
In addition to your paycheck, other examples of countable gross income include:
- child support
- rental income
- pension/retirement income
- workman’s compensation
- short and long term disability payments
Do not include Supplemental Security Income or Social Security Disability Insurance (SSI or SSDI) as income. Also excluded from this calculation is Veterans Disability income. You automatically pass the Chapter 7 means test if SSI, SSDI or VA disability are your household’s only source of income.
Once you have added up your monthly income, divide the total by six. The result is your current monthly income under the Chapter 7 bankruptcy means test.
Keep in mind that this figure may not necessarily reflect what you are currently making. Your average monthly income may be higher than you expected if you received significant overtime pay or a bonus during the last six months.
On the flip side, if you were unemployed for three of the last six months before finding a new job, your average income could be much lower than what you’re making now.
The next step is to take your current monthly income and multiply it by 12. This is your annual income under the Chapter 7 means test.
Now, compare that number to the annual income for a Colorado household of your size.
What if My Income is Too High?
The higher your disposable income, the less likely you are to qualify for Chapter 7 bankruptcy. However, that doesn’t mean you won’t qualify for it.
If your first calculation indicates your income is too high based on Colorado’s median income, there are two other means tests to consider.
The second means test allows you to deduct certain expenses from your income. This provides a better look at just how much money you have left over to put toward your debt.
Finally, some people don’t have to take the Chapter 7 Means Test. For instance, certain military veterans and businesses are exempt from the income test.
If you still do not meet the Chapter 7 income threshold, a Chapter 13 filing might be in your future.
What Happens to My Property if I File for Bankruptcy?
One of the most tangible differences between Chapter 7 and Chapter 13 bankruptcy is what happens to your property.
Your Property and Chapter 7
In a Chapter 7 bankruptcy, your debt is discharged by selling off some, or all, of your property to square away your debts. The court will review all your assets and sell any property that is not legally exempt from bankruptcy proceedings.
Once your Chapter 7 matter is complete, you will no longer owe the dischargeable debts that were included in the bankruptcy (there are certain types of debt that cannot be discharged in bankruptcy such as certain tax debts, student loans and debt incurred through fraud). This would not include secured debt for property which you are keeping such as for a car loan or mortgage. This is why Chapter 7 is such an attractive option for many filers–you can literally start fresh, completely unencumbered by debt.
A major downside, however, is that you risk losing property that is not covered by Colorado bankruptcy exemption laws. Luxury items, such as a fishing boat or a flashy sports car, are an example of property that you can’t exempt from Chapter 7. Also, if the equity in your home or vehicle is above a certain threshold, it, too, can be sold off to pay your debt.
However, both federal and Colorado laws allow for certain bankruptcy exemptions. Colorado bankruptcy exemptions can include:
- household items
- equity in homes and vehicles
An experienced bankruptcy attorney can help protect your assets from liquidation in a Chapter 7 bankruptcy.
Your Property and Chapter 13
One major advantage of Chapter 13 bankruptcy is the ability to keep your property, by buying back the equity in the property over a period of time.
Chapter 13 does not make your debts disappear. Instead, it buys you more time to resolve them.
As an example, I had a client who hired us only two days before their house was slated for foreclosure. We were able to file a case, stop the foreclosure, and allow them time to sell the property so they did not lose their equity.
Under Chapter 13, you will submit a reorganization plan that shields certain assets (like your house and car) against foreclosure or repossession. This offers some temporary relief from creditors, but it does not get rid of the debt.
Depending on your income, you’ll spend three to five years making monthly payments toward your outstanding debt.
As long as you follow the repayment plan, you will receive a discharge when you are done making payments. This releases you from most of your debts.
You cannot discharge:
- child support
- student loans
- certain tax debts
- debt incurred through fraud
Which Bankruptcy is Right for Me?
Chapter 7 is a cheaper, simpler, and quicker process than Chapter 13. It is usually the best option for debtors with limited income and minimal assets.
If you are behind on mortgage payments and you want to keep your home, Chapter 13 might be a better alternative than Chapter 7. Chapter 7 does not allow someone the ability to catch up on secured debt payments that they have fallen behind on such as a mortgage or car loan. If you have filed and received a discharge for a Chapter 7 bankruptcy in the last 8 years you cannot file another Chapter 7 for another 8 years from the date of filing so your only option might be a Chapter 13 Bankruptcy.
You may still choose to file for Chapter 13 even if you qualify for Chapter 7. This way, you’ll be able to keep certain assets and/or get caught up on secured debt payments.
Let Us Help You Today
Choosing to file for bankruptcy is a tough decision. Our Bankruptcy Team can help you determine which one is right for you and weigh the pros and cons of each one. Let us help you safeguard your most valuable assets and take full advantage of the clean slate that bankruptcy offers. Call 303-688-0944 today to begin your case assessment.