Making Sense of Bankruptcy: The Sometimes Easy, Sometimes Not So Easy, Choice between Chapter 7 and 13
Chapter 7 “straight bankruptcy” and Chapter 13 “adjustment of debts” are quite different, but still be open-minded about which is better.
Here’s the sentence we’re explaining today:
Given how starkly different Chapter 7 is from Chapter 13, choosing between them can be less straightforward than you think—sometimes it IS very obvious which will work better for you, but sometimes the “other” option will help in ways you totally didn’t expect, as an example illustrates—so keep an open mind as you have your initial meeting with your attorney.
Chapter 7 and Chapter 13 are Completely Different
A legal procedure that seldom takes longer than 4 months vs. one that usually must be between 3 and 5 years long only begins to demonstrate the great differences between Chapter 7 and Chapter 13. (Please see our blog posts of last Wednesday and Friday for more about this.)
The Not-Always-So-Easy Choice
Once you’ve made up your mind that you need bankruptcy relief, selecting the appropriate Chapter to file under can be really simple. Everything in your situation may point towards one option or the other. But surprisingly often, this can be a not-so-obvious choice, with advantages and disadvantages on both sides that have to be weighed carefully.
Sometimes what appeared at first to have been an obvious choice ends up not being so once everything about your case is considered. Your situation can turn out to have a minor-sounding twist or two that ends up turning your case towards the Chapter you weren’t expecting.
The unexpected twist is usually either an unexpected advantage to filing under the Chapter you had not intended to file, or an unexpected disadvantage to filing under the Chapter you had intended to file.
Initial Expectations ARE Often Right
Practically speaking, when our clients first come in to see us many do have a good idea whether they want to file a Chapter 7 or a Chapter 13 case. There’s lots of information available about this, including on this website. So people often come in after having done some homework. They’ve at least heard something about the two Chapters and have an impression which makes sense to them. And much of the time, that initial impression ends up being the right choice.
But Often There Are Surprises
Initial impressions about which Chapter of bankruptcy you should file are often wrong because of advantages and disadvantages you simply were unaware of. This new information can be a game-changer.
The reality is that bankruptcy law can be maddeningly complicated. The main differences between Chapter 7 and Chapter 13 can be summarized in a few sentences, but the truth is that there are dozens of often subtle but sometimes crucial differences. These may not matter in some situations, but other times those differences can swing the decision in a completely new direction. Without a thorough review of your case by an experienced bankruptcy attorney, you could file your case under not the best Chapter, and pay the consequences for years to come.
An Example of This
Let’s say you have a home you’ve been struggling to hold onto for quite a while, but have now decided not to do so any longer. You’re seriously behind on both the first and the second mortgages. The home is worth less than you owe. In fact, you owe just on the first mortgage about what the home is worth. Given all that you also owe on the second mortgage, so the home is “under water” by so much that it’ll be a long time before you’d have any equity. You and your family would definitely like to stay there, but you absolutely don’t have the money to pay both mortgages. Besides, you figure it makes little economic sense to keep struggling to hang on to property worth so much less than what you owe against it. You’ve heard that with a Chapter 7 case you could walk away from the home and owe nothing, so you’ve decided to do that.
But then you have your first meeting with your bankruptcy attorney and find out some surprising good news. Because your home is worth less than the balance on the first mortgage, through a Chapter 13 case you can “strip” the second mortgage off the title of your home. You would no longer have to make the monthly payments on it, immediately costing you hundreds of dollars less each month to keep your home. Also, you would likely avoid paying most of that second mortgage balance, and sometimes all of it. You would just have to pay into your Chapter 13 plan a designated amount each month based on your budget for the three-to-five year length of your Chapter 13 case. That money would over time bring you current on your first and second mortgage, some would possibly go to other special debts (such as any recent income taxes owed), and then the rest—if any—would go to the rest of your debts including the second mortgage. At the end of your case, whatever amount is left unpaid on that second mortgage (and your other debts) would be “discharged”—legally written-off. So you’d own the home without owing anything ever again on that second mortgage. You’d be usually altogether debt-free, other than your first mortgage.
When you find out from your attorney about this “stripping” of the second mortgage, which is NOT available under the Chapter 7, Chapter 13 looks a lot more attractive to you. After your attorney and you do the calculations for your payment plan, you find out that you can keep your home by significantly lowering its monthly cost to you and bringing the debt against it much closer to its value. So you decide to file a Chapter 13 case, contrary to what you had originally thought you wanted.
So Meet with Your Attorney with an Open Mind
This is just one example of countless ways that the Chapter you initially thought was the right one may not be. So commit to being flexible about your options when you first consult with your attorney. Lay out your goals to your attorney candidly, and if one Chapter seems to be the right one for you say why you think so. In the end, after laying out your story and hearing the attorney’s advice, it’s your choice. But do yourself a favor and be willing to look at all the options, because you might get better news than you expected.